Energy Weekly Component Report PDF-06.09.2021

Energy Weekly Component Report Spreadsheet-06.09.2021

Ethanol was unchanged since June 2, while crude oil, oil products, natural gas, and coal prices continued to move higher. Oil products marginally underperformed the raw energy commodity, causing crack spreads to slip. NYMEX crude oil rose to its highest price since October 2018 at the $70.62 per barrel level despite OPEC+’s intention to taper production cuts. Falling US oil and gas output as the energy demand is booming is creating bullish price action in the energy futures arena.  

July NYMEX crude oil futures rose 1.64% since June 2 to settle at $69.96 per barrel after reaching a new short-term high at $70.62 on June 9. NYMEX crude oil has been making higher lows and higher highs since April 2020 and is at a price not seen since 2018. Meanwhile, OPEC+ and US energy policy continue to support the oil price. OPEC+ is now in a position to squeeze US consumers as US energy policy shifts towards addressing climate change. The cartel will l increase output as demand rises and US production declines to keep a healthy balance that favors the producers. After announcing they will taper the supply cuts over the coming months, the oil price moved higher in a sign that demand remains robust and is increasing.

The progress on vaccines has been welcome news for crude oil demand, which sparked the rally to over $60. OPEC and Russia seem likely to coordinate policy according to changes in the US regulatory environment. OPEC’s mission is to optimize returns for petroleum producers, which is bullish for the global petroleum markets. The Saudis warned the oil market to be “cautious” as uncertainty remains high. Tension in US Saudi relations could push the Saudis closer to Russia and President Vladimir Putin.

The Biden administration is taking a hard line against Crown Prince MbS, the heir to the Saudi throne, over the murder of a Saudi journalist in Turkey several years ago. Meanwhile, the Saudi oil minister told a CNBC reporter that “drill-baby-drill” in the US is dead. As I had been warning, the pricing power in the crude oil market has passed from the US to the oil ministers and Russia as the shift in US energy policy means less output from the country that was the world’s leading producer. The changes in global petroleum dynamics are a significant event with ramifications for the coming years. Rising tensions between President Biden and Russian President Putin will only add to OPEC+’s desire to extract as much as possible from US consumers. President Biden called the Russian leader a “killer.” The US recently rolled out new sanctions on Russia.

However, the two leaders will meet in Switzerland this month. The potential for much higher prices remains a clear and present danger. An inflationary environment only increases the potential for higher oil prices. The administration ended oil and gas leases on federal lands in Alaska, which is not bearish for the prices of the traditional energy commodities.  August Brent futures underperformed July NYMEX WTI futures, as they moved 1.22% higher since June 2. The critical technical resistance level in Brent is at the April 2019 $75.60 high. Brent for August delivery was trading at the $72.25 level on Wednesday. July gasoline rose 0.38% and was just above the $2.20 per gallon level. The gasoline processing spread in July moved 3.71% lower since the previous report. The active month July gasoline crack spread was at $22.56 per barrel after trading to a high of $26.09 on May 10 on the back of the Colonial pipeline issues and shortages along the US east coast. The hack is a sign of what could happen to parts of the US’s infrastructure over the coming weeks, months, and years. Gasoline crack spreads tend to exhibit strength during the summer driving season in the US and weakness during the fall and winter months.

As I wrote in earlier this year:

“We are now moving towards the 2021 driving season, which could take the gasoline crack higher over the coming weeks and months.” 

July heating oil futures rose 1.06% from the last report. The active month July heating oil crack spread was 1.12% below the June 2 level. Heating oil is a proxy for other distillates such as jet and diesel fuels. Economic growth and increasing air travel demand boosted distillate prices over the past months. The July distillate crack spread closed on Wednesday at $19.49 per barrel after reaching a high at $21.18 on May 19. Distillates received support from increased demand for air travel. The crack spreads are a real-time indicator of demand for crude oil as well as barometers for the earnings of refining companies that process raw crude oil into oil products.

I pointed out that:

“The crack spreads could be a significant indicator of demand over the coming weeks and months.”

Meanwhile, the energy market remains highly sensitive to new outbreaks and hotspots in the US and worldwide. Vaccines are bullish. Stimulus and a stricter regulatory environment in the US under the Biden administration support the price of crude oil. The reaction to the one million bpd Saudi output cut in January was a sign that the international oil cartel has increased influence and pricing power in the petroleum market as US energy policy takes a greener path. The new high on March 8 on the back of an attack on Saudi Arabia is a sign that crude oil is more sensitive to events in the Middle East, home to over half the world’s crude oil reserves. 

Moreover, the oil price rallied in the wake of OPEC+’s decision to increase output. When a market rallies on what should be bearish news, watch out. Crude oil and product prices suffered sharp pullbacks in mid-March but bounced back to make new and higher highs. OPEC+ and US energy policy are not bearish for the crude oil market.  The measure of daily historical volatility in NYMEX crude oil was at 12.50% on June 9, significantly lower from the level on June 2. The price variance metric was at over 68% in March as the market corrected. Since crude oil tends to take the stairs higher and an elevator lower, volatility tends to move lower during bullish periods and vice versa. Daily historical volatility peaked at nearly 40% on May 24 and has halved since crude oil rose to a new multi-year high.

US energy policy is the most significant factor in the oil market in 2021. Daily production reached an all-time peak of 13.1 mbpd in March 2020. A more restrictive regulatory environment is likely to make that peak unattainable over the coming months and years. As the vaccines create herd immunity to the coronavirus, the demand for crude oil is likely to rise. With OPEC and Russia in a more influential position when it comes to supplies, higher prices could be on the horizon.

Worsening US-Saudi relations that push the KSA towards Russia could exacerbate the rift and drive oil prices higher. Brent and WTI failed at the March 8 highs, leading to the March 18 and March 23 selloffs. Both recovered, and Goldman Sachs is looking for higher highs over the coming months.

The continuous NYMEX crude oil futures contract made higher lows and higher highs from late April 2020 until the end of August, when it moved into a consolidation pattern. On November 2, it fell to a low of $33.64 and broke some technical support levels. The vaccine news reversed the bearish price action. The close above $41.70 at the end of November on the continuous contract put in a bullish reversal on the monthly chart. The close above $43.78 on December 31 put in the same bullish pattern on the quarterly chart. Crude oil posted gains over the past four consecutive quarters. A close above $59.43 on June 30 would mark the fifth straight quarterly gain. Nearby futures have not traded below $50 since January 6. The price fell below $60 in March, and the level had become a pivot point for the energy commodity. Over the past weeks, it remained well above the $60 level and made a higher high at over $70 per barrel.

Meanwhile, the Middle East remains a potential flashpoint for the crude oil market. The area is home to more than half the world’s crude oil reserves. Any hostilities that cause supply concerns could send the price of crude oil for nearby delivery appreciably higher in the blink of an eye. The Middle East could provide surprises to the oil market, but global demand remains the primary factor for the price over the coming weeks. The Iranians could test the new US administration. Iran remains a turbulent factor in the area that is home to over half the world’s crude oil reserves. Recently, the US bombed Iranian-backed militia in Syria. Even though the Biden administration seeks to move back into the nuclear nonproliferation treaty with Iran, tensions between the two nations remain high.

Meanwhile, the dramatic shift in US production policy increases OPEC and Russia’s influence in the crude oil market, which is ultimately bullish for the price of the energy commodity.  Crude oil open interest moved 0.18% higher over the past week. The total number of open long and short positions declined during the pullback as speculators scrambled for the exit on March 18 as the price became a falling knife. The rise in the metric together with the price increase over the past months was a technical validation of the bullish trend. NYMEX crude oil moved 1.64% higher since the previous report. The energy shares underperformed crude oil since June 2. The XLE was 0.74% higher since last week. When it comes to the energy-related shares, we should continue to see consolidation in the oil business over the coming months. We saw sector rotation towards energy in the stock market since the end of October, which continues over the past weeks. 

In previous reports, I wrote:

“I would only consider those with the most robust balance sheets like XOM and CVX in the US. Exxon and Chevron could stand to pick up lots of production assets at bargain-basement prices over the coming months as the number of bankruptcies rises in the oil and gas sectors. Both companies pay substantial dividends and have yet to cut or eliminate payments to shareholders. XOM and CVX are the two leading US integrated oil companies. I would only purchase these companies during corrective periods using wide scales.”

After buying the leading companies on weakness, I had begun taking profits on a scale-up basis after the substantial rally over the past weeks. I will continue to cash in on the move as the prices move higher. I did no selling over the past weeks as I expect higher highs in the oil stocks.

The spread between Brent and WTI crude oil futures in August moved lower to the $2.46 per barrel level with a premium for Brent on June 9, 29.0 cents lower since last week. The Brent premium tends to move higher during bullish periods in the oil market and vice versa. However, in the first months of 2020, it was the carnage in the price of WTI futures that drove the spread to higher levels. Brent crude can travel by ocean vessel to consumers around the globe, while WTI is a landlocked crude oil. The lack of storage capacity was responsible for the price action in the spread and outright prices in late April that took nearby NYMEX futures into negative territory. Meanwhile, any problems with Iran could cause the Brent premium to spike higher.

A decline in US production could cause significant volatility in the Brent-WTI spread. Before 2010, WTI often traded at a $2 to $4 premium to Brent. The WTI grade has a lower sulfur content making it the preferable crude oil for processing into gasoline, the world’s most ubiquitous fuel. If US output continues to decline significantly and demand returns to the market, we could see it impact the Brent-WTI differential and cause periods where WTI returns to a premium to the Brent, which is better suited for refining into distillate products. The spread also reflects the political risk in the Middle East as the region uses the Brent price for its output. The USO and BNO ETF products replicate the short-term price action in WTI and Brent futures, respectively.

While both do an adequate job tracking the futures in the short-term, neither are particularly effective for medium or long-term positions because of the volatility of the forward curves in both crude oil benchmarks. The path of least resistance of the oil market will be a function of the ups and downs of the global pandemic and the stock market over the coming months. Iran and the pandemic continue to be factors that could prompt price volatility.  Term structure in the oil market experienced a significant shift as the price of crude oil tanked in March and April.

The flip from backwardation to contango in the spread reflected the flood of supplies in the crude oil market. Oil traders filled tanks and storage all over the world to take advantage of the wide contango with financing rates at historic lows. Cash and carry trades in the oil market became one of the only profitable areas of the market as demand evaporated back in February through April. The cash and carry trade put upward pressure on freight and storage rates. The forward curve had moved to the widest contango in years. The contango caused the price of May futures to plunge to an incredible low of negative $40.32 per barrel. As prices moved higher since late April 2020, the contango declined and moved into backwardation.

Since June 2, crude oil for delivery in July 2022, minus July 2021, moved from a backwardation of $5.97 to a backwardation of $5.74 over the period, loosening by $0.23 per barrel over the period.  The backwardation traded at a $7.42 high on February 22. In 2021, the July one-year spread had been in backwardation in a range from a $1.30 to $7.42 premium for the nearby contract. Rising contango is a sign of a glut in the oil market, while falling contango and backwardation signifies tighter supplies. The capacity for crude oil storage around the globe fell dramatically as well-capitalized traders purchased nearby crude oil, put it in storage, and sold it for futures delivery.

The widening backwardation likely triggered profit-taking, which opens up more capacity on the storage front.  Falling production caused the spread to tighten. Production declines and declining inventories over the coming months would result in significant profits for well-capitalized crude oil traders who continue to store crude oil against deferred short positions. The rally in crude oil since the lows in early November drove the one-year spread into backwardation, which was a sign of tightening supplies.

Any problems in the Middle East could cause lots of volatility in the term structure for crude oil as they would likely push nearby prices higher compared to deferred levels. Dominant market participants in the petroleum arena manage the forward structure to create backwardations, making consumers pay the highest possible price for the energy commodity. 

The number of rigs operating in the US was unchanged over the past week. According to Baker Hughes, on June 4, the number of rigs in operation was at 359, 206 above the level last year at the same time. While US energy policy will cause drilling activities to decline, the number of rigs operating dropped precipitously last year as the pandemic caused industrial activity, mining, and drilling to grind to a halt. Higher prices are causing rig counts to rise in the US, but not at the same rate they would given the regulatory environment under the Biden administration. 

US daily production stood at 11.0 million barrels per day of output as of June 4, according to the Energy Information Administration. Daily production was up 200,000 bpd since May 28. As of May 28, the API reported a decline of 5.36 million barrels of crude oil stockpiles, while the EIA said they fell by 5.10 million barrels for the same week. The API reported a rise of 2.51 million barrels of gasoline stocks and said distillate inventories increased by 1.585 million barrels as of May 28. The EIA reported that gasoline stocks grew by 1.50 million barrels and said distillate stockpiles moved 3.7 million barrels higher.

The inventory data was neutral for the crude oil market as declines in petroleum were offset by increases in product stocks.  As of May 21, US production dropped by 2.10 million barrels per day or 16% since the March 2020 record high in output.   OIH and VLO shares moved lower since June 2. OIH was down 1.40%, while VLO dropped 2.92% over the period. OIH was trading at $236.89 per share level on Wednesday. I am holding a small position in OIH. We are long three units of VLO at an average of $63.81 per share. VLO was trading at $81.93 per share on Wednesday. The shares should follow and could outperform the oil market over the coming weeks and months as investors look for value in the stock market. 

July NYMEX natural gas rose to $3.1290 per MMBtu or 1.76% above the price on June 2. US energy policy considerations could cause price volatility over the coming weeks and months as a shift to address environmental concerns may limit production.

Support in June natural gas futures is at $2.903 per MMBtu, the May 24 low. Technical resistance is at $3.204, the May 17 peak on the June contract. Natural gas futures put in bullish reversals on the daily chart on April 22 and 26 and followed through on the upside. Since then, it has consolidated around the $3 level. After moving to just over $3.20 in mid-May, the price returned to the $3 level and then rallied to a lower high at $3.198 on June 8.

The EIA reported just under a 100 bcf increase in stocks for the week ending on May 28.

Source: EIA

The EIA said stocks rose by 98 bcf to 2.313 tcf for the week ending on May 28. Stocks moved 14.3% below last year and 2.6% below the five-year average. We are still in the early days of the 2021 withdrawal season in the natural gas market. The EIA will report inventory data for the week ending on May 28 on Thursday, June 3. The market expects a 98 bcf injection into stockpiles.  

Stockpiles peaked at 3.958 tcf before the beginning of the peak season. Baker Hughes reported that a total of 97 natural gas rigs were operating in the US as of June 4, one lower than last week but 21 above last year’s level. LNG shipments to destinations outside the US are an expanding demand vertical for the natural gas market, pushing the number of operating rigs higher.

However, US energy policy that increases regulations on fracking could weigh on further increases and supplies and support the price of the energy commodity.  At the end of the 2019/2020 withdrawal season, stocks reached a low of 1.986 tcf. We declined below that level on February 19. The low in the 2020/2021 withdrawal season was 1.750 tcf, 236 bcf lower than the 1.986 tcf at the start of last year’s injection season. If production declines because of the regulatory environment in Washington, DC, we should expect injections to flow into storage at a slower pace in 2021 than in 2020, which could put upward pressure on the natural gas price. We have seen that trend develop over the past weeks.  Open interest fell by 0.29% in natural gas over the past week. Price momentum and relative strength on the daily chart was above neutral readings on Wednesday. I continue to expect the natural gas market to reflect the shift away from fossil fuel production under the Biden administration. Lower production could lead to higher base prices for the energy commodity. The trend turned higher on January 22 and lower on February 18. The short-term trend turned higher again on April 6 at $2.616 per MMBtu on June futures. The price returned to over the $3.00 level in June.

July ethanol prices were unchanged since June 2, with the price at $2.460 per gallon wholesale. Open interest was at 31 contracts of open long and short positions, unchanged from the previous report, making the biofuel market is untradeable. The futures contract has become nothing more than a pricing benchmark and is heading for delisting. Ethanol edged higher despite the correction in the corn futures market.

The price of July thermal coal futures for delivery in Rotterdam moved 12.37% higher since last week after rallying 14.32% higher in the previous report. Thermal coal was trading at $106.75 per ton. The demand for metallurgical coal for steel making had been robust over the past months.

On Tuesday, June 8, the API reported that crude oil inventories fell by 2.108 barrels for the week ending on June 4. The API said gasoline stockpiles rose by 2.405 million barrels, and distillates increased by 3.752 million barrels for the week. On Wednesday, June 9, the EIA reported that crude oil inventories fell by 5.20 million barrels for the week ending on June 4. The EIA reported that gasoline stocks rose by 7.00 million barrels, and distillate inventories moved 4.40 million barrels higher. The latest API and EIA reports were modestly bearish for the price of the energy commodity as product stocks moved higher than petroleum inventories moved lower. Weather, US energy policy, geopolitical events, the stock market, and the US dollar will guide the price action in the crude oil market over the coming weeks and months.  Natural gas is in the injection season. While natural gas typically displays weakness during the injection season, changes in US energy policy could support the price as production will decline. US relations with Iran and Saudi Arabia could add to price volatility in the oil market over the coming months and years.

I have been taking profits quickly and stopping losses looking for a 1:2 risk-reward ratio on forays into the crude oil futures market. UCO and SCO products can be helpful for those who do not trade futures. In natural gas, I have been using the BOIL and KOLD products, which offer some leverage on the long and short sides. We are holding a long position in PBR, Petroleo Brasileiro SA at $11.71 per share, PBR was up 3.63% since June 2. I have a small position that I will hold as a long-term investment. PBR is under pressure as Brazil’s President Bolsonaro fired the state-run company’s CEO.

As I wrote when the shares dropped below the $8 level:

“I believe PBR is at a level that offers compelling value at below $8 per share.”  

Tight stops continue to be the key when approaching energy commodities in the futures or ETF arena. When it comes to share prices, I have been a seller of the leading oil companies on price strength that I bought scale-down over the past weeks. I have sold 80% of the long positions that were in place when crude oil hit its low in early November. I bought the shares scale-down and am gently selling as share prices rise. Over the past week, I did no selling as I expect the rising trend to continue.  Energy powers the world, and demand is critical throughout the rest of 2020. A sudden drop in the US stock market would likely weigh on crude oil prices.  

I am trading natural gas from both sides of the market with very tight stops. I have only been trading in the crude oil and natural gas markets with very tight stops on futures and ETF products. I will work wide selling scales when taking profits in XOM, CVX, BP, RDS-B, and TOT. For the long-term, the stimulus, liquidity, and falling US dollar are bullish factors for crude oil as they erode the value of currencies. Keep an eye on events surrounding Iran as they could cause sudden price spikes. When taking risk positions home overnight or over weekends, keep the potential for Iranian retaliation in mind. The theocracy in Teheran may want to further test the US as they look for an edge in nuclear talks.

When it comes to energy-related stocks, sector rotation can be influential, so my upside scales are gentle, but I remain a seller in the leading energy companies. As we found out on March 18, the risk of a correction increased with the oil price. Meanwhile, at nearly the $70 per barrel level, the medium and long-term trends over the last year remain higher.

In natural gas, US energy policy could be the most influential factor in 2021. Warren Buffet made a $10 billion investment in natural gas infrastructure in mid-2020, which was a vote of confidence for the future price action. I believe the base price for natural gas will rise over the coming months and years. In the short term, it will trade with the weather conditions and the pressure of the offseason for demand.  Rising inflationary pressures support the prices for all energy commodities. However, any risk-off periods in markets could cause a sudden correction in the oil market. I believe the move to new highs after probing below the $60 level was constructive, and we will see higher lows and higher highs in both crude oil and natural gas over the coming weeks and months.