Energy – Q2 Overview – Q3 Outlook 2021

Energy Weekly Component Report PDF-09.22.2021

Energy Weekly Component Report Spreadsheet-09.22.2021

Crude oil was on either side of unchanged over the past week, with heating oil posting a marginal loss and gasoline declining. Crack spreads reflected seasonal factors as distillates moved higher and gasoline refining spreads falling. Natural gas and ethanol prices moved lower since September 15, while thermal coal for delivery in Rotterdam in November moved higher.

October NYMEX crude oil futures rolled to November and fell 0.14% since September 15 to settle at $72.23 per barrel. NYMEX crude oil had been making higher lows and higher highs since April 2020 and moved marginally above technical resistance at the $76.90 per barrel level, the October 2018 continuous contract peak. Crude oil fell on the back of OPEC+’s compromise to taper production cuts and an increase in the number of delta variant COVID-19 cases. The price recovered before the latest bout of selling that took the nearby futures to a lower low and threatened to challenge the $60 level. The delta variant, a rising dollar index, Chinese economic weakness, and the potential for higher interest rates weighed on the energy commodity’s price. Oil took an elevator lower in August before the price put in a bullish reversal on the daily chart on August 23 and the weekly chart at the end of that week. Over the past two weeks, the price moved back above the $70 per barrel level and has been heading towards a test of the early July multi-year high.

OPEC and Russia are the prime beneficiaries of changes in the US regulatory environment. OPEC’s mission is to optimize returns for petroleum producers, which is bullish for the global petroleum markets. 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 the Russians and Saudis only add to OPEC+’s desire to extract as much as possible from US consumers. The potential for much higher prices remains a clear and present danger. The administration’s request for OPEC+ to increase output would be comical if it weren’t tragic. At the latest OPEC+ meeting on September 1, the cartel officially denied the request, leaving production policy unchanged from the last meeting. The oil-producing nations basically spit in the US administration’s face in another policy disaster following on the heels of the Afghanistan debacle.

An inflationary environment 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. The move below $65 threatened crude oil’s bullish trend since April 2020. Technical support sits at $69.39, the September 21 low, with resistance at $72.87, the high from September 15. The crude oil market rallied after the Biden administration said it was ready to release crude oil from the strategic petroleum reserve. The price action was bullish over the past week.

November Brent futures outperformed the NYMEX WTI futures as they moved 0.97% higher since September 15. The next technical resistance levels in November Brent is now at $76.26, the high on September 22. Brent for November delivery was trading at the $76.21 level on Wednesday. Support is at $69.77, the August 26 low. November gasoline fell 2.03% to the $2.0837 per gallon level after reaching nearly $2.37 on the continuous contract. The gasoline processing spread in November fell by 9.31% since the previous report. The active month November gasoline crack spread was at $15.39 per barrel after the continuous contract traded to a high of $27.76 on August 9. Gasoline crack spreads tend to exhibit strength during the summer driving season in the US and weakness during the fall and winter months. The futures market is now in the offseason for gasoline demand during the winter months.  

November heating oil futures moved 0.01% lower since the last report. The active month November heating oil crack spread was 1.13% above the September 15 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 November distillate crack spread closed on Wednesday at $20.54 per barrel after the continuous contract reached a high at $21.49 on September 7. Distillates received support from increased demand for air travel over the past months. 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.”

Vaccines are bullish for energy demand the latest outbreaks were bearish. Meanwhile, crude oil tends to take the elevator to the downside. On August 23, the selling stopped dead when the crude oil futures market put in a bullish reversal. By the end of the week, it put in a bullish reversal on the weekly chart.

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. After trading to nearly $77 per barrel, the oil market has been choppy, but it is closing in on the multi-year high.

The measure of daily historical volatility in NYMEX crude oil was at 26.30% on September 22, slightly lower than the level on September 15. The price variance metric was at over 64% in March when 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, which was a reason for caution in late July when it rose to over the 50% level. Daily historical volatility peaked at 50.43% on July 22. While the metric is still at an elevated level compared to in June, when it briefly fell below 10% as the energy commodity was taking the stairs higher.  

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. OPEC and Russia are in a more influential position when it comes to supplies. Worsening US-Saudi relations that push the KSA towards Russia could exacerbate the rift and drive oil prices higher. Goldman Sachs reiterated that it is looking for higher highs and the $80 level over the coming months.

Crude oil posted gains over the past five consecutive quarters. A close over $73.46 on September 30 is necessary to extend the streak to six quarters. 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. In August, we moved back towards a test of the $60 previous pivot point and bounced appreciably higher.

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. Iran remains a turbulent factor in the area that is home to over half the world’s crude oil reserves. Even though the Biden administration seeks to move back into the nuclear nonproliferation treaty with Iran, tensions between the two nations remain high. 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. The situation in Afghanistan is weakening the US’s negotiating position in the Middle East and could open the possibility of hostile acts from enemies.

Crude oil open interest moved 2.03% lower over the past week. NYMEX crude oil moved 0.14% lower since the previous report. The energy shares underperformed crude oil since September 15. The XLE fell 2.87% 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.

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 taken profits on a scale-up basis. I continued to gently add to long position positions over the past weeks on price weakness through the Monday, August 23 low.

The spread between Brent and WTI crude oil futures in November moved higher to the $3.98 per barrel level with a premium for Brent on September 15, up 83.0 cents since the previous report. 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 2020 that took nearby NYMEX futures into negative territory. Meanwhile, any problems with Iran could cause the Brent premium to spike higher. The US failure in Afghanistan could have an impact in the Middle East, which would cause increased volatility in the oil futures arena.

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 2020. 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 September 15, crude oil for delivery in November 2022, minus November 2021, moved from a backwardation of $5.74 to a backwardation of $6.13 over the period, tightening by 39.0 cents per barrel over the period.  The backwardation traded at a new $7.60 high on July 9. In 2021, the November-November one-year spread had been in backwardation in a range from a $2.72 to $7.60 premium for the nearby contract.

The backwardation widened over the past week. Rising contango is a sign of a glut in the oil market, while falling contango and backwardation signifies tighter supplies. Falling production causes the spread to tighten. 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. Over the past week, the backwardation in the October-October spread widened, which is a sign of tight supplies.  

The number of rigs operating in the US was up ten over the past week. According to Baker Hughes, on September 10, the number of rigs in operation was at 411, 232 above the level last year at the same time. The rig count dropped during the storm that gripped the Gulf Coast states. 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 10.60 million barrels per day of output as of September 17, according to the Energy Information Administration, up 500,000 bpd since the previous week. As of September 10, the API reported a decline of 5.437 million barrels of crude oil stockpiles, while the EIA said they decreased by 6.40 million barrels for the same week. The API reported a decline of 2.761 million barrels of gasoline stocks and said distillate inventories decreased by 2.888 million barrels as of September 10. The EIA reported that gasoline stocks fell by 1.90 million barrels and said distillate stockpiles moved 1.70 million barrels lower. The inventory data was bullish for the crude oil market.  As of September 17, US production dropped by 2.50 million barrels per day or 19% since the March 2020 record high in output. The production decline was likely because of Hurricane Ida’s impact on energy infrastructure in the Gulf Coast states.

OIH and VLO shares moved lower since September 15. OIH was 7.52% lower, while VLO moved 1.79% to the downside over the period. OIH was trading at $180.13 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 $65.32 per share on Wednesday. The shares should follow the crude oil and stock market over the coming days and weeks. I am cautiously bullish on both and added to long positions last week on the dip.

October NYMEX natural gas corrected from the September 15, $5.65 high, and was at $4.805 per MMBtu or 12.0% below the price on September 15. 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 October natural gas futures is at $4.557 per MMBtu, the September 7 low. Technical resistance is at $5.65 and $6.493 the February 2014 high. Natural gas put in a bullish reversal on the weekly chart on the week of June 21 and exploded on the upside. Natural gas had not traded above the $5 level in September since 2008. Natural gas corrected over the past week as the EIA reported a higher than expected inventory injection on September 16.

Source: EIA

The EIA said stocks rose by 83 bcf to 3.006 tcf for the week ending on September 10. Stocks were 16.5% below last year and 7.1% below the five-year average. The EIA will report inventory data for the week ending on September 10 on Thursday, September 23. The market expects an 81 bcf injection into storage.

Stockpiles peaked at 3.958 tcf before the beginning of the peak season. Baker Hughes reported that a total of 100 natural gas rigs were operating in the US as of September 3, down one from last week and 27 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 continue to flow into storage at a slower pace in 2021 than in 2020, which has put upward pressure on the natural gas price. We have seen that trend develop over the past months throughout the injection season. Increased demand because of hot weather and a booming LNG export market is only feeding the bullish natural gas futures market. Last week, Cheniere’s CEO told CNBC that his company, the leading US LNG company, was sold out of LNG for the next twenty years because of rising Asian demand for the energy product.

Open interest moved 3.60% lower in natural gas over the past week. Price momentum and relative strength on the daily chart crossed lower from overbought conditions and were falling on Wednesday as the price ran out of upside steam. 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 shift in US energy policy is clearly bullish for oil and gas. The risk of a correction increased with the volatile price, but the trend remains bullish.

November Chicago-swap ethanol prices were 1.73% lower since September 15, with the price at $1.8500 per gallon wholesale. The price of November thermal coal futures for delivery in Rotterdam rose 6.14% since last week after significant gains in previous reports. The demand for metallurgical coal for steel making had been robust over the past months. Thermal coal for delivery in Rotterdam is trading at the highest level since 2008 at $164.30 per ton after probing the $170 level.   

On Tuesday, September 21, the API reported that crude oil inventories fell by 6.108 million barrels for the week ending on September 17. The API said gasoline stockpiles fell by 432,000 barrels, and distillates decreased by 2.720 million barrels for the week. On September 22, the EIA said crude oil inventories fell by 3.50 million barrels for the week ending on September 17. The EIA said gasoline stocks rose 3.50 million barrels and distillate stockpiles moved 2.60 million barrels lower as of the end of last week. The API and EIA reports were mostly bullish for the price of the energy commodity.

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 $9.98 per share, PBR moved 2.92% lower since September 15. I have a small position that I will hold as a long-term investment.

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. I am only buying the top companies and ETFs, including, XLE, CVX, XOM, OIH, VLO, TOT, BP, RDS-B, and PBR.  As of September 8, my position was around 78% the level as we moved towards the early July high and I took profits. I added over the past week on price weakness.

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 am a buyer of leading oil companies. 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 provocations in mind. The theocracy in Teheran may want to further test the US as they look for an edge in nuclear talks and sense weakness because of the events in Afghanistan in late August.

Meanwhile, the move below $65 threatened the short-term trend. Crude oil held the $60 level and eclipsed the $70 level over the past week. 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. Natural gas more than tripled from its price at the June 2020 low at $1.432 per MMBtu at the most recent high. I believe the base price for natural gas will continue rise over the coming months and years. In the short term, the risk of a correction rises with the price.

Expect the unexpected in the energy sector. Crude oil will be watching the developments surrounding COVID-19 variants and the Chinese economy along with the many other issues impacting the US and global economies. If the Fed stalls on tapering QE, we could see the dollar fall, which would support oil prices. Natural gas corrected from an explosive bullish trend. Ethanol reached a short-term peak and moved lower over the past weeks. Coal continued to rally. Bull markets rarely move in straight lines.

While alternative fuels are the future, hydrocarbons remain the present. Consumers will pay higher prices as the cartel now has control.  I agree with Goldman Sachs that we are likely to see the $80 level and higher sooner rather than later. Nothing changed my opinion of the energy sector over the past week. We may be coming into a seasonally weak time of the year in gasoline, but US energy policy could be the most bullish factor for oil, natural gas, and coal as the fundamental equation continues to favor higher prices. The trend is always your best friend, and it remains bullish.