Oil & Gasoline Inventories Still Surging
The bad news for the economy and industrial sector is the growing oil glut. The good news is there is a strong seasonality where we expect inventories to peak in the March – May time frame and decline into the July – September period. Prices tend to rise in anticipation of Oil refinery maintenance shutdowns as low vapor volatility summer gasoline blends replace high evaporation mixtures. As long as the glut is increasing, there is risk of lower prices, but recent lows at $26/barrel should be enough as markets begin to expect declining inventories during the 2nd quarter and fund sentiment has reached extreme levels of pessimism along with extreme contango spreads. Buy the dips!
Thus far there is no sign of the temporary inventory peak we expect soon, but new storage capacity is constantly coming online to accommodate the glut. As we iterated the past couple of years, the enormous oil drilling rig reduction is not that important in measuring when output will stop adding to stockpiles. US production is slowing modestly and demand is growing, but production by OPEC countries will sustain surplus Oil levels well into 2017. Any hike in price back to $50 and above will only guarantee faster production levels and lost OPEC market share. Expect depressed Oil prices under ~ $60-70 for the long term.
Below we included our chart from a few months ago that correctly charted the dip and subsequent build in Crude Oil stocks this quarter. Most analysts throughout 2015 felt supplies would shrink along with production as lower prices would quickly shut down Oil wells. Some even correctly caught the rally in the the spring of 2015 back over $60, but their analysis was dead wrong. Prices did not rise due to shrinking production and inventories as they assumed, but due to seasonality. We forecasted the rally from $40 to $60 into the summer as well as the move back to new lows by year end. Last summer when average gasoline prices were over $2.60 a gallon at the pump our August report forecasted a move back under $2.00. In December we added that prices would fall to $1.80, which was achieved in early February. We are fallible, but like to point out when precise forecasting is validated and for the correct reasons.
When Will Oil Glut End?
There is significant confidence that the Global Petroleum Glut will not end anytime soon – not in 2016 and not in 2017. There is potential for supply and demand to reach parity and begin to work off the excess stockpile by the later part of 2017. The markets may even be overestimating world growth as well as underestimating supply. Many producers outside of US shale producers have too much invested to stop the planned ramp up in output they projected prior to 2014. We forecasted the 2015 summer rally and decline to new lows last month as well as an Oil bounce back into the $40’s and $50’s this spring. However, the supply and demand trends support our continued theme that Oil will remain oversupplied into 2017 and once the 2nd quarter 2016 seasonal rally has run its course we should expect that the highs and lows of 2016 will be roughly in place and mark a projected trading range for Oil prices into 2017.
Oil Leads Everything
It’s not unusual for Oil to rise and fall with the economy, but the extraordinary price drop and continued rising energy production has been unique to this cycle. The only other major declines in oil prices in the 1980’s & 2008 were coincident with declines in both supply and demand. This cycle has seen supply and demand rise even as prices have collapsed. Since Oil crashed from its heights of $108 in 2014 we have seen this oil glut keenly influence economic data. A promising surge in manufacturing in 2014 was chopped off at the knees and headed south along with the sharp drop in oil prices. This persistent trend has pushed US, China and Global manufacturing close to contraction levels. If/when Oil rebounds this spring we suspect manufacturing will pop higher in unison.
The negative trend in exports, industrial production and earnings may also be correlated with Oil prices as they are all proxies for the secular supply and demand imbalances of an excessively debt impaired and aging Western consumer.
It Takes Two to Contango
It takes 2 contract months to measure contango, which is a measure of how much the futures price exceeds the current spot price. When the degree of contango approaches $10 a barrel it implies a Buy signal is near as spot prices have accelerated lower ahead of the more distant futures contracts. This was the case when Oil recently tested $26/barrel on February 11th. Contango has been modestly alleviated in the recent weeks as prices have risen more than $8. When we were interviewed last November (Financialsense.com) we expected seasonal weakness into the December – February window with a final low in February. This has occurred and the $10 spread on the chart was a good warning that it was time to be a Buyer! With the Oil glut still growing into March and economic forecasts being reduced, there is still room for Oil prices to dip once more and approach extreme contango conditions again. However, medium term we shifted our forecast from negative to positive in February.
One more medium term metric we often utilize in many markets is the Commitment of Traders. In Oil we will keep it simple and just look at the relationship between Managed Money funds and oil prices. While slightly more negative sentiment and positions could be seen, the recent low (blue line) hit “7 year lows” in January and February with oil beneath $30, signaling it was time to exit short sales and begin Buying longs positions for a rally into the 2nd quarter. This indicator lacks precision, but combined with our other data has provided good entry zones in the past.
Positive response to negative news is—Positive! It’s interesting that despite the recent contraction in US and China manufacturing reports the past 2 months and new record high levels of excess oil inventory, prices have managed to rally which could be a less tangible sign that seasonal factors of expected refinery shutdowns for summer fuel conversions are exerting upward pressure on prices despite the increasingly negative fundamentals. By the end of March we expect prices to move above the $36 to $37/barrel resistance on its way to $43+, with even higher prices by May.