Good News is Bad News for Oil

When markets rally on negative news, it belies a Bullish undercurrent among investors. The 6 to 7% surge over just 5 days last week in the US stock market on weaker economic news was the most recent example of bad news is good news. Conversely, when a negative supply shock surprises energy investors, we expect to witness panic buying. When Hamas launched their surprise war upon Israel on October 7th, everyone expected Oil prices to explode higher over fears of shutting down Oil transit in the petroleum rich Middle East. Over the ensuing 2 weeks, Oil prices initially moved about $9/barrel higher. This moderate rally occurred as war rhetoric and loss of life rose parabolically. However, over the 2 weeks since that $89/barrel peak, prices have erased more than the entire panic rally and now threaten key $80 support. North Korea and Iran are flooding arms to Hezbollah, Iran has activated its proxy armies, China has brought its Navy into the region and Turkey has vowed to support Gaza. Additional global Oil supply risk exists due to 19.5-year lows in US inventories and major supply cuts by OPEC. The news continues to evolve in a Bullish manner, yet Oil prices are falling. This implies that without a dramatic war escalation directly involving Oil producers, prices are at risk of further decline.

Natural Gas does not always move in sync with Oil, but since a third of land-based Oil drilling produces undesirable Nat Gas, the fundamentals here are also somewhat negative until this Administration permits faster adoption of LNG ports and pipelines.

 

President Biden’s antipathy toward fossil fuels that appeal to his base have been axiomatic in his past campaign and as President. He has stopped pipelines, prevented leases on Federal Land and only recently offered a paltry number of offshore leases in order to add more subsidies toward offshore wind farms. Prices to build and maintain wind farms are soaring and technology is falling behind the demand for larger blades and turbines. This requires larger subsidies, better supply chains and calls for rewriting his Inflation Reduction Act. The gradual adoption of alternative energy is admirable as the technology improves and domestic supply chains, which don’t include China and Russia, are developed, but we are many years form that goal. US and European energy supply vulnerability is much greater than usual, but the so-called good news is that there are signs of waning demand as the global economy slows. 

The global battle to normalize high inflation by keeping the cost of capital (interest rates) high along with quantitative tightening of bank lending capabilities is expected to push energy consumption lower over the next year. This fundamental headwind along with seasonality and the negative Oil price response to Bullish news are the primary reasons we warned to stay away from energy companies in late September after Oil breached $90/barrel. The energy group was the worst stock market sector during October. Our negative forecast occurred despite enormous Bullish consensus on Oil and energy stocks in particular. Bank of America reported that October fund manager surveys revealed the most overweight allocation to energy stocks in 7 months. Instead of higher prices, Oil fell 13% and the Energy index of stocks (XLE) fell 10%. Fund managers are undeterred by the recent correction and remain Bullish, while we would rate the risk of a downside shock as more likely than a strong upside move. Of course, the potential for an exogenous price shock above $100/barrel would be likely if Iran or any Oil producer was attacked, but the price action thus far supports a less sanguine thesis. If support at $80/barrel Oil is broken, we would expect an immediate test of $78 with the potential for $70 before year end.

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