Your author is a firm believer in the idea that sentiment- rather than fundamentals- drives market prices in the short term. That’s why our notes tend to obsess over sentiment measures like hedge fund positioning, options markets and time spreads instead of longer term supply and demand balances. As Lord Keynes once put it- “the market can stay irrational longer than you can stay solvent.”
You often get more bang for your buck as a trader if you can accurately gauge the temperature of the herd as opposed to having prescient calls related to fundamentals or geopolitics. Nevertheless, we still need to work to have as good an understanding as we can on long term oil market themes and were excited as always when BP recently released their comprehensive Energy Outlook for 2019 last week. After a not so quick read, the trend which most interested us was the discussion of renewable energy and electric vehicle market penetration in the context of what we view as short term bearish issues with US gasoline demand growth.
BP sees renewable energy supplying about 4% of total energy today and expects that figure to reach 15% by 2040. The company also argues that renewables will become the largest source of power generation by 2040. To paraphrase BP Chief Economist Spencer Dale, this would represent the fastest penetration of the world’s energy system of any fuel in history.
Just for fun, let’s assume that BP’s forecast is ultimately correct. At first glance, 4% of current energy supply and just 15% in the next twenty-one years may not seem like a terrible threat to anyone with natural length in oil. Unfortunately, BP’s report also sees global oil demand peaking near 108m bpd near 2030 (currently running 100.0m bpd) suggesting meager growth for the next decade. If renewables penetrate the market at a rate of about +0.5% per year through 2040 while global oil demand grows less than 0.5% per year what sort of scenarios does that create for oil price risk?
We’d argue one with increasingly small potential for 2008-style ‘scarcity fear’ rallies which are built on the perception of runaway demand growth and exacerbated by supply challenges. This certainly doesn’t mean that crude prices won’t top $75, but it will drastically reduce the likelihood of a +$100/bbl spike. In the U.S., gasoline consumption + exports have achieved growth of just 0.6% and 1.4% over the last two years and are slightly lower y/y through the first six recorded weeks of 2019. Such lackluster demand suggests to us that fuel efficiency initiatives and EV growth- though too small to drive prices sharply lower- are already tamping down growth at the margins and reducing the likelihood of a major upside move from oil.
Moving forward, the world will increasingly look to China to drive growth in energy consumption and this could ultimately drive more frustration for crude oil bulls as the country dominates growth in electric vehicle sales. According to the China Passenger Car Association China’s EV sales topped 159k in December of 2018. EV sales in China- representing about 3% of all cars sold in the country and 50% of all EVs sold globally- are widely believed to have topped 1 million units in 2018 which may not instantaneously change the dynamics of the global energy market but, again, seems meaningful enough to eat into the potential for a rally driven by runaway oil demand growth.
The impact of electric vehicles and renewable energy sources on oil prices is a long term theme who’s most important days are decades away. In the short term, however, even modest growth in both trends seems to be reducing the potential for sharp spikes in the oil market.
- Oil markets were essentially treading water this week and holding on to last week’s gains. Brent crude futures traded near $66 while WTI were near $56. Brent and WTI are higher on the year by about 22% and 24%, respectively after spending the last three weeks in narrow $5 ranges.
- Russia and Saudi Arabia agreed to continue working together to curb oil supplies according to a Russian government website.
- Reuters reported that Iranian crude shipments are holding steady near 1.25m bpd in February after averaging near 1.2m bpd in January. The current mark is substantially higher than many traders had expected but could drop soon as US-granted waivers for the country’s key customers are scheduled to expire in May. Iran was producing Reuters estimated Iranian exports at 2.5m bpd in spring of ’18 prior to the Trump administration’s release of new sanctions.
- India has emerged as the primary buyer of Venezuelan crude during US sanctions purchasing more than 600k bpd so far in February.
- Nigeria is holding general elections later this week at a time of increased political strife. Nigeria crude production fell by 120k bpd in January to 1.66m bpd.
- A recent note penned by Morgan Stanley analysts claims that the first meaningful shale oil discovery in China could lead to a 100k bpd – 200k bpd of additional output by 2025.
- Trade talks between the US and China are reportedly improving heading into the next round of tarrif increased which kick in on March 1.
- Hedge funds were net buyers of ICE Brent crude oil futures and options last week to the tune of 32k contracts representing their largest buying spree since August of last year.
- NY Fed President John Williams gave what we consider to be an extremely important interview to Reuters on Tuesday offering two separate gems- he expects the Fed to hold off on expected rate hikes in 2019 unless economic data significantly surprises to the upside and he expects the Fed’s trading desk to cease winding down their balance sheet after another $600b in sales. We still believe that Fed asset sales were a key contributor to risk market weakness in the fourth quarter of last year. US bond rates continued to move lower to begin the week with the US 10yr yield moving to 2.64%.
DOE Wrap Up
- US crude stocks added 3.6m bbls w/w due to the seasonal slowdown in refiner demand. Overall stocks jumped to 451m bbls and are higher by 6% y/y over the least three-week period and +5% versus their 5yr seasonal average.
- US production remains bearishly high printing 11.9m bpd for the fifth straight week- up an incredible 3m bpd in the last two years.
- Crude oil stocks in the Cushing delivery hub fell by about 14k bbls w/w to 41.6m bbls.
- OPEC production cuts and Venezuelan sanctions revealed themselves aggressively this week as US crude imports fell to their lowest level (6.2m bpd) in more than 20 years. Imports had been averaging 7.6m bpd in the six months prior.
- US crude exports jumped from 2.om bpd to 2.9m bpd and are averaging 2.3m bpd over the last six months.
- The aforementioned drop in US refiner demand equaled 860k bpd bringing total US inputs from 16.63m bpd to 15.77m bpd. Overall inputs are just +1% y/y after showing promising growth through January.
- US gasoline margins jumped sharply this week moving from below $6/bbl to above $8/bbl. US heating oil margins continued to run near $28/bbl. We’re still concerned that the abysmally low gasoline margins will keep refiner demand low as we emerge from turnarounds into summer driving season.
- US gasoline stocks added 450k bbls w/w and are higher y/y by about 5% over the last three-week period.
- US distillate inventories added 1.2m bbls w/w and are flat y/y.
- US gasoline demand + exports are averaging 9.67m bpd so far in 2019 which is flat y/y.