The oil and gas markets are currently in the throes of yet another downturn, with Brent crude down 34% from its May 2022 peak while U.S. Henry Hub natural gas has crashed 73% from the August 2022 peak. Energy stocks and crude oil futures have also come under pressure after the latest weekly U.S. data showed commercial crude inventories spiked by a whopping 16.3M barrels.
According to the U.S. Energy Information Administration (EIA), crude stockpiles rose to 471.4M barrels, ~8% above the five-year average and way above the Wall Street consensus of just 800K barrels.
Meanwhile, refinery activity slowed down unexpectedly, with the weekly capacity utilization rate falling by 1.4 percentage points to 86.5%, compared to the consensus of a 0.2 percentage point increase.
Whereas the current oil and gas price trends do not look very encouraging, zooming out and looking at the bigger picture reveals that the current slump is part of a boom and bust cycle that repeats itself with alarming regularity. Indeed, Reuters market analyst John Kemp has argued that the ongoing selloff is part of the Kitchin cycle that lasts for 3 to 4 four years.
Discovered by Joseph Kitchin (1861-1932), Kitchin cycles are attributed to the accumulation and liquidation of excess inventories. The Kitchin theory goes like this: as growth accelerates, the market gets ‘flooded’ with commodities; however falling demand leads to falling prices and produced commodities getting accumulated in inventories. Kitchin cycles can be used to predict demand, prices and output.
According to Reuters, in real terms, oil prices are not down by much going by historical standards: oil prices are currently in the 67th percentile for all months since 1990, down from the 86th percentile in May; however, natural gas prices have fared much worse, falling to the 3rd percentile down from the 86th percentile in August.
There are other business cycles similar to Kitchin that can be used to understand and even predict various parameters in the commodities markets.
Named after Clément Juglar (1819-1905), Juglar cycles last 7 to 11 years, and are attributed to investment in longer-lived fixed assets such as machinery. The investment delay in the Juglar cycle is usually 1-2 years, while the investment delay in the Kitchin cycle is only 4-7 months. In addition to Kitchin's lagging inventory signal, Juglar cycles incorporate an additional lagging fixed investment signal. Juglar cycles can be used to predict capital investment levels.
Kuznets cycles have a duration of 15-25 years, and are attributed to construction, demographics and migration. Named after Simon Kuznets (1901-1985), Kuznets cycles theorize that as a country develops, there is a market-driven cycle that at first increases inequality then decreases it after a certain average income is attained. Kuznets can be used to predict income.
Meanwhile, Kondratieff waves are long-duration cycles lasting 45-60 years attributed to the diffusion of major new technologies. Named after Nikolai Kondratiev (1892-1938), Kondratieff waves stipulate that economic growth in capitalist countries comes in long waves driven by technological innovations. Kondratieff waves can be used to predict interest rates, foreign trade, prices, coal production and pig iron production.
So, what can we deduce about the current market cycle? According to the Kitchin cycle, the current slowdown in energy is likely to be a mid-cycle soft patch, meaning that gas and especially oil prices are likely to get stronger in the latter half of 2023.
Kemp notes that global inventories of petroleum and more cyclically sensitive components such as distillates remain below the long-term average. This means that inventories are likely to deplete quickly in the event that the economy gains momentum again leaving little spare capacity to rebuild them in the short-term. This is likely to lead to a supply squeeze. However, last week’s crude inventory data is likely to test this part of the thesis especially if we witness another large inventory build. Meanwhile, Kemp says that natural gas inventories are currently more comfortable after a mild winter in 2022/23 but could also deplete quickly in the event of an economic uptick or the 2023/2024 winter turns out to be more severe.
However, the analyst warns that if the current economic slowdown descends into a recession, both oil and gas prices are likely to come under more downward pressure in the near-term. This would lead to a situation where the resulting accumulation of inventories and increase in spare production capacity would create some degree of cyclical slack, meaning the next upswing in prices might not happen until 2024.
By Alex Kimani for Oilprice.com
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