Friday, June 24, 2016

Fundamental Friday: 24 June 2016

Crude oil: Crude oil fundamentals are reacting bullishly to the spike in refining this summer. Domestic production fell 39,000 b/d to 8.677 million b/d approaching another significant milestone at 8.5 million b/d. Since the beginning of the year, U.S. producers have cut 542,000 b/d worth of production as the squeeze on supply continues despite the stabilization of oil prices. Crude oil stockpiles continued their decline as well. With a drop of about 900,000 barrels, last week stockpiles were reported at 1.225 billion barrels. For the year, stocks are up about 48 million barrels but have declined in the past two months at a rate of about 13 million barrels.

Refinery data spiked to new highs this week as upstream operations heat up with the temperatures. Refinery inputs grew by 190,000 b/d to 16.505 million b/d reaching a new peak for the year. So far, June averages are well above the earlier 2016 months. Compared to last year, this week's refinery inputs are just 27,000 b/d lower, on par with the season average. Utilization peaked this week as well jumping 1.1 percent to 91.3 percent. Utilization data, compared to what it was last year, is 2.7 percent lower hinting at higher refinery input to come later in the summer.

WTI and Brent spot prices traded turbulently this week with Brexit weighing at the end of the week. The declines on Friday helped solidify the $50 mark as a potential resistance going forward. WTI settled at $47.50, and Brent settled at $49.00.

Natural gas: Natural gas supply and demand trends extend the pattern that has developed in the past couple of months. Underground stockpiles of natural gas jumped 62 bcf to another new high of 3103 bcf. The rig count jumped at the highest rate in awhile, up 4 rigs to a total of 90 for this week. The growth in rig operation is most likely caused by an even stronger jump in demand. The EIA estimates a 0.3 bcf/d increase in supply for this week. The estimate for demand growth is 1.8 bcf/d completely offsetting and overwhelming the corresponding shifts in supply.

In the weekly report on natural gas fundamentals, the EIA discusses the pace at which the 2016 summer season is growing. Last week's peak above 3,000 bcf marked the earliest date at which this level was reached over the past 20 years. In 2012, supply reached this point by June but was still below 2016 fundamental data. Projections have the 2016 summer injection season ending with stockpiles just above 4,000 bcf, a point never reached before.

Henry Hub spot prices continued their impressive streak of gains despite losses on Friday. A 5-day gain of 0.84 percent adds on to three-month growth of 23.99 percent.

Gasoline: Gasoline supply data reflected the expectation of more consumption to come in the next two months. Finished motor gasoline production grew by 580,000 b/d to end at a six-week high of 10.289 million b/d. As a result, finished motor gasoline stockpiles grew as well adding just under 1.5 million barrels for a total of 25.016 million b/d last week. Component stocks fell by 800,000 barrels to 212.615 million barrels. These data confirm the expectation that higher consumption is imminent. Product supplied contradicted the assumed trend falling 830,000 b/d to 20.010 million b/d after a peak the week before.

Regular and diesel gas prices reversed this week after a long streak of gains. Regular gas fell by $0.046 to $2.353 per gallon with declines across all regions. Diesel gas prices fell as well down $0.005 to $2.426 per gallon with mixed data across the regions. The drop in prices may have been a reaction to higher product supply corresponding with flat demand.

Thursday, June 23, 2016

Predicting a Crash: Part Three

The next step in predicting a crisis is identifying the causes behind the growth of the global debt problem. The proliferation of credit, loans, and any other form of borrowing does not occur randomly. Individuals, businesses, and governments are all affected by the state of risk in the economy, the availability of capital in the current setting, and how costly this capital will be. The growth of mortgage-backed securities (MBS) during the prelude to the financial crisis was caused by the perception that these assets were low risk increasing the demand for their creation. As a result, the amount of residential mortgage debt skyrocketed. After the unraveling of the housing market in 2009 and 2010, a similar trajectory has developed leading up to today. In this episode of Predicting a Crash, we're going to look at how central banks in developed nations have encouraged the formation of a debt crisis with cheap capital and a bloated money supply.

Before visiting the current debt crisis that has encroached upon the economic safety of the next three years, it's important to review the effects that the 2008 crisis had on shaping the market conditions in the next eight years. The failure of the housing market caused panic and uncertainty to freeze the credit mechanism in the residential, corporate, and public sectors of the economy. Banks which had been more than willing to initiate home mortgages just a couple years ago were reluctant to lend to anyone. The commercial paper market, an outlet of credit used daily by financial institutions, became a quiet doldrum. Even governments found it difficult to convince lenders to loan at a reasonable rate. After the capital mechanisms at the base levels of the economy broke down, a recession hit, and the Federal Reserve was forced to move into action. Ben Bernanke and now Janet Yellen sought to counter the debilitating effects of the crash by lowering every kind of interest rate their Board of Governors could think of, starting with the Fed Funds rate. Through conventional and unconventional open market operations they found ways to cut the discount rate, rates for mortgages, rates for interbank lending, and many more lending rates that were responding to panic and fear. The lower interest rates and a Federal Reserve willing to pump money into the economy caused money supply growth to accelerate in the years after the recession. Companies and households that were affected by the economic downturn that followed were not wary of the building debt crisis that they were creating; instead, they focused on recovering.

For corporations, recovering meant taking advantage of newly available capital with interest rates that were at record low levels. The Federal Reserve, exemplifying the "lender of last resort" role discussed by Walter Bagehot in 1871, encouraged the flourishing trend of lending capital in the face of uncertainty with their own loans to AIG, GMC, Chrysler, and most of the leaders of the financial services sector. When the recession hit commercial and industrial loans peaked during the recession as the Fed's easy money encouraged emergency lending. Financials eventually improved and loans dipped. Around the beginning of 2011, we see a different trend set in. Interest rates were still at all time lows and the Federal Reserve was still trying to prop up the floundering economy. The commercial and industrial businesses saw an opportunity; they could take the cheap money and invest it into their operations which were producing returns that were worth well above the cost of the loan. The result, the past five years of low-interest rates have pushed commercial and industrial loans 29.4 percent above its peak in 2009. Meanwhile, corporate profits after tax have only increased 5.7 percent since 2010. This disparity between earnings and debt load has come to define this period of low-interest rates and signals a potential breakdown in the balance sheets of companies in every sector of the economy. The built up pressure might finally crash the system if circumstances were to change (like a sudden drop in profits or consumption, or an increase in interest rates).

The same situation arose in the major consumer credit markets. Low-interest rates among institutions allowed them to charge less for mortgages, car loans, personal loans, and credit card rates. This is a healthy scenario when a recession is threatened. The low cost of loans allows consumers to get back on their feet and enter the market with a smaller chance of default. Lower repayment fees also leave a more income available for consumption. This makes sense. The healthy response soon denigrated into a dangerous environment where debt was encouraged even after the recovery had taken place. In between 2011 and 2015, interest rates on new car loans, personal loans, and credit cards fell significantly even though the recession had been over for almost two years. Delinquencies successfully fell, but in its place, a growing debt burden subtly inched its Monthly growth rates suggest that consumer credit growth had reached levels comparable to the years leading up to the financial crisis, debt growth rates that had ultimately brought down an economy. The same could be said about the housing market and mortgages. The Mortgage Bankers Association revealed a trend in mortgage purchases that reflects the trend in the early 2000's. Estimates for 2016, 2017, and 2018 continue to follow that pattern.

The charts and data above reveal the Federal Reserve's era of loose money which encouraged consumers and businesses to add on to debt loads that were already high. The picture painted in the United States is mirrored by monetary policy in countries across the globe. Japan, a developed nation with one of the highest debt-to-GDP ratios, saw credit explode as its central bank dropped interest rates to zero. The mature Asian nation also flirted with the idea of negative interest rates, an unconventional method that would lead to the addition of even more corporate and consumer debt. The European Central Bank continues to keep their interest rates low as the economic leaders there try to coax growth despite an aging population. Along with cheap capital, the ECB head Mario Draghi have employed aggressive quantitative easing measures hoping to encourage investments by supporting asset prices. Both policies have allowed the development of a credit trend similar to the one in the U.S. and Japan. Because of the interconnectedness of the institutions to which the largest central banks lend, the debt crisis spread to small, emerging economies in tandem. New firms in countries like Brazil, Russia, and China could access these funds through the hands of foreign investors able to lend at lower interest rates because of the atmosphere created by the Federal Reserve, the Bank of Japan, the ECB, and the many other institutions implementing loose monetary policy in the past few years.

So we're starting to approach a verdict. As we have looked further into the weakness of the global economy and the pressure of debt, fingers start to point at monetary leaders for their irresponsible handling of interest rate trends. In hindsight, almost everyone will assert that rate hikes came too late, a statement that is quickly followed by the question, "When will they raise rates?" During economic expansion that typically follows a recession, monetary institutions are generally supposed to increase interest rates to cool down the recovery. That path was not taken. Now, debt loads and weak market fundamentals are waited to unravel when necessary rate hikes finally occur. The unfortunate scenario has monetary leaders choosing between higher interest rates and another recession or more low-interest rates and more debt. The former will be chosen; thus, a crash should be expected. If you're worried about credit markets now, be prepared for even more anxiety when "helium" stocks are discussed in the next installment of Predicting a Crash.     

Monday, June 20, 2016

Predicting a Crash: Part Two

In the first part of Predicting a Crash, I identified debt as one of the main drivers of global weakness in the past couple of years. Despite the mountains of debt that brought down the housing market, developed and emerging economies have continued to borrow piling onto record levels of sovereign, household, and corporate debt. At some point, this pyramid will implode taking down the global economy with it. If you don't believe me, refer back to the financial crisis just eight years ago for an example of the crushing effects of too much debt. But the crash of the housing market would be small potatoes compared to what could happen if governments and multinational corporations tumble from the leveraged pedestal from which they rule. In this installment of Predicting the Crash, we'll begin to dissect the debt problems and what companies, governments, and analysts are saying about its implications.

Because of its large growth rates and massive population, China, and its insatiable demand, has quickly become the key driver of global economic expansion since the financial crisis. It's GDP growth rate, which approached 10 percent in the years of the recovery, catapulted the Asian country's total output above the United States. The robust expansion of the Chinese economy is a very optimistic economic prospect promising more demand and consumption of exports from its trade partners and blue chip investments from developed economies looking for a stable way to grow their capital. However, the trends underneath it all finally began to show themselves in late 2015 and early 2016 when stock markets crashed around the globe. The sell-offs were caused by the realization that Chinese stocks had been built up into bubble territory by foreign capital that was unsupported by expansion in domestic Chinese consumption. In a chart from the Bank of Canada's Financial System Review in December of 2012, data shows a declining consumption share of GDP in China leading up to the financial crisis remaining below 35 percent through 2012. This level is extremely low compared to its emerging Asian peers, Latin America, Japan, and Germany.

Since the capital flowing through the hands of Chinese consumers wasn't sufficient in supporting the growth of the Chinese private sector, the firms there looked to its government, local banks, and foreign investors to raise the money. In the most recent Financial System Review report, the Bank of Canada pointed to this chart to summarize the proliferation of outstanding loans in the world's largest producer of goods and services. Ever since the financial crisis caused emergency loans to bail-out the nations company's, debt has continue to build approaching the frightening level of 225 percent of GDP. The weakness that was revealed in August of 2015 toppled these company's share prices but the problem has only gotten worse. In fact, interest on these loans has become the biggest issue as 16 percent of the largest 1,000 Chinese companies "owed more in interest than they earned before tax" according to The Economist. Eventually, weakness and fragility turns into defaults and bankruptcy then soon panic. In the same The Economist article, the author writes, "When the debt cycle turns, both asset prices and the real economy will be in for a shock." It's true. China's debt problem is a ticking time bomb. And we're all exposed.

As the emerging economies have quickly become the world's growth leaders, foreign capital has flooded their companies and governments in search for high yield in a low interest rate global economy. China, the fastest growing developing nation, has claimed a large share of the foreign direct investment because if its bullish demographics and stock market. In the World Bank's International Debt Statistics 2016, the report highlights the Chinese share of foreign investment in the charts above. In 2014, the Asian giant absorbed over $260 billion of foreign direct investment. The demand for Chinese debt securities has caused its bond market to grow to $7.5 trillion, "the world's third-biggest," according the The Economist. Instead of the housing market, easy capital egged on by low interest rates is accumulating in the debt heavy companies China. And its government is doing its best to support those investments. The Economist reports that the "$200 billion" was spent to "prop up the stock market" as "$65 billion of bank loans" went bad in the same time period. The kingpin of global growth will attempt to shoulder the debt load going into the future, but foreign investors may be convinced to withdraw their capital as pessimism looms and debt crises in their own countries develop.

Many developed nations, the source of much of the foreign direct investment that finds its way into the hands of China and other emerging economies, find themselves facing debt problems themselves. The growth rate of the economies in the European Union have slowed drastically sometimes struggling to reach a meager 2 percent. As the markets have started to flatten, debt-to-GDP ratios have blossomed in their place. As shown by the chart above, the four most leveraged nations in the EU have seen their debt-to-GDP ratios grow significantly from 2010 to 2014. Greece, a country that has already tested the fragility of the economic unity in the eurozone, is approaching a ratio of almost 200 percent despite austerity measures. The rest of the EU-15 nations are only relatively better compared to the Greece, Portugal, Italy, and Ireland. The average government debt-to-GDP ratio in the European Union is 84.4 percent according to 2014 data, up from 83.2 percent in 2013. Pressure in united Europe will continue to build as each country takes its turn on the brink of a debt crisis. A failure in any one economy could be devastating enough to dissolve the union indefinitely, an outcome that would surely lead to an unraveling of the global economy.  


The jaded European nations are not the only developed countries to carry the heavy burden of excessive debt. Japan, notorious for its low growth "Lost Decade," operates on a debt-to-GDP- ratio above 200 percent, the highest of the OECD countries. The nation has been a large contributor to the expansion of the Chinese economy as its established companies poured money into the emerging private sector in the world's most populous region. However, data produced in the latter parts of 2015 revealed a "25.1 percent" drop in Japanese direct investment in China, according to the Global Times. This decline is reported just after the Shanghai Composite index lost much of the growth it experienced in the years before. This is just the first signal of investors finally coming to terms with the weight of the debt load on these two Asian economies. The next step will be the flight of American investors as the first two crashes introduce the taste blood to their trading taste buds. The United States is not a country that has avoided debt problems with a debt-to-GDP-ration of 97 percent and a national debt of almost $20 trillion. The unique relationship that China, as creditor, and United States, as debtor, could eventually crumble if the U.S. proves to be irresponsible with its repayments. Nevertheless, a sovereign debt default in the United States is not likely to be the catalyst in the global crisis that is to come.

In this article, we've identified the frightening debt trend that has consumed the global economy and the stock and bond markets in just about every country. While risk can be found just about anywhere, the overpriced Chinese firms built on loans and foreign capital are the largest current threat. A crisis will most likely start in the bond and stock markets after more bubbles are forced to deflate, crashes that would cause investors and governments to panic. The last thing anyone wants if for debts to be called in, but this nightmare could become a reality if sentiment deteriorates enough. As the world's central banks' hold their fingers on the detonator, reluctant to let go, all eyes turn to them. Since that is the case, I shall turn with them as I continue Predicting a Crash.

Friday, June 17, 2016

Fundamental Friday: 17 June 2016

Crude oil: Crude oil fundamentals continue to support a bullish recovery in spot prices. After growing slightly last week, total production fell once again losing 29,000 b/d to land at 8.716 million b/d total. While rig data showed an increase in drilling operations, extraction rates continue to fall with the exception of last week's peculiar gain. Crude oil stocks added onto its losing streak dropping about 900,000 barrels to 1.226 billion barrels total. The draw on crude inventories marks the 4th straight decline as the accelerated refinery season suggests a bullish trend in stockpiles could speed up as well.

Refinery inputs fell slightly last week. Down about 100,000 b/d, refinery usage of crude oil totaled 16.317 million b/d. While this week appears to be a drawback, the overall trend should continue upward throughout the summer. Rig utilization dropped by 0.7 percent to land just above 90 for the week. Refinery statistics for the summer of 2016 are well above the trends in the last five years. There should be no concern that downstream fundamentals will undermine a recovery in WTI and Brent futures markets.

After approaching the $50 last week, crude oil moved with volatility through this past week losing about 1.65 percent in the market for WTI contracts. Brent crude reflected a similar trend of volatility with losses of 2.29 percent over the past five days.

Natural gas: A warm summer continues to set up natural gas fundamentals to return to levels seen during the same time last year. Now down to just 26 percent above the 2015 reading, underground stockpiles grew 69 bcf to 3041 bcf last week. Rig utilization is slowing increasing from its bottom in late May. U.S. firms added 1 rig last week to end at a total of 86. Supply changes continue to be bearish, growing 0.7 bcf/d to 79.9 bcf/d, but demand counters with a stronger bullish growth of 1.3 bcf/d to 70.2 bcf/d.

The EIA's Natural Gas Weekly Update reported on an increase in global LNG imports. Over the course of 2015, the increase of floating storage and regasification units caused exports to grow 46 percent in 2015. The news is supplemented with the report that Pakistan hopes to, "build infrastructure for a second floating storage and regasification unit (FSRU) to import liquefied natural gas (LNG)." This method, being implemented around the world as one of the most "flexible, cost-effective" methods of processing LNG, should signal higher prices for LNG and natural gas in the future.

The natural gas Henry Hub spot price continued to show bullish signs of recovery this week growing 1.92 percent over the past five days. In the past three months, traders have pushed this energy commodity over 20 percent higher as fundamentals begin to improve after bearish developments in the winter.

Gasoline: Gasoline fundamentals see a slight shrink in supply with a pick in demand becoming evident. Finished gasoline stocks fell about 1.5 million barrels to 23.569 million barrels total. Component gasoline stocks fell just over 1 million barrels to 213.435 million barrels as well. Increases in refinery output and demand having an effect on the supply shrinking from less supply. Finished gasoline production dropped by about 400,000 b/d to 9.707 million b/d. That product supply is the lowest over the past 6 weeks. On the other hand, product supplied jumped by over 1 million b/d to 20.840 million b/d posting its highest recording in the same 6 weeks.

Supply and demand differences continue to shrink going into the summer forcing prices to go up. Average U.S. regular gas prices jumped $0.018 to $2.399 per gallon. Average U.S. diesel prices jumped $0.024 to $2.431 per gallon. Both prices measuring petroleum products should continue their upward trends this summer despite signs that movement is flattening.

Monday, June 13, 2016

Predicting a Crash: Part One

It's the holy grail of bears and the ultimate breath of relief for bulls. It only occurs every once in awhile even though its coveted by economists and analysts across the country. Many claim to have it, but only a few are truly owners. Some might not even realize when it has stumbled upon them. Viewers of the movie The Big Short  have seen dramatized representations of some of the best. Stock market crash predictions are definitely hard to come by, but they can save an investor thousands if not millions of dollars while making them seem more intelligent than an entire horde of bumbling day traders that drove stock prices to the ground. This new series, featured on Black Gold Disease, seeks to identify the trends and alerts that will give way to the next "I told you so" moment. In the end, that petty mentality has no room in the words of the next few writings. Instead, this author hopes to dissect the path to the next market crash which he believes is not far on the horizon. Just over seven years ago, the worst financial crisis since the Great Depression plagued the global economy with a major economic downturn that followed in the years that followed. While that event is unforgettable, some might not remember the years of 1936-1937 just about seven years after the crisis in 1929 when markets relapsed into recession after appearing to recover. It is paramount to acknowledge the truth that the economy now is vulnerable to that same weakness. In BGD's Predicting a Crash, I will attempt to find (or fail to find) trends and analysis that tell us when the next crash will come.

Ever since the end of the financial crisis in 2009, equities skyrocketed out of the hole they fell in during a record sized sell-off. The 50-day moving average fell well below its 200-day counterpart but crossed back over in 2011 after two years of a solid rebound. In fact, the optimistic mentality of traders supported an S&P 500 growth rate of 213 percent from the bottom in 2009 to the peak in 2015. A new bull market, defined by an average yearly expansion of 35.4 percent, was ushered in as the Federal Reserve lowered interest rates and the economy recovered. About seven years later, the wide gap between the 50-day average and the 200-day average has begun to shrink and equity movement has entered a trend that appears flat. In addition to the consolidation patterns, two stock market corrections have occurred in the past year both forcing investors to come to terms with the deteriorating global economic condition. Weakness in China, the world's largest source of demand, was almost the sole reason for two minor crashes in late 2015 and early 2016. Despite the sell-offs, equities continued to rebound as sentiment surrounding stocks appeared immovable. While some might wish to ignore it, more risk and fragility are crouching beneath the less volatile environment, and many individuals claim they can see it too.

 While just a few commentators will be mentioned, there are thousands of perspectives on the potential of a crisis in 2016. Henry Blodget, on Business Insider, wasn't afraid to highlight the lofty valuations of equities in an article written in January 2016. After looking at many indicators that show expensive (or cheap) stocks are, he concluded that "By many, many historically predictive valuation measures, stocks are overvalued to the tune of 75%-100%." As he explains correctly in the next paragraph, valuations at these levels are often, if not always, subjected to brutal corrections as the asset bubble pops. In the end, he asserts that "the annual returns over the next decade are likely to net out to about 0% per year."  In an article by Profit Confidential, the author cites Warren Buffett, John Paulson, and George Soros as the newest bears of the day. These individuals, perhaps the most successful stock traders of our time, have been selling stocks since early 2014 and continue to do so as the pressure builds. If the article's suggestion of "following the smart money" is logical, shouldn't one assume a crash is afoot? Any smart investor knows that only takes a few bears to take down the rickety stock market. In the political arena, two of the largest figures in the Republican party are warning of a looming crash that will come within the year. Ex-Republican presidential candidate Ted Cruz is cited as saying a "crash will be coming," according to CNN Money. His counterpart still in the race, Donald Trump, has also voiced his concern with the market saying it is a "terrible time" to invest and "we're in a bubble right now." Skeptics are everywhere and they tend to point out some of the same things.

Large valuations are only supported by the appropriate fundamentals. But, a look at the balance sheets of companies, households, and governments will reveal little improvement in their personal fundamental position. In fact, most growth has been in the debt category. A report from the McKinsey Global Institute said, "Global debt has grown by $57 trillion and no major economy has decreased its debt-to-GDP ratio since 2007." The chilling realization that liabilities have only increased since the crisis should be scaring investors away from the investing world, but it hasn't. While it isn't often described that way, the global financial crisis in 2008 was a crisis caused by debt, housing debt specifically. The shaded region on the graph indicating the resulting recession in 2009 depicts a flattening of the trend of increasing debt. One would expect the problem to be solved, but the opposite is true. With almost $64 trillion of debt recorded for the last quarter of 2015, the world has failed to learn its lesson, and it might not ever without another crisis. The trend of inflated debt levels forms the basis for by analysis and predictions. The truth is, we cannot eternally increase liabilities because eventually there will be a time for them to be settled. Currently, the global economy is teetering on the edge of these calls, and figuring out what will trigger them is the way forward in predicting a crash. 

Friday, June 10, 2016

Fundamental Friday: 10 June 2016

Crude oil: Crude oil fundamentals record a very important move this week in the EIA supply estimates. Domestic production reversed its long downtrend to add 10,000 b/d for a total of 8.745 million b/d. After a thirteen week losing streak, U.S. suppliers finally signaled that are ready to increase output in a recovering environment. While 10,000 b/d will not have a large impact on supply and demand dynamics, it represents a reversal that could heap bearish sentiment onto the markets (if confirmed of course). Stockpiles, though, fell by just over 3 million barrels to end at 1.227 billion for the same week. Because stocks tend to lag production, the new trend of draws on inventories could be in danger.

Refineries provided a bullish counter to the increase in production this week. Crude oil inputs jumped 211,000 b/d to 16.417 million b/d, higher than any of the values estimated for the weeks in May. Rig utilization jumped 1.1 percent to 90.9 percent. Some growth in both categories should be expected as refinery operations usually peak in July. Typically, the acceleration weighs on stocks, but a substantial boost in production could cancel out that effect.

After peaking above $51, the WTI spot price fell to about $49.40 on Friday with a five-day gain of 1.4 percent. Brent crude maintained its growth over the $50 mark ending around $50.70 on Friday after a five-day jump of 2.1 percent.

Natural gas: Natural gas fundamentals appear to reflect the expectations of higher consumption in the coming summer months. Underground stockpiles grew by 65 bcf to a total of 2,972 bcf for the week. While the glut continues, smaller increases have allowed the current storage values to approach the historical averages. After this week, natural gas stocks are just 32 percent higher than the 5-year average when it was about 69 percent higher a little over two months ago. Supply fell by 0.4 bcf/d and demand grew 0.8 bcf/d adding to the bullish pressure. The natural gas rig count increased by 3 to 85 as companies start to bring more drills online due to higher prices

This week in petroleum, the Henry Hub futures curve began to form a slight contango pattern with investors expecting prices to rise over the summer. The EIA found a $0.20 difference between the July contract and the expired June contract on May 27th. Last year, the difference was only $0.09. While the summer months usually cause this pattern to develop, this year's futures difference is well above the average. If temperatures continue to rise to above-average levels, the cooling season could instigate a more secure uptrend going into the heating season.

Natural gas Henry Hub spot price grew an impressive 7.55 percent in the past five days after some small gains on Friday brought the price from its peak of $2.617 on Thursday.

Gasoline: Increases in refinery operations have caused a parallel growth in product supplies. Finished gasoline soared to new highs of 25.037 million barrels after a 1.6 million barrel growth in the last week. Component gasoline stocks fell about 600,000 barrels to 214.593 million barrels in conjunction with higher refining rates. Finished gasoline production grew 200,000 b/d to 10.122 million b/d total. Finished gasoline data were well above those recorded for the month May. Product supplied fell about 600,000 b/d to 19.779 million b/d for last week. If the industry expectations are correct, this value, reflecting demand, should increase during the summer driving season.

Gas prices continue to extend their incline into the summer months, something not out of the ordinary according to seasonal analysis. U.S. regular gas prices grew $0.042 to $2.381 per gallon with a consistent trend evident throughout the PADD regions. Diesel fuel prices grew by $0.025 to $2.407 per gallon. The differential between diesel and regular gas prices has shrunk to a new low of $0.026.

Wednesday, June 8, 2016

The Short-Term Energy Outlook

On a monthly basis, the Energy Information Agency releases the Short Term Energy Outlook which looks at data and analysis of recent trends in the oil and gas industry. In addition to looking at the near-term historical trends, some projections for price, supply, and demand are presented for the use of industry officials, economists, and investors. The fifty-page report presents many insights that are worth looking into for any analyst interested in the world's general economic growth. This article will extract what it can from the June 2016 Short-Term Energy Outlook and provide its own opinions and insights along the way. All pictures and data are based on the report from the EIA linked above.

One of the main functions of the STEO is to produce a projection of the West Texas Intermediate spot price over the next couple of years. By the end of 2017, the EIA sees prices approaching the $60 level although their range of possibilities is quite large. Even though traders are trading with optimism, there is still a lot of uncertainty regarding the choices of OPEC and the changes in U.S. production in the latter half of 2016. In fact, the recovery could be its own undoing as firms will look to boost production as soon as it becomes economical. A volatile tone is still evident in the leading U.S. energy agency as it predicts $46 a barrel by September 2016, $4 below what spot prices closed at today. Still variation in the futures spread "suggests the market expects WTI prices could range
from $36/b to $69/b (at the 95% confidence interval) in September 2016." Contango patterns in the WTI futures market has been heavy throughout 2015 and the beginning of 2016, but the recovery has seen this formation reduced by "59 cents/b and 52 cents/b for Brent and WTI, respectively, since May 2."

WTI contango had gotten as bad as $10+ when the markets were trading oil as low as $30 a barrel. With bullish hedging and more activity on the market, merchants and position traders have pushed up futures prices causing the spread between the front month and the 13th month to fall as shown by the chart. The normalization of the futures curve should signal to oil and gas firms that volatility is starting to taper off and selling contracts can help realizations in the long run. Downstream firms will be more competitive as well, looking to find the cheapest barrel that can get their hands on. The EIA expects high refinery utilization to "contribute to continued price strength for North American crude oils over global crude oils." As U.S. producers cut operations and the WTI spot price shows some upside, its international doppelganger, Brent, might feel more downside with Russia and OPEC members opting for higher production levels and consumption falling in Europe and stalling in emerging economies.

The spot price spreads, which fluctuated wildly in 2015, have finally settled down between $2/b and -$2/b. Almost a year ago, Brent prices were almost $8/b higher than WTI stressing the oversupply in the United States at the time, but the trend reversed and pushed the spot prices closer together. Smaller differentials will have a bullish impact on investors who are encouraged by less uncertainty in the market. Converging prices discourage arbitrage and encourage export and import opportunities as suppliers and their customers feel safer from sudden shifts in the market. The EIA attributed the recent decrease in the spread to "the large, temporary decline in a major source of crude oil supply" caused by the Canadian wildfires. While the deviation could be corrected in the next couple of weeks, the brief bullishness certainly adds optimism to a market with growing momentum. If traders see that energy prices are vulnerable to these short-term events, they might build up in anticipation of an uptrend and accelerate the move with greater volume.

Group psychology that represents the dynamic just explained helped to propel energy securities to an impressive rebound in April and May 2016. After recorded one of the worst years in history in 2015, "energy prices increased 29%, whereas nonenergy commodities and the S&P 500 index increased only 6% and 3%, respectively." It appears that betting against the trend would have, once again, been the correct position for a trader in late 2015. In short, the contrarian prevails. The consistency bullish supply news has helped drive the trends seen above which is "reflective of less concern over a slowdown in global economic growth" according to the EIA. Contrarians looking for the next trend to defy might point out that the market is still oversupplied and higher prices will worsen that side of the market. Their argument garners some legitimacy and deserves to be heeded as equities and commodities investors trade into the third quarter.

On the demand side, the EIA sees consumption growing steadily through the next two years. Global consumption grew 1.4 million b/d in 2015 with an "increase by 1.5 million b/d in both 2016 and
2017." Despite falling into quasi-crisis mode during the global slowdown, emerging economies are expected to remain the solid base of global consumption through 2017. China's is expected to grow by 400,000 b/d in 2016 and 2017 while India's is forecast at 300,000 b/d in 2016 and 400,000 b/d by 2017. Developed economies will grow at slower rates with Europe and Japan dragging down the growth in the United States and Korea. In 2015, consumption growth was 500,000 b/d, but predictions for 2016 and 2017 have growth shrinking to 200,000 b/d and 100,000 b/d respectively. Oil markets in the near future will look to focus their attention on these emerging nations as oil and gas firms from every country will fight to secure contracts there.

On the supply side, things start to get interesting. Suppliers are divided between OPEC and non-OPEC with a different trend emerging in either camp. Non-OPEC production grew by 1.5 million b/d in 2015 fueling the glut that caused the oil price crash. In 2016 and 2017, the EIA projects output to fall by 600,000 b/d and 200,000 b/d respectively. Of the plays that are expected to slow, "the largest declines are forecast to be in Asia and in the North Sea." The trend in the non-OPEC camp will be offset by changes in OPEC production. As member nations start to implement their own policies, they will seek to maximize output in order to bolster their revenue streams. In 2015, OPEC production grew by 800,000 b/d, and the EIA forecasts growth in 2016 and 2017 at 800,000 b/d and 700,000 b/d respectively. Iran will be the cause of most of the growth in the oil cartel. Disruptions in Nigeria, due to military conflict, are expected to last through 2017 which could cushion the bearish pressure from supply change.

Monday, June 6, 2016

The North Sea Dries Up

The pressure on the oil and gas sectors around the world has not been restricted to the major players in the United States and the Middle East. In fact, suppliers with major stakes in the North Sea are feeling even more pain as declining operations coincide with the region's diminishing financial viability. Oil and gas companies are generating lower reserve replacement ratios. A Financial Times article reported that North Sea decommissioning rates are projected to increase then peak by the 2020's. In fact, a UK oil and gas group predicts that £16.9 billion will be spent on unwinding assets from 2015 to 2024. In that time, oil and gas production in the continental shelf is projected by the UK's Oil and Gas Authority to go from 85 million tonnes to just 57 million tonnes. As one might imagine, the energy sectors in European countries are in danger of falling into financial crisis.

From Crystol Energy
Norway and the United Kingdom are two homes of oil and gas firms with large stakes in the North Sea play. Production from both of these countries appears to have peaked at the turn of the century as they now face a flattening trend in the early parts of the 2010's. At the peak, Norway and the UK supplied 9 percent of the world's oil. In 2014, their share dropped to just 3 percent. In Crystol Energy's assessment of the North Sea's viability, it said, "the North Sea is unlikely to relive its heyday of the 1990s." Because improvements in efficiency are unlikely in mature fields like the North Sea, low oil prices will discourage expansion there. Capital expenditures and operating costs from these firms have dropped to all-time lows as the Brent spot price dipped to its own lows. Unless Brent approaches its 2014 highs, the conditions could signal the death of many firms that rely on the continental shelf region for a majority of its production. The Bank of Scotland recently published their annual analysis of the oil and gas sector in the UK. The reports reveal the firms' thought processes as the deflation in oil prices begins to give way to a recovery. The survey of 141 decision makers in the industry found that "the short-term outlook is understandably gloomy" even though their barrels of oil will soon be selling for $50 a barrel (over 25 percent increase from the beginning of the year).

Only 38 percent of the firms surveyed think that prices will return to $75-$80 a barrel between 2020 and 2022. The low rates of optimism in the industry are relatively unprecedented as "nine
out of ten companies planned expansion" when a recovery to $70 a barrel was predicted last year. This "psychological correction" means that UK energy companies will be adjusting their strategies in the upcoming years with new plans for exploration and production a necessary ingredient for the survival in the new markets. Going into the new year, the survey found that 48 percent would be looking for ways to cut operating costs and increase efficiency, both of which are hard to do in a weak oil play like the North Sea. As a result, most of these firms will hope to be able to place their bets abroad in regions like West Africa and Asia where reserves are more bountiful. According to the report, none of the large companies surveyed said they had plans for expansion in the North Sea. The lack of interest in local drilling could be very detrimental to the UK's energy sector which has already seen employment go down as a result of low realization. So far, 51 percent of oil and gas companies were forced to cut jobs. However, the worst may not be over; 24 percent of the largest firms expecting that "headcount will decrease" over the next 12 months. As operating capital quickly transitions into decommissioning expenses, the weakness in North Sea production could hinder growth in the UK and Norway.

What's next? Firms committed to the production in the continental shift are focused on cutting costs as Brent attempts a recovery. Of the larger firms that plan to stay, 72 percent intend to focus on "efficiency measures," well above the 25 percent hoping to achieve "growth." Still, major energy players feel that sticking with the typical incessant drilling is not enough to conquer the dangers posed by another deflationary crash in commodity prices. In fact, 71 percent of the largest claimed "there is still more to do" to "survive the downturn." Exactly half of he smallest, though, answered, "Yes, we feel we have done all we can/enough to survive the downturn." But as the contrarian might say in the face of a crisis, opportunities abound at the bottom, and too much optimism at this point in time could translate to a naive approach to recovery. The smallest firms had the largest percentage of no's when asked the question, "Has the current business climate presented new opportunities for your business in the UK?" Large- and mid-sized firms answered "yes" the most. Like every good businessman responding to risk, the companies in the survey said that diversification was a new opportunity 51 percent of the time, more frequent than the other five options. If the probabilities hold, the energy sector in the United Kingdom could experience one of the first pushes to renewable energy sources as their major source of oil begins to fade into the background. Only 22 percent of firms said that investment in research and development was an opportunity while 57 percent of big companies said decommissioning as an opportunity. Many of the responders who answered bearishly on local petroleum opportunities may be looking towards a new horizon. 38 percent of large-sized companies, 46 percent of mid-sized companies, and 37 percent of small-sized companies answered, "Are you interested in diversifying into work involving renewables?" with, "high interest." Watch out investors. The energy sector in the United Kingdom could come out of the glut green, sleek, and renewable.

So how does one trade on a report like this? First of all, investors must identify the unique position in which the UK oil and gas industry finds itself after global crash of energy spot prices. While shale producers in the United States revitalized their domestic energy sector with expansion in production, modest growth in demand, and increasing exports, their peers in the UK were forced to grapple with declining production, contracting demand, and increasing import dependency. Between the two regions, an extreme makeover in energy is more likely (and more in demand) in the UK. Second, investors must realize that companies that continue to pour money into production in the North Sea are misusing their capital. Investments in their stocks should be avoided unless they exhibit the desire to diversify and unwind uneconomic plays in the jaded oil field. Lastly, investors must watch for the transformation of the energy firms who saw the opportunity to migrate into renewables. It is only a matter of time until green becomes viable and, eventually, more economical than black. If European companies find that petroleum demand continues to fall, they will have a robust incentive and an incredible opportunity to burst onto the mainstream green energy scene before the rest of the world.

Friday, June 3, 2016

Fundamental Friday: 3 June 2016

Crude oil: Crude oil fundamentals support another week of a shrinking glut. Domestic production fell 32,000 b/d to 8.735 million b/d. Net change in May output came out to 90,000 b/d a reduction of just over 1 percent. If the trend continues through the end of the year, extraction rates could approach levels close to 8 million b/d. Crude oil stockpiles added on to it loss last week increasing the streak to two. Last week stocks fell 1.37 million barrels to 1.238 billion barrels total. The draws on inventory, coupled with further production cuts, are pressuring investors into a bullish energy outlook. A continuation of these trends could result in pushing prices above $50 a barrel.

Refinery data were, once again, relatively flat from last week. After losing just 73,000 b/d worth of refinery inputs, total inputs ended at 16.206 million b/d. Compared to months in the first quarter of the year, refineries are taking in high amounts of liquids. Capacity utilization remained just below 90 percent after a flat change of 0.1 percent last week. As downstream operations approach the peak refining month of July, look for the combination of falling upstream and heating downstream capacities to encourage more bullish trading on the futures market.

Crude oil spot prices resisted the $50 ceiling that appears to have taken effect this week. Flat movement all week has WTI trading around $48.80 on Friday, a loss of just over 1 percent. The Brent spot price logged a flat loss of 0.24 percent this week with a close around $48.82 on Friday.

Natural gas: Natural gas fundamentals continue to respond to the cooling season as temperatures. Underground stockpiles grew by 82 bcf to 2907 bcf. The growth was slower than the five-year average as a result of a smaller rig count. Pacific stocks are actually smaller than they were a year ago. Operating rigs fell 5 to 82, a new all-time low and a sign that stockpile growth could slow in the near future. There was no supply change from the week before as producers extracted 79.6 bcf/d, but demand grew by 4.4 bcf/d to 68.1 bcf/d for the week.

Due to higher temperatures, air-conditioning demand has ramped up consumption well over the 5-year average. According to EIA estimates, "power burn on May 31 was at its highest level so far this year at 31.2 bcf." In fact, this summer, so far, has produced bullish temperature and consumption figures. The EIA also reports that "in 2016, average power burn has exceeded 2015 levels by 8.6 percent or 2.0 bcf/d." The consumption from the Southeast is up over 10 percent from last year for the month May.

Natural gas spot prices staged an impressive comeback this week adding over 10 percent. After starting around $2.16 on Tuesday, traders lifted the Henry Hub spot price to settle around $2.40 on Friday.

Gasoline: Gasoline fundamentals remain relatively flat from last week. Stocks of finished gasoline fell by just under 900,000 barrels to 23.456 million barrels total. Component stocks fell by just over 600,000 barrels to 215.163 million barrels total. Higher consumption continues to mitigate any significant growth in stocks of refinery inputs and outputs. Finished gasoline ticked higher by 50,000 b/d to end at 9.916 million b/d, relatively higher than the 2016 first quarter averages. Product supplied fell by about 100,000 b/d to 20.335 million b/d last week.

Gasoline prices continue their rebound going into the summer months. Regular gasoline price grew by $0.039 to $2.339 per gallon. Diesel prices grew by $0.025 to $2.382 per gallon. Despite weeks of straight inclines, both prices are well below what they were last year. Regular is down $0.44 and diesel is down $0.52 from last year's prices.

Wednesday, June 1, 2016

Can OPEC Convince the World that the Glut's Over?

This week in energy, investors are gearing up to digest the proceedings of the next Organization of Petroleum Exporting Countries in Vienna. As oil prices appear to stabilize, the group of oil exporters may have more room to breathe going into the latter part of 2016. The output freeze discussion has finally withered down to a whisper as most oil ministers dismiss the idea entirely. In fact, the consortium may be more similar to Pamplona as the bulls rush to the table looking to win the race to more market share. The worst appears to be behind OPEC as its members look to maintain the fragile equilibrium of price stability while trying to pump as many barrels as possible. We've already seen Chevron act on their bullish outlook in the Tengiz oil field. Now, oil exporting nations begin to play their own trump cards as price improvement encourages an aggressive reentrance in the market.

In OPEC's monthly oil market report, it featured the developments of "non-OPEC oil supply" as if pleading for more bullish sentiment behind the current price trend. Spot prices in Europe and North America have been steadily increasing, a fact that has been well covered, but few have pointed out the steep recovery in the OPEC basket price. From its trough in late January 2016, the member countries have seen their personal spot price grow by over 100 percent putting the price less than $20 from its peak in March 2015. A doubling of revenue coming into these economies has encouraged a bullish viewpoint, and in turn, has caused OPEC to advance their perspective in the investment world. Articles featuring the decline of non-OPEC supply are not coincidences. They represent the analysis and data that oil exporting countries want observers to imbibe so that they can push their agenda of higher production under higher oil prices. So don't be surprised if representatives at Thursday's meeting spout off bullish proclamations. No matter what is said, the fragility of the oil cartel remains, teetering on the volatile levers that control each nation's oil spigot.

Kuwait has chosen to be a part of the optimistic convoy to come through Vienna. Over the weekend, the head of the Kuwaiti national oil company, Wafa al-Zaabi, announced an investment of $115 billion in the local oil and gas industry in the next five years. According to the Economic Times, al-Zaabi said "We have earmarked 34.5 billion dinars for spending on oil projects over the next five years. Over 30 billion dinars ($100 billion) will be spent on the local market and the rest abroad." Most of the spending will be allocated for the exploration of new reserves, and what's leftover will be used to expand refinery capacity with a new "615,000 b/d refinery." Kuwait hopes that these long-term goals can be achieved by 2020 so that production of crude oil and natural gas can reach 4 million b/d and 2 billion bcf /d respectively. Since the beginning of the oil glut in 2014, Kuwait Petroleum Corp has had to mitigate any growth in output with a small drop off of in 2016. In April, the country's production fell 132,000 b/d to its lowest point in the past two years. As non-OPEC production falls, Kuwait is just one country among many of the oil exporting members that are looking to fill that newly created hole. Representatives of this small Middle Eastern country will be rushing to Vienna like bulls at a rodeo. The signal of increased output and a whole new capital expenditure program was not coincidentally timed before Thursday. Instead, Kuwait hopes to establish an early resistance against any talks of an output freeze and, perhaps, any cohesion at all.

Kuwait is not the only major country betting on the price rebound scenario in their dealings with the oil cartel. The oil minister of the United Arab Emirates has openly supported a bullish outlook for the energy markets in the near future. Suhail bin Mohammed al-Mazroui from the UAE told reporters, "We are optimistic. We are seeing that the market is correcting upward," according to CNBC. While it's not clear whether Mazroui referred to his own country or OPEC in entirety when he said "we," a clear bullish interpretation is put forth by the leader of over 2.5 million b/d worth of production. After peaking in 2015, the United Arab Emirates is slowly adding more to its capacity with 56,800 added in April of 2016. His use of the word "correction" is quite interesting because it suggests that OPEC thinks the markets were illegitimately priced in the low $40's (or $30's if you're talking about the OPEC basket price). Once again, it's not clear whether the diction was purposefully worded to encourage bullishness or it accurately reflects the analysis and outlook which the UAE and other member countries currently espouse.

The Venezuelan government has voiced its concern with OPEC leaders' decision to not cut production and support prices. When an output freeze fell through, the South American country felt undermined by its "economic allies" in the cartel as it succumbed to deficits in the low oil price environment. Wednesday, though, the energy minister, Eulogio Del Pino, abandoned his concerned position for a pro-OPEC perspective saying, "Production has been frozen ... Because if you see the decline in the non-OPEC and all the situation that happened in several countries, production has been maintained the same in the last three or four months," according to Reuters. He's only partially right. Most established producers like Kuwait, Saudi Arabia, the UAE, Qatar, Algeria, and others have limited their output growth with some even reducing it. However, Iran and Iran continue to push their own individual agendas adding a combined 352,2000 b/d worth of production in just the month of April. Venezuelan officials will be completely off the mark if they plan on going into Vienna looking to maintain a "de facto output freeze." Like Iran and Iraq, other smaller member nations will be looking to graduate to a more aggressive oil and gas policy with OPEC support or without it. Iraq itself has said it wishes to export 5 million more barrels in June according to If the South American oil giant plans on coming to Vienna looking for a compromise, it will find itself leaving empty handed with the newly available market share going elsewhere.

What? Available market share? That's right. A fellow member nation has fell under the pressure of military conflict as local militants have targeted wells in Nigeria. As of Wednesday, two of Chevron's wells have been attacked in attempts to sabotage the Nigerian oil capacity according to the Financial Times. The conflict has all together brought production down from 1.9 million b/d in 2014 to just over 1.6 million b/d in April. Additional uncertainty surrounds the likelihood that capacity will be repaired or that more production will be lost. The Nigerian conflict will provide the cherry on top of the mountain of bullish sentiment that various OPEC members are bringing to the table. Predictions? An output freeze will be wholeheartedly denied with those words never to be uttered again by Saudi Arabia and the other cartel members. Instead, the meeting will be centered on presenting the optimistic case to the world. In short, the glut is over and demand is rapidly overcoming the deficit we once saw grow. Be prepared for the oil cartel to once again attempt to manipulate the energy narrative in their favor with non-OPEC supply reductions headlined in glitter and gold. At the same time, don't be fooled. U.S. oil companies will be more than happy to reverse the trend when prices recover sufficiently. Couple that with bullish bets from Kuwait, the UAE, Saudi Arabia, and other member nations, and one will find themselves right back where he started.