Global Oil Market - June 23

[dan_s]

Note I received from
Helima Croft, one of the smartest people on Earth IMO
Head of Global Commodity Strategy and Middle East / North Africa (MENA) Research at RBC Capital

June 22, 2022
Oil Market in 60 Seconds: Thoughts on the Recent Pullback

Major crude oil benchmarks fell some 4.5% today (6/22). Spot WTI prices have retraced by 13% over the
past 10 days. What has changed fundamental wise? Not much, nada, zilch, but macro concerns of
a recession are clearly dominating sentiment. In my discussions today, I posed the following
question: ”Is oil, which has been one of the last major financial asset classes not pricing in an
economic slowdown, beginning to succumb to the bearish macro pressure?”. One sharp energy
trader responded: “oil has long since been pricing in a global recession, which is why we have been
confined to the $105-$120/bbl range rather than pricing at $150/bbl”. Commodity risk allocators
will let the length liquidation run its course, but further dips are likely to be ferociously defended.
The low to mid $90/bbl range has served as strong support on pullbacks in the event the rout
deepens. This is certainly not our base case, and the strong physical market supports that notion.

The financial, paper market is plunging, but the physical market remains undeniably strong. Our
marginal barrel framework continues to suggest that North Sea and West African physical crudes
are seeing incredibly strong buying trends. In fact, we recently highlighted a major physical
inflection point in the Atlantic Basin physical differentials. The velocity of the move in pricing
differentials suggests a massive physical bid into the market for the global marginal barrels. In fact,
we hypothesized as to whether this was China returning to the market.

The bulk of our recent client conversations start and end with demand destruction. There are
minimal major signs of material demand destruction despite elevated crude price and record US
retail gasoline pricing, and the strength in crack spreads re-iterate that notion. However, we would
be remiss if we did not highlight that consumers are altering their behavior at the margin. For
example, consumers are flocking to discount gas stations, which are seeing volumes sold at higher
than pre-pandemic levels, while conventional gas stations continue to see sales below pre-COVID
levels. The 30¢/gal discount at the pump (or $7.50 per fill up, assuming a 25 gallon tank) is enticing
enough for many to drive further and queue longer to fill their tank.

Travel inflation is eating into future demand. Our Get Out and Travel (GOAT) index includes leading
indicators of future travel. Search interest for air travel and accommodation are down 13% and
14.2%, MoM. US wide traffic congestion has softened by 10.5%, MoM while public transit usage
has increased by 5.2%. Those interested in real time mobility trends to monitor our Get Out And
Travel & Get Out And Live indices can visit our website, which updates every Wednesday ahead of
the US equity market open.

Given soaring retail pump prices, demand destruction remains central among discussions, but our
view remains that demand does not have to be profoundly strong, it just simply cannot be weak.
This is where we sit in the cycle given that the market is pricing in scarcity given multi-decade low
OECD diesel inventories. Refilling product stocks is why the market continues to search and price
for demand destruction. The potential for President Biden’s gasoline tax holiday effectively leads
to demand preservation, which comes with the unintended consequence of further drawing down
product stockpiles and keeping prices elevated for longer. Such policy likely leaves the market in an
even bigger inventory hole exiting the summer.

It typically makes sense to refer to historical precedents when asked about demand destruction. US
gasoline demand destruction kicked in when average retail gasoline prices reached $4.10/gal in
2008. This was the previous record high for retail pricing and marked the last time that the market
saw true demand destruction. Inflation adjusting that figure leads to $5.20/gal in today’s dollars.
This is a mere 20¢/gal away from current levels. Now, the problem is that historical precedents do
not hold. Here’s why: Dating back over the past 60 years, the 12 months leading into all-time peak
for oil prices in 2008 was punctuated by the trough in US household savings rates at 3.5%. This is
less than half of the historical average of 8.3% and current levels of 7.8%. Put simply, the US
consumer was never more financially vulnerable to record gasoline prices than in 2008.