Schachter’s Eye on Energy: MEME Investors Move Into Oil Buying US$100 Call Options. Option Holdings Rise Five Times In Recent Weeks To 100Mb.

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Each week Josef Schachter will give you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 30 energy, energy service and pipeline & infrastructure companies with regular updates. We hold quarterly subscriber webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more

EIA Weekly Data: The EIA data on Thursday June 9th was mixed. The headline Commercial Crude Inventories data was bullish as it fell 5.2Mb to 474.0Mb as Refinery Utilization rose 2.6% to 91.3% last week (last year was 73.1% and two years ago, 93.2% as refiners ramped up for the summer holiday driving season). As a result more product was created and the bearish information was that Gasoline Inventories rose by 7.0Mb and Distillate Fuel oil volumes rose by 4.4Mb on the week. Total Stocks (excluding the SPR) rose by a whopping 15.2Mb on the week to 1.29Bb. US Crude Production rose by 200Kb/d to 11.0Mb/d reversing last week’s decline of 200Kb/d which likely fell due to the Colonial Pipeline operational problems after the ransomware attack. Over the coming months we see US crude production lifting to 11.5-12.0Mb/d as the increase in drilling activity and higher energy company cash flows are reinvested to stabilize production volumes which are still declining for many producers. 

Total Product Demand fell 7.5% last week or by 1.43Mb/d to 17.7Mb/d as the Memorial holiday  high-travel period ended. Gasoline Demand fell 7.3% or by 666Kb/d to 8.48Mb/d. Jet Fuel Consumption fell by 28% or by 409Kb/d to 1.03Mb/d. Cushing Inventories rose last week by 200Kb to 45.7Mb compared to 49.4Mb last year.

Baker Hughes Rig Data: The data for the week ending June 4th showed the US rig count fell by one rig (up two rigs in the prior week). Canada had a large 15 rig increase (up by four rigs in the prior week). Canadian activity is now up 370% from the pandemic lows of last year. There are 77 rigs working in Canada now compared to 21 rigs working last year. Of the Canadian increase there were 15 more oil rigs working last week, or 43 rigs working, up from just seven last year. In the US there were 456 rigs active, up 61% from 284 rigs working a year ago

Conclusion:

This month OPEC will increase production by 700Kb/d, after raising production by 600Kb/d in May, and then in July they plan to lift production by a further 840Kb/d. With worldwide Crude Demand now around 95-95.5Mb/d (OPEC forecast) we expect by year-end demand may rise by 2Mb/d to 97-97.5Mb/d, but not back to pre-pandemic levels of 100-101Mb/d forecast by energy bulls. The three monthly increases by OPEC should fully meet all the world’s consumption increases this year. OPEC will hold its next meeting on July 1st.

Bearish pressure on crude prices:

  1. The new Covid variant ‘Delta” is spreading around the world and is replacing the prior B.1.1.7 variant. This version from India is now the most active in the UK and has been found in 60 countries including the US. The problem with this version is that one dose of the Covid vaccines is only 33% effective against the strain. One needs two shots of the Pfizer version to get to 88% protection and two shots of the AstraZeneca to 60% effective. There was no data on the Moderna vaccine. This variant is especially virulent for young people who have not been vaccinated. To date there have been 3.74M deaths worldwide of which the US has 598K (more than have died in all the US’s foreign wars). The highest number of single day new cases is occurring now in Afghanistan and Colombia.
  2. Iran is in the final stages of talks to return to the 2015 UN nuclear deal and if an accord is completed this month or in July in Vienna, they could increase production quickly by 1.0- 2.0Mb/d to 4Mb/d up from 2.39Mb/d produced in April 2021. Iran last produced over 4Mb/d in 2016. A deal would lift current sanctions on Iran’s oil, banking and shipping sectors. Iran has been working to be able to ramp up production quickly as it has a new 1,000Km – 1Mb/d pipeline that bypasses the Strait of Hormuz. It is situated at Jask, in the Gulf of Oman. It will make shipping crude cheaper to buyers in Asian countries. China and India are expected to be the biggest buyers of this new crude supply.
  3. China wants to restrain inflation and has told industry to not raise prices or horde inventories of raw materials. As a result, imports of crude in May fell 14.6%. With the maintenance season now underway this will hold off importation of crude for another month.

Bullish pressure on crude prices:

  1. Rising vaccination levels to herd immunity level of 70% by July in the US is expected to provide a return to normal summer holidaying and energy consumption. 
  2. Weather impacts (hurricane season) should start soon in the Gulf of Mexico which would necessitate shutting in some of the offshore production. 
  3. There has been a lift in crude prices as some commentators have commented that the Iran talks are not going well and that a deal may come much later than the August prior forecast, delaying the large increase in Iranian crude volumes. 
  4. MEME madness has spread from buying stocks on margin like GameStop, AMC, Blackberry to Tuesday’s frenzy into Wendy’s which rose 26% on Tuesday and to crude oil options priced at US$100/b over the last few weeks. The popularity of US$100/b for the options is not just for 2021 but also into 2022. Nearly 100Mb of crude is now held by option traders, up five-fold in just a few weeks. Of these 15.9Mb are for the December 2021 options and 60Mb are for the 2022 December options. This non-fundamental investor mania has usually ended badly and we see this one being a bubble that, when burst, will see many books written about it. This mania appears to me to be worse than before the financial crisis of 2008 and is more like Tulipmania of the 1600’s.  

CONCLUSION: We remain skeptical of the optimism about the projected 4-5Mb/d full recovery in energy demand to 100Mb/d before year-end (OPEC forecast 99.8Mb/d). The tug of war between the normal summer holiday travel demand pick-up and the 3-4Mb/d increase in crude oil supplies this year remains the key determinant of future energy consumption and crude oil prices. We see demand picking up by around 2Mb/d before year-end which is less than the amount of production that will be brought on by OPEC alone. Between some OPEC cheating and Iran adding 1-2Mb/d by August (if a deal is concluded), the additional product will be in excess of current demand and will build inventories. This would endanger the OPEC bullish scenario.

WTI crude oil prices rose above US$70/b (first time since October 2018 – today US$70.08/b) and are now in a mania level. We see crude topping in the US$68-72/b area and a decline below US$66/b should start the corrective phase we have been forecasting. The current enthusiasm by hedge fund futures traders and now MEME speculators for the sector, appears to be like that seen in late 2018 when crude oil prices rose to US$76.90/b in September and three months later had declined to US$42.36/b, down by 45%. The price of crude now is above the pre-pandemic price of early 2020, yet demand is 4-5Mb/d less and production is ramping up by 2.1Mb/d from OPEC alone. This does not make sense! 

Energy Stock Market: The S&P/TSX Energy Index trades currently at 139. A close below 130  should initiate the next sharp decline. An initial downside target after such a breach is the 100 area. The expected general stock market weakness would be the catalyst for the energy sector to lose its current momentum and back off meaningfully.

Subscribe to the Schachter Energy Report and receive access to our two monthly reports, all  archived Webinars, Action Alerts, TOP PICK recommendations when the next BUY or SELL signal occurs, as well as our Quality Scoring System review of the 30 companies that we cover. We go over the markets in much more detail and highlight individual companies’ financial results in our reports. If you are interested in the energy industry this should be of interest to you. 

I was interviewed by Mark Bunting (formerly of BNN/Bloomberg) for his Uncommon Sense Investor product. The video interview on the energy sector can be seen on their website (uncommonsenseinvestor.com) or our own website where we have a link to the different interview sections. For long term investors this product should be one you access regularly to see interviews of knowledgeable players in different sectors of the markets, market overview or macro input.

We completed our review of 14 energy, energy service companies for our June Interim Report that will be released on Thursday June 10th. If you want to access this report and to become a subscriber go to https://bit.ly/3jjCPgH to subscribe. Our next quarterly webinar is now scheduled for Thursday August 12th.

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