The Good News On Oil

Crude oil has so far not reached the heights expected by industry insiders, including senior executives at Exxon Mobil (XOM) and Chevron (CVX). The reasons include China’s decision to stop building its inventories, which reduced demand by 3-4 Million Barrels per Day (MMB/D). Their high penetration of EVs has supported a shifting from gasoline to coal as owners of hybrids shifted to recharging versus refueling at the pump. EV charging is up 69% year-on-year.

Carlyle (CG)’s Jeff Currie estimates China’s EV flexibility alone at 1-2 MMB/D of reduced demand for oil. China’s renewable energy strategy was always about security not climate. The world’s biggest coal consumer is switching to use more of what they have in abundance.

Some crude is getting out of the Persian Gulf under US military protection by sailing the narrow waterway on Oman’s side of the Strait of Hormuz. US Energy Secretary Chris Wright said last week that ship traffic had “increased very meaningfully” over the past week or two.

Shipping experts worry about a collision on a route that in places is as little as 800 meters wide. US exports of crude and refined products such as jet fuel have increased by 2-3 MMB/D, albeit made possible mostly by withdrawals from our Strategic Petroleum Reserve rather than increased production.

Europeans are driving less, another example of demand destruction.

The crude market has shown more flexibility than many expected. But many of the buffers against a shock are eroding. It still seems to us that a bet on higher oil prices offers an asymmetric risk/return. And once normal shipping resumes, there will likely be a rush to replenish inventories in case hostilities flare back up.

Jeff Currie remains bullish on crude oil. Inventory drawdown and China’s shift away from oil can’t be repeated, and the northern hemisphere is heading into seasonally strong demand (“the summer driving season”).

The equanimity of the oil market’s response will erode over time, with the US and Iran both betting that they can outlast the other. It’s no coincidence that last week’s resumption of US bombing closely followed the 4.2% CPI report. The Commander in Chief is getting frustrated. Interest rate futures reflect the possibility of a rate hike later this year. The ECB just raised rates.

Thursday’s canceled capture of Kharg Island on reported progress in talks had less of an effect on crude prices than previous similar announcements. As much as algorithms react instantly to the president’s social media updates, the persistent inability of both sides to agree must be reducing the perceived value in such trades.

While a peace agreement remains elusive, albeit apparently close once again according to presidential tweets, the positioning of US LNG exporters is steadily strengthening. Qatar was the world’s #2 exporter last year, behind the US and ahead of Australia. Since declaring force majeure in March, a handful of LNG tankers that were already loaded have left Qatar and made it through the Strait.

The most optimistic forecast sees operations resuming at Ras Laffen and reaching 80% of pre-war capacity by late August. Repairing the damage inflicted by Iranian missiles that took 20% offline is estimated to be five years away. Qatar’s plans to expand production, which drove last year’s worry of an LNG glut, are in flux. The promise of uninterrupted deliveries is no longer part of their brand.

But even this upside case depends heavily on the Strait reopening to normal traffic imminently, which it is not. It was notable on Friday that while crude prices fell on hopes of a formal truce, US LNG stocks traded up.

US LNG exporters are reportedly negotiating for better terms since hostilities began. Whether or not every pitchbook includes a map of the Persian Gulf as a helpful reminder of Qatar’s vulnerability, every potential buyer is well aware of the geography.