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Oil prices could not shake off the potential ramifications of the downgrade of the US credit rating by Fitch as it increased the risk that US government spending would have to slow or we are headed on a path of fiscal suicide. Even the ominous 17.0 million barrel crude oil draw, reported by the Energy Information Administration, the largest weekly draw in history, was not enough to keep the highs for this year as the market has been very sensitive to macro considerations. Now the market will have to balance macro fear against supply concerns as we should see them tangent significantly in the coming months.

Distillate inventories globally are again the number one concern. The EIA reported that, “Distillate fuel inventories decreased by 0.8 million barrels last week and are about 15% below the five-year average for this time of year. That is not good because even as we have seen a slowdown in US manufacturing, the diesel supplies are way too tight.

John Kemp at Reuters wrote that, “U.S. manufacturers reported another decline in activity in July 2023, but industrial electricity and especially diesel consumption have declined less than expected in recent months, explaining why prices remain relatively firm. The Institute for Supply Management’s purchasing managers index increased slightly to 46.4 (13th percentile for all months since 1980) in July from 46.0 (11th percentile) in June but down from 52.8 (51st percentile) a year ago. Despite the improvement, the manufacturing index has been below the 50-point threshold dividing expanding activity from a contraction for nine months since November 2022. The length of the downturn already puts it somewhere between a mid-cycle slowdown (generally eight months or fewer) and a full cycle-ending recession (generally 11 months or more). If the slowdown proves to be a “soft landing”, it is already the second longest mid-cycle slowdown after the Second World War, exceeded in duration only by the slowdown in 1995/96, which lasted a total of 10 months. The forward-looking new orders component remained weak, indicating the downturn is likely to last for several months more, which is likely to make it the longest on record. The new orders index was stuck at 47.3 (13th percentile) in July up from 45.6 (9th percentile) in June but still down from 48.0 (16th percentile) a year earlier.

But he points out that Industrial electricity use and distillate fuel oil consumption are both correlated with the manufacturing and freight cycle and therefore with the purchasing managers index. Both have fallen much less than expected given the length and apparent depth of the downturn in industrial activity, especially in the case of diesel and other distillate fuel oils. Based on the most recent data available, industrial electricity consumption was down by only -1.3% in the three months from February to April compared with the same period a year earlier.

Distillate fuel oil consumption actually rose by almost +0.8% in the three months from March to May compared with a year earlier. The change in apparent distillate consumption was in the 44th percentile for all three-month periods since 1980 which is not consistent with an industrial recession. The strength of domestic distillate consumption helps explain why fuel oil inventories have remained well below the prior ten-year seasonal average. The resilience of industrial electricity use and especially apparent distillate fuel oil consumption may indicate the ISM manufacturing index is overstating the depth of the downturn.

While the ISM may be overstating the downturn in manufacturing, the EIA has been understating US gasoline demand. The EIA reported that total motor gasoline inventories increased by 1.5 million barrels from last week and are about 6% below the five-year average for this time of year.

Total oil product demand passed on supplied over the last four-week period averaged 20.2 million barrels a day, up by 1.4% from the same period last year. Over the past four weeks, motor gasoline products supplied averaged 8.8 million barrels a day, up by 3.0% from the same period last year. Distillate fuel product supplied averaged 3.5 million barrels a day over the past four weeks, down by 3.5% from the same period last year. Jet fuel product supplied was up 7.0% compared with the same four-week period last year.  

The break in oil prices should also increase the odds that OPEC Plus will do what everyone expected they would do anyway and that is extend their production cuts. Bloomberg reports that the joint Ministerial Monitoring Committee is to meet on Friday and traders expect Saudis to extend the 1 million b/d cut into Sept.

US petroleum exports surged last week to a near-record 11,779 million barrels a day. It was led by 5,283 million barrels of crude oil a day.

The US Fitch downgrade did slow the oil market’s momentum, but the risks are still on the upside. Look for consolidation trade to build a base for the next leg up.

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