Posted by & filed under Daily Intelligence Briefing, Energy.

Daily Intelligence Briefing

Thursday, April 4, 2024

Identifying Change-Driven Investment Themes

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.


I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Strong US Export Growth and Geopolitical Risks Ramp Up Oil and Gasoline Prices, SPR Re-Fill May Skid to Halt

Summary: Both crude oil and gasoline prices touched multi-month highs this week, likely induced by narrower inventories of petroleum products and increasing exports out of the US. More gasoline has been drained from American commercial stockpiles in the past nine weeks than in any other identical period throughout the past five years and overseas shipments are likely being boosted by an ongoing suspension of Russian gasoline exports. Increasing international needs for gasoline are weighing on narrower crude output growth in North America.


The wars in Gaza and Ukraine are each providing bullish catalysts for oil futures, particularly a wave of ongoing drone strikes that have targeted almost half of Russia’s major oil refineries. With these geopolitical issues largely outside of the White House’s control, the Department of Energy has decided it will cancel the acquisition of 3 million barrels of oil meant to be delivered to the Strategic Petroleum Reserve (SPR) later this year. The administration has had to balance their desire to re-fill the relatively thin SPR with the risk that their buys could stoke oil demand and increase prices, but futures have now risen too far above a $79.00 per barrel target to maintain its repurchase schedule.


Related ETFs: Energy Select Sector SPDR Fund (XLE), Invesco DB Oil Fund (DBO), United States Gasoline Fund, LP (UGA), United States Natural Gas Fund, LP (UNG)

McAlinden Research Partners is offering a complimentary 60 day subscription to receive the full Daily Intelligence Briefing to Hedge Connection clients/friends.

Activate your Free Trial now

International benchmark Brent crude oil futures closed north of $89.50 per barrel yesterday evening, a five-month high. At the same time, GasBuddy indicated that national average gasoline price across the US reached a six-month high of $3.58 per gallon, up by more than 2% YoY. Gasoline retailers tracked by the EIA are selling for slightly less at $3.52, but this figure has still risen almost 14% in the year-to-date period. Narrowing petroleum product inventories appear to be igniting a fire under energy prices.


US gasoline inventories fell for the eighth time in nine weeks throughout the seven days to March 29, decreasing by -4.256 million barrels. More gasoline has been drained from commercial stockpiles in the past nine weeks (-26.318 million barrels) than in any other identical period throughout the past five years. MRP has suggested before that the ongoing drain of American gasoline stockpiles can be partially ascribed to an increased pace of exports recently. That may be bolstering oil futures in spite of a net increase in US inventories of crude oil throughout 2024. New EIA data shows total US exports of finished motor gasoline in the six months to January reached their highest level since April at 156.2 million barrels.


Deep declines in gasoline stocks mean that higher levels crude oil will need to be processed to fill the gap, but US exports of crude oil have also been surging lately. The six-month sum of overseas shipments rose to an all-time high of more than 765.4 million barrels in the latest data release. Though the US is on track to produce more crude oil in 2024 than in any other year before it, the share of monthly exports relative to output remained very elevated at 32.3% in January. December’s export/production ratio was calculated at a record 34.0%.


Throughout the past several months, MRP has repeatedly highlighted an ongoing wave of drone attacks that have now targeted almost half of Russia’s 32 major oil refineries, reducing Russian oil refining capacity by 14%, and has resulted in an ongoing suspension of the country’s fuel exports until at least September. We’ve posited that these disruptions could be exacerbating already elevated demand for US gasoline exports, pushing energy prices up further. In March, it was reported by the Financial Times that the US was urging Kyiv to halt attacks on Russia’s energy infrastructure, due to the risk of retaliation against energy infrastructure relied on by Ukraine’s western allies – which has now come to pass in Russian missile bombardments of underground natural gas storage in Ukraine. Further targeting of critical pipelines that run through Russia and Ukraine could still be on the table. 


Ukrainian officials have dismissed any concerns about their strategy, continuing their regime of unconventional warfare against one of Moscow’s primary sources of revenue by hitting Russia’s third-largest refinery with a long-range drone strike this week. Reuters reporting suggests this latest operation may not have been the most devastating in terms of material damage, but it showed Ukraine’s special forces have the capability to reach targets as deep as 1,300km behind Russia’s border. Previous drone strikes on Russian energy infrastructure had only reached a maximum distance of approximately 850km.


The FT noted that the White House has become “increasingly frustrated” by the drop in oil and gasoline output that will likely put further strain on global supplies in the midst of an election year for the incumbent President. Oil prices are also being bolstered by building tension in the Middle East, as Israel’s war in Gaza and air strikes on regional adversaries like Syria and Lebanon are stoking increasingly aggressive rhetoric from Iran. If geopolitical developments outside of the White House’s control will not play out in the US’s favor, the administration appears to be taking some action domestically to wrangle rapidly increasing energy prices, which not only carry electoral implications, but threaten to derail the nation’s progress in bringing down inflation.


US Energy Secretary Jennifer Granholm stated earlier this month that the government has secured a total of 30 million barrels in repurchases for the country’s Strategic Petroleum Reserve (SPR), which has received delivery of 16.9 million of those barrels over the past eight months. However, the Department of Energy (DoE) has announced that solicitations for a further 3 million barrels, slated for delivery in August and September, would not be awarded due to prices rising too far above the price level targeted by the administration. The White House had originally planned to begin re-filling the SPR for less than $72.00 per barrel in 2022, but that target became untenable and was raised to $79.00 in 2023. Now that US benchmark WTI crude futures have jumped past $86.00 per barrel in recent days, it appears the administration has become concerned about the amount it is spending to rebuild its relatively narrow crude reserve, as well as their own impact in supporting higher prices if they continue buying several hundred thousand barrels per week. 


More than 291.0 million barrels had been drained from the SPR between the start of 2021 and July 2023, so the small amount of re-filling that has been done is only canceling out less than 6% of those releases. The US did cancel the congressionally-mandated sale of 140 million barrels from the SPR that were meant to take place between 2024 – 2027, but the reality is that the reserve is comprised of 363.6 million barrels today, down -43% from 638.0 million at the end of 2020. Until the SPR is sufficiently re-filled, the US’s thinner cushion to deal with an energy emergency, like the beginning of Russia’s formal invasion of Ukraine, remains a risk factor for energy prices.


As MRP noted in March, energy firms with significant US exposure have recently managed to capture a larger portion of global market share without adding a particularly large amount of new production on top of what was already available to them at the start of the decade. This has been beneficial for big oil firms, which have recently been buying up more resources at a record pace – likely to increase their hold on overall output levels. We have repeatedly posited that the consolidation of the world’s output capacity, particularly that of the US’s shale resources, around among a smaller number of large firms could end up keeping prices elevated for a longer period of time – especially if those firms are concerned with keeping their lucrative oil and gas businesses running for a long time. The shale boom of the mid 2010s was spurred by a tsunami of smaller producers pouring into the fracking business to scale up production, but many of them were run out of business by years of losses and the crushing impact of COVID-19’s oil price collapse.


Oil majors have helped to raise the US’s weekly field production of crude by as muhc as 1.5 million barrels per day (bpd) since the start of 2022, but this jump mostly represented a recovery to pre-pandemic levels of production at 13.1 million bpd. Record production figures reached near the end of 2023 were just 200,000 bpd above that threshold and weekly output has only fallen this year. In other words, it took the US more than three years just to recover production lost as a result of the more than 100 bankruptcies that hollowed out the American oil and gas industry in 2020 alone. Further, the EIA has recently suggested production of US crude will not grow at all in 2024. In fact, it said a new record level of production may not be reached until 2025.


The syndicate of OPEC+ members led by Saudi Arabia and Russia recently agreed to extend ongoing voluntary oil output cuts of 2.2 million bpd into Q2. Iraq, UAE, Kuwait, Kazakhstan, Algeria and Oman will also be continuing reductions in smaller amounts. Moscow will cut its oil production and exports by an extra -471,000 bpd in the second quarter, compounding the material drop in fuel supplies flowing out of the country recently. In January, Saudi Aramco announced plans to slash future production capacity from 13 million bpd to 12 million bpd, eliminating a massive pile of spare volume that was expected to be brought online by 2027. This move is likely reflective of the Kingdom’s need for higher prices to sustain its fiscal budget.


The production goals of western fossil fuel producers appear to have shifted significantly over the past couple of years as well. According to reporting from Barron’s, compensation packages at energy majors have cut incentives for energy executives to prioritize production and boosted their pay for pumping cash instead. In 2019, production goals made up about 15% of executive compensation incentives, according to Morgan Stanley analyst Devin McDermott. By 2022, production made up just 6% of the packages. Meanwhile, the percentage for hitting free cash flow goals rose to 18% in 2022 from about 7% in 2019. That inversion is a break from historical trends and coincides with heavily criticized spending on buybacks, dividends, and other shareholder payouts over the last year.


MRP added LONG US Energy to our list of Active Themes on December 20, 2023. Since then, the Energy Select Sector SPDR Fund (XLE) has returned 15%, outperforming an S&P 500 gain of 11% over the same period.


There is much more to this report! McAlinden Research Partners is offering a complimentary 60 day subscription to receive the full Daily Intelligence Briefing to Hedge Connection clients/friends.

Activate yours by signing up today

Leave a Reply

Your email address will not be published. Required fields are marked *