Month: July 2022

One of the ways central banks break the ice to markets is via their research. While said research is not the official opinion of any Central Bank, it is nevertheless an outcome that is likely to happen.

Research from the Federal Reserve Bank of NY (link here) suggests that a recession is almost certain. And I quote from their most recent blog post:

“The model’s outlook is considerably more pessimistic than it was in March. It projects inflation to remain elevated in 2022 at 3.8 percent, up a full percentage point relative to March, and to decline only gradually toward 2 percent thereafter (2.5 and 2.1 percent in 2023 and 2024, respectively).

This disinflation path is accompanied by a not-so-soft landing: the model predicts modestly negative GDP growth in both 2022 (-0.6 percent versus 0.9 percent in March) and 2023 (-0.5 percent versus 1.2 percent).

So, the NY Fed tells us to expect about 2 years of negative growth to the tune of about -0.6% and 0.5% for 2022 and 2023 respectively. This is a huge downward revision from just 1 month ago.

According to the model, the probability of a soft landing—defined as four-quarter GDP growth staying positive over the next ten quarters—is only about 10 percent.

Conversely, the chances of a hard landing—defined to include at least one quarter in the next ten in which four-quarter GDP growth dips below -1 percent, as occurred during the 1990 recession—are about 80 percent.”

So, not only is a soft landing unlikely, but a hard landing is almost a sure thing according to the NY Fed’s model. On the other hand, the Atlanta Fed’s GDPnow model (as of the date if this article) is forecasting 2nd quarter GDP lower about 1-2%.

The above wording confirms my suspicion that the US economy is in worse shape that what Mr. Powell is telling us, and that achieving a soft landing is far-fetched.

United States Michigan Consumer Sentiment

The above chart depicts consumer confidence in the US. Please note that the reading is at an all-time low. In fact, lower than the 2008 crisis and the 1980’s recessions. The Fed tells us that this is because of high inflation. While there is some truth to this, I suspect there is more to it.

Now let’s look at some charts of the US consumer and the US economy that the Fed is about to technically crash. Personal saving levels during the pandemic have been depleted and are now back to 2013 levels.

The chart below depicts the Personal Savings rate defined as personal saving as a percentage of disposable personal income. As the charts shows, the personal Savings rate has returned to 2008 levels.

During the pandemic the talk of the town was that consumers used the free cash to pay off debt. While that was true for a while, today short-term consumer debt (mostly credit cards) is at a new high. Please note this debt carries a very high interest rates, that will only go higher as the Fed continues to raise rates.

Finally, something else that will not help consumers is their mortgage payment. It’s amazing that the average 30-year fixed mortgage rate has almost about doubled over the past year.

The takeaway from the above charts is that consumers in the US are not as strong as the mainstream media would like us to believe. And in my opinion the Fed is making a huge gamble with its current policy, because like I said in previous posts, current inflationary pressures are not the result of monetary policy. The Fed can’t do anything about stopping a war, energy costs, and supply shocks because of the pandemic. Finally, the Fed has no control over politics (the tug of war between China and the US being an example).

However, politics being what they are, there is a lot of pressure from US politicians towards the Fed to do something about inflation. As such the Fed has decided to take the traditional stance of raising rates until the US economy breaks. And chances are the US is already in recession as many analysts think.

So, what will markets do?

As is well known, markets are forward looking. Meaning, what is priced-in today mostly reflects what markets think might happen in the future. As such, this also means that while the economy might still be sluggish, or be in a recession, it is possible for markets to bottom and even rally. But in order to call any kind of bottom, we must know where we stand insofar as what the market has priced in.

What has the market priced in?

The truth is that the market has priced in a lot. The chart below from Bloomberg shows that we have witnessed the greatest and the fastest multiple compression ever.

Another way of looking at the multiple compression is the forward multiple of major US indexes.

The above chart comes from Professor Yardeni and is indicative of the compression described above. The eyeopener is the S&P Small cap index that went from a forward multiple of 27 in 2020 to about 11 today.

With multiples down so much, one can make the case that current valuations are appropriate for building positions. The only variable we don’t know is how bad things might get as a result of the Fed’s monetary policy.

A multiple compression simply means equities have gone down. But if EPS estimates start to come down also, then equity prices might have further to go to the downside.

Inflation needs to be on a downward trajectory.

Inflation does not need to come down to 2% in order for markets to bottom or rally. All is needed are lower prints over the course of several months. Once this happens, I think inflation will not be a concern anymore. And while I think inflation has peaked, we need a confirmation of the trajectory.

Oil is by far the biggest component of current inflationary pressures. The problem is that the $30-$50 oil premium embedded in current prices (depending on who you ask) is also a function of the Russian-Ukraine conflict. Currently there is no way to determine when this conflict will end, or when oil production will increase, or when refining capacity will meet demand. As such inflation as a function of oil prices is a big unknown.

On the bright side inflation expectations, as measured by the 10-Year Breakeven Inflation rate at the St. Louis Fed’s site, shows expectations are coming down.

In fact, expectations are not that higher than in 2018, and overall are trending at about the average over the past decade.

Quantitative tightening

Perhaps the greatest headwind for markets is the contraction of the Fed’s balance sheet. This contraction goes by the code-name QT, or quantitative tightening. The Fed has stated it intends to reduce its balance sheet by about $2-3 trillion (some say even more). What this essentially means is that $2-3 trillion of illiquidity will disappear, cease to exist.

It is without a doubt that QE (quantitative easing) was responsible for some part of the market rally since the pandemic. I fact it is estimated the correlation between US markets and QE is about 0.92%. In other words, for every dollar of QE the market cap of US markets increased by 92 cents. Now that the Fed aims to reduce its balance sheet, it is likely that markets will be hard pressed against a shrinking liquidity pool. And because markets go to extremes, we might be in the middle of a multiple contraction that might surprise us.

The bottom line

The Fed has become extremely hawkish and aggressive in its monetary policy stance, with a total disregard for the US economy, but also the global economy. The strong dollar acts both as a headwind for US earnings (estimated to be about 8% lower because of the strong dollar), but also causes tightened financial conditions on a global scale. It is very hard to be bullish with such strong headwinds.

While current equity valuations are more than fair, if EPS estimates are revised downward, US and other major markets might have another leg down. So far EPS estimates have not changed, but the possibility of downward revisions are high.

However, at the end of the day what matters is what the Fed will do. If the Fed raises interest rates another 75 basis points, and then pauses, chances are that markets will stabilize or even rally. This despite the harsh economic reality of a recession in the US and Europe.

If on the other hand the Fed insists on raising rates much higher, as has been indicated by chairman Powell, then chances are that downward EPS revisions might take equities another leg down, and bonds will probably take another hit also.

As such, we continue to have a very defensive investment stance, characterized by very high cash levels, but being vigilant of opportunities as they arise. At the same time, we are closely following monetary policy which might give us clues if the US and Europe enter recession or not, and any change in monetary policy that might act as a catalyst for equities during the next quarter.

One of the ways central banks break the ice to markets is via their research. While said research is not the official opinion of any Central Bank, it is nevertheless an outcome that is likely to happen.

Research from the Federal Reserve Bank of NY (link here) suggests that a recession is almost certain. And I quote from their most recent blog post:

“The model’s outlook is considerably more pessimistic than it was in March. It projects inflation to remain elevated in 2022 at 3.8 percent, up a full percentage point relative to March, and to decline only gradually toward 2 percent thereafter (2.5 and 2.1 percent in 2023 and 2024, respectively).

This disinflation path is accompanied by a not-so-soft landing: the model predicts modestly negative GDP growth in both 2022 (-0.6 percent versus 0.9 percent in March) and 2023 (-0.5 percent versus 1.2 percent).

So, the NY Fed tells us to expect about 2 years of negative growth to the tune of about -0.6% and 0.5% for 2022 and 2023 respectively. This is a huge downward revision from just 1 month ago.

According to the model, the probability of a soft landing—defined as four-quarter GDP growth staying positive over the next ten quarters—is only about 10 percent.

Conversely, the chances of a hard landing—defined to include at least one quarter in the next ten in which four-quarter GDP growth dips below -1 percent, as occurred during the 1990 recession—are about 80 percent.”

So, not only is a soft landing unlikely, but a hard landing is almost a sure thing according to the NY Fed’s model. On the other hand, the Atlanta Fed’s GDPnow model (as of the date if this article) is forecasting 2nd quarter GDP lower about 1-2%.

The above wording confirms my suspicion that the US economy is in worse shape that what Mr. Powell is telling us, and that achieving a soft landing is far-fetched.

United States Michigan Consumer Sentiment

The above chart depicts consumer confidence in the US. Please note that the reading is at an all-time low. In fact, lower than the 2008 crisis and the 1980’s recessions. The Fed tells us that this is because of high inflation. While there is some truth to this, I suspect there is more to it.

Now let’s look at some charts of the US consumer and the US economy that the Fed is about to technically crash. Personal saving levels during the pandemic have been depleted and are now back to 2013 levels.

The chart below depicts the Personal Savings rate defined as personal saving as a percentage of disposable personal income. As the charts shows, the personal Savings rate has returned to 2008 levels.

During the pandemic the talk of the town was that consumers used the free cash to pay off debt. While that was true for a while, today short-term consumer debt (mostly credit cards) is at a new high. Please note this debt carries a very high interest rates, that will only go higher as the Fed continues to raise rates.

Finally, something else that will not help consumers is their mortgage payment. It’s amazing that the average 30-year fixed mortgage rate has almost about doubled over the past year.

The takeaway from the above charts is that consumers in the US are not as strong as the mainstream media would like us to believe. And in my opinion the Fed is making a huge gamble with its current policy, because like I said in previous posts, current inflationary pressures are not the result of monetary policy. The Fed can’t do anything about stopping a war, energy costs, and supply shocks because of the pandemic. Finally, the Fed has no control over politics (the tug of war between China and the US being an example).

However, politics being what they are, there is a lot of pressure from US politicians towards the Fed to do something about inflation. As such the Fed has decided to take the traditional stance of raising rates until the US economy breaks. And chances are the US is already in recession as many analysts think.

So, what will markets do?

As is well known, markets are forward looking. Meaning, what is priced-in today mostly reflects what markets think might happen in the future. As such, this also means that while the economy might still be sluggish, or be in a recession, it is possible for markets to bottom and even rally. But in order to call any kind of bottom, we must know where we stand insofar as what the market has priced in.

What has the market priced in?

The truth is that the market has priced in a lot. The chart below from Bloomberg shows that we have witnessed the greatest and the fastest multiple compression ever.

Another way of looking at the multiple compression is the forward multiple of major US indexes.

The above chart comes from Professor Yardeni and is indicative of the compression described above. The eyeopener is the S&P Small cap index that went from a forward multiple of 27 in 2020 to about 11 today.

With multiples down so much, one can make the case that current valuations are appropriate for building positions. The only variable we don’t know is how bad things might get as a result of the Fed’s monetary policy.

A multiple compression simply means equities have gone down. But if EPS estimates start to come down also, then equity prices might have further to go to the downside.

Inflation needs to be on a downward trajectory.

Inflation does not need to come down to 2% in order for markets to bottom or rally. All is needed are lower prints over the course of several months. Once this happens, I think inflation will not be a concern anymore. And while I think inflation has peaked, we need a confirmation of the trajectory.

Oil is by far the biggest component of current inflationary pressures. The problem is that the $30-$50 oil premium embedded in current prices (depending on who you ask) is also a function of the Russian-Ukraine conflict. Currently there is no way to determine when this conflict will end, or when oil production will increase, or when refining capacity will meet demand. As such inflation as a function of oil prices is a big unknown.

On the bright side inflation expectations, as measured by the 10-Year Breakeven Inflation rate at the St. Louis Fed’s site, shows expectations are coming down.

In fact, expectations are not that higher than in 2018, and overall are trending at about the average over the past decade.

Quantitative tightening

Perhaps the greatest headwind for markets is the contraction of the Fed’s balance sheet. This contraction goes by the code-name QT, or quantitative tightening. The Fed has stated it intends to reduce its balance sheet by about $2-3 trillion (some say even more). What this essentially means is that $2-3 trillion of illiquidity will disappear, cease to exist.

It is without a doubt that QE (quantitative easing) was responsible for some part of the market rally since the pandemic. I fact it is estimated the correlation between US markets and QE is about 0.92%. In other words, for every dollar of QE the market cap of US markets increased by 92 cents. Now that the Fed aims to reduce its balance sheet, it is likely that markets will be hard pressed against a shrinking liquidity pool. And because markets go to extremes, we might be in the middle of a multiple contraction that might surprise us.

The bottom line

The Fed has become extremely hawkish and aggressive in its monetary policy stance, with a total disregard for the US economy, but also the global economy. The strong dollar acts both as a headwind for US earnings (estimated to be about 8% lower because of the strong dollar), but also causes tightened financial conditions on a global scale. It is very hard to be bullish with such strong headwinds.

While current equity valuations are more than fair, if EPS estimates are revised downward, US and other major markets might have another leg down. So far EPS estimates have not changed, but the possibility of downward revisions are high.

However, at the end of the day what matters is what the Fed will do. If the Fed raises interest rates another 75 basis points, and then pauses, chances are that markets will stabilize or even rally. This despite the harsh economic reality of a recession in the US and Europe.

If on the other hand the Fed insists on raising rates much higher, as has been indicated by chairman Powell, then chances are that downward EPS revisions might take equities another leg down, and bonds will probably take another hit also.

As such, we continue to have a very defensive investment stance, characterized by very high cash levels, but being vigilant of opportunities as they arise. At the same time, we are closely following monetary policy which might give us clues if the US and Europe enter recession or not, and any change in monetary policy that might act as a catalyst for equities during the next quarter.

We remain bullish on crude oil prices as the third quarter of 2022 begins in the anticipation that ongoing underinvestment conditions in the global petroleum industry, the increase in demand for gasoline and jet fuels ahead of the start of the summer vacation season, the record-low spare capacity, the Western oil embargo on Russian oil, and the tight supplies will maintain the upward trend momentum on the crude oil and refined products, despite the global economic uncertainties and the recession worries.

3-month targets:

Base scenario: We expect the Brent and WTI crude oil prices to be averaging at the $110/b key level throughout Q3 and trading into a range between $100/b-$120/b.

Bullish scenario: Brent crude oil price could revisit March 2022 highs of $140/b range on global supply tightness, up approx. 33% from the current levels of $105/b (July 08).

Bearish scenario: Brent crude oil price could trade in range between $90/b-$100/b key psychological level in case recession fears outweigh tight supply worries.

However, any briefly pullback of Brent and WTI oil prices below $100/b or even $90/b levels could be a buying opportunity given the market tightness, the underinvestment thesis, the solid fuel demand, and the ongoing geopolitical risks.

Crude oil rally hit our Q2, 2022 price targets:

We are delighted to announce that our Q2, 2022 average price projection of $100-$110/b range for both Brent and WTI crude oil contracts, which was anticipated back in March 2022 (when the oil prices were ranging between $90/b-$100/b) was realized. The Western sanctions on Russian oil and gas had a significant impact on the petroleum products, which further tightened the global supply.

Here is the link for the Crude Oil Outlook Q2, 2022: https://exclusivecapital.com/research/quarterly-outlook/crude-oil-outlook-for-q2-2022/

Analysis:

Our base-case scenario for oil prices to average $110/b for Q3, 2022 is based on the supposition that worries about a tight global supply, underinvestment in the oil and gas sector, a lack of spare capacity, potential supply disruptions due to political unrest, sanctions on Russian energy, and potential damage from hurricanes to oil and gas facilities in the Gulf of Mexico will outweigh worries that demand for petroleum products may slow in the coming months.

Key market catalysts that will boost oil prices in Q3:

Global refining capacity lost:

We think that the loss of roughly 3 million bpd of refining capacity over the past few years has been the main issue currently facing the energy market, not the low crude oil production or the conflict in Ukraine.

Due to the greater operational expenses, environmental constrains, and the decreased demand for refined goods during the Covid era, many energy corporations or refiners made the decision to close or reduce some of their outdated and unprofitable facilities during the pandemic period.

Hence, some refiners closed some of their facilities in expectation of lower refined demand in the next 10-20 years due to the green transition and the dominance of the environmental-friendly hybrid or electric vehicles, while some others have downsized refining operations to cut carbon dioxide (CO2) emissions, as part of its ambition to be a net-zero emissions business by 2050 or sooner.

On top of that, the global market had also missed the refined capacity from Russia and Ukraine due to the war and the economic sanctions, sending gasoline and diesel stockpiles to multi-year lows.

Underinvestment conditions:

The underinvestment saga in the petroleum industry in the past 5 years has been seen as one of the main reasons for the current imbalance between supply and demand in the global markets.

Even though Brent oil price briefly climbed to $140/b and WTI to $130/b at the beginning of March 2022, we haven’t seen a relative boost in the oil production from major OPEC+ producers or the U.S. shale drillers because of some major reasons such as the widespread shortages of equipment, workforce, and raw materials, at a time the supply chains delays had also increased the production costs of the wells.

The U.S. oil production remains about a million barrels daily below the record of nearly 13 million bpd the country produced in early 2020, the OPEC+ group struggles to meet its production targets due to political unrest and lack of spare capacity, at a time Russian oil output is slightly falling due to Western sanctions.

The Shale oil and gas industry has been facing certain constraints in boosting production owing to the combination of the continued attacks from U.S. President Joe Biden, the regulatory uncertainties, the huge service costs, and the supply chain issues which don’t encourage companies to invest in the exploration of new oilfields and increase their drilling activity.

OPEC+ and limited spare capacity support bullish momentum:

We expect the crude oil prices to maintain their upward price momentum in Q3 as we believe that any weak signs of fuel demand amid recession fears would be limited on the view that global supply tightness will continue since there is limited room for the major OPEC producers such as Saudi Arabia, and the United Arab Emirates to be able to raise output significantly to meet recovering demand, plus, to make up for lost Russian supply and also to cover the below-the-agreed output from other OPEC member nations.

Although Saudi Arabia and UAE are the only producers across the OPEC+ group with some little spare capacity of only 100k-150k bpd respectively, we believe that they might not want to sacrifice this small capacity to protect the market from any unexpected supply disruptions from the ongoing political unrest in Nigeria, Ecuador, and Libya or a major hurricane in the Gulf of Mexico ahead of the kick-off of the hurricane season in the U.S.

Sanctions on Russian oil and gas:

Oil prices will continue getting support from any attempt from the Western countries to pose additional sanctions on Russian oil and gas in response for the invasion of Ukraine.

The leaders of the Group of Seven rich nations, including the U.S, France, Germany, UK, Italy, Japan, and Canada promised to tighten the squeeze on Russia’s petroleum revenues with new sanctions which could limit Moscow’s ability to fund its invasion of Ukraine, that include a plan to cap the price of Russian oil and gas.

Yet, this event could benefit oil prices since crude oil could be one of the substitutes (the other is Coal) for natural gas in Europe, which struggles with significantly reduced Russian supply via the Nord Stream pipeline and sanctions.

Recovering demand:

We have signs of a faster-than-expected demand recovery for petroleum products in key fuel consumer regions such as North America and Asia despite the current economic and pandemic challenges.

The fuel demand has boosted by the massive infrastructure packages and economic stimulus, coupled with robust demand for gasoline and jet fuels moving into the summer driving and traveling season in the Northern Hemisphere.

The demand for crude oil and refined products has almost recovered to pre-Covid levels following the rapid recovery of industrial and economic activities in emerging countries in Asia, especially China and India, driven by the removal of the Covid-led mobility restrictions and the restart of the global trade.

Concerns that will cap oil price gains in Q3:

Slowing economic growth:

Energy investors will pivot away from the inflation saga to fears over a global recession in the third quarter that could suppress economic activity and reduce petroleum demand.

We expect that the aggressive monetary tightening (rate hikes) by the major central banks around the world to curb the 40-year record high inflation would lead to a slowdown in the global economic growth (soft landing) or even worst, to a recession (hard landing) during the next quarter, which in turn could harm demand for petroleum products and cap oil price gains above $120/b mark.

Global economies have already wrestled with high energy and food prices, expensive raw materials, and ongoing supply chain disruptions, which have deteriorated the investment and consumption spending sentiment.

Furthermore, a stronger U.S. dollar might also cap price gains of the oil prices, since the dollar-denominated crude oil contracts will become more expensive for buyers using other currencies.

However, we believe that the supply tightness, the lower OPEC output, the unrest in Libya, and the energy sanctions on Russia should put a floor under the price slide and prevent Brent oil prices to fall far below $100/b in case the recession fears bring a general market sell-off amid a risk aversion sentiment.

We remain bullish on crude oil prices as the third quarter of 2022 begins in the anticipation that ongoing underinvestment conditions in the global petroleum industry, the increase in demand for gasoline and jet fuels ahead of the start of the summer vacation season, the record-low spare capacity, the Western oil embargo on Russian oil, and the tight supplies will maintain the upward trend momentum on the crude oil and refined products, despite the global economic uncertainties and the recession worries.

3-month targets:

Base scenario: We expect the Brent and WTI crude oil prices to be averaging at the $110/b key level throughout Q3 and trading into a range between $100/b-$120/b.

Bullish scenario: Brent crude oil price could revisit March 2022 highs of $140/b range on global supply tightness, up approx. 33% from the current levels of $105/b (July 08).

Bearish scenario: Brent crude oil price could trade in range between $90/b-$100/b key psychological level in case recession fears outweigh tight supply worries.

However, any briefly pullback of Brent and WTI oil prices below $100/b or even $90/b levels could be a buying opportunity given the market tightness, the underinvestment thesis, the solid fuel demand, and the ongoing geopolitical risks.

Crude oil rally hit our Q2, 2022 price targets:

We are delighted to announce that our Q2, 2022 average price projection of $100-$110/b range for both Brent and WTI crude oil contracts, which was anticipated back in March 2022 (when the oil prices were ranging between $90/b-$100/b) was realized. The Western sanctions on Russian oil and gas had a significant impact on the petroleum products, which further tightened the global supply.

Here is the link for the Crude Oil Outlook Q2, 2022: https://exclusivecapital.com/research/quarterly-outlook/crude-oil-outlook-for-q2-2022/

Analysis:

Our base-case scenario for oil prices to average $110/b for Q3, 2022 is based on the supposition that worries about a tight global supply, underinvestment in the oil and gas sector, a lack of spare capacity, potential supply disruptions due to political unrest, sanctions on Russian energy, and potential damage from hurricanes to oil and gas facilities in the Gulf of Mexico will outweigh worries that demand for petroleum products may slow in the coming months.

Key market catalysts that will boost oil prices in Q3:

Global refining capacity lost:

We think that the loss of roughly 3 million bpd of refining capacity over the past few years has been the main issue currently facing the energy market, not the low crude oil production or the conflict in Ukraine.

Due to the greater operational expenses, environmental constrains, and the decreased demand for refined goods during the Covid era, many energy corporations or refiners made the decision to close or reduce some of their outdated and unprofitable facilities during the pandemic period.

Hence, some refiners closed some of their facilities in expectation of lower refined demand in the next 10-20 years due to the green transition and the dominance of the environmental-friendly hybrid or electric vehicles, while some others have downsized refining operations to cut carbon dioxide (CO2) emissions, as part of its ambition to be a net-zero emissions business by 2050 or sooner.

On top of that, the global market had also missed the refined capacity from Russia and Ukraine due to the war and the economic sanctions, sending gasoline and diesel stockpiles to multi-year lows.

Underinvestment conditions:

The underinvestment saga in the petroleum industry in the past 5 years has been seen as one of the main reasons for the current imbalance between supply and demand in the global markets.

Even though Brent oil price briefly climbed to $140/b and WTI to $130/b at the beginning of March 2022, we haven’t seen a relative boost in the oil production from major OPEC+ producers or the U.S. shale drillers because of some major reasons such as the widespread shortages of equipment, workforce, and raw materials, at a time the supply chains delays had also increased the production costs of the wells.

The U.S. oil production remains about a million barrels daily below the record of nearly 13 million bpd the country produced in early 2020, the OPEC+ group struggles to meet its production targets due to political unrest and lack of spare capacity, at a time Russian oil output is slightly falling due to Western sanctions.

The Shale oil and gas industry has been facing certain constraints in boosting production owing to the combination of the continued attacks from U.S. President Joe Biden, the regulatory uncertainties, the huge service costs, and the supply chain issues which don’t encourage companies to invest in the exploration of new oilfields and increase their drilling activity.

OPEC+ and limited spare capacity support bullish momentum:

We expect the crude oil prices to maintain their upward price momentum in Q3 as we believe that any weak signs of fuel demand amid recession fears would be limited on the view that global supply tightness will continue since there is limited room for the major OPEC producers such as Saudi Arabia, and the United Arab Emirates to be able to raise output significantly to meet recovering demand, plus, to make up for lost Russian supply and also to cover the below-the-agreed output from other OPEC member nations.

Although Saudi Arabia and UAE are the only producers across the OPEC+ group with some little spare capacity of only 100k-150k bpd respectively, we believe that they might not want to sacrifice this small capacity to protect the market from any unexpected supply disruptions from the ongoing political unrest in Nigeria, Ecuador, and Libya or a major hurricane in the Gulf of Mexico ahead of the kick-off of the hurricane season in the U.S.

Sanctions on Russian oil and gas:

Oil prices will continue getting support from any attempt from the Western countries to pose additional sanctions on Russian oil and gas in response for the invasion of Ukraine.

The leaders of the Group of Seven rich nations, including the U.S, France, Germany, UK, Italy, Japan, and Canada promised to tighten the squeeze on Russia’s petroleum revenues with new sanctions which could limit Moscow’s ability to fund its invasion of Ukraine, that include a plan to cap the price of Russian oil and gas.

Yet, this event could benefit oil prices since crude oil could be one of the substitutes (the other is Coal) for natural gas in Europe, which struggles with significantly reduced Russian supply via the Nord Stream pipeline and sanctions.

Recovering demand:

We have signs of a faster-than-expected demand recovery for petroleum products in key fuel consumer regions such as North America and Asia despite the current economic and pandemic challenges.

The fuel demand has boosted by the massive infrastructure packages and economic stimulus, coupled with robust demand for gasoline and jet fuels moving into the summer driving and traveling season in the Northern Hemisphere.

The demand for crude oil and refined products has almost recovered to pre-Covid levels following the rapid recovery of industrial and economic activities in emerging countries in Asia, especially China and India, driven by the removal of the Covid-led mobility restrictions and the restart of the global trade.

Concerns that will cap oil price gains in Q3:

Slowing economic growth:

Energy investors will pivot away from the inflation saga to fears over a global recession in the third quarter that could suppress economic activity and reduce petroleum demand.

We expect that the aggressive monetary tightening (rate hikes) by the major central banks around the world to curb the 40-year record high inflation would lead to a slowdown in the global economic growth (soft landing) or even worst, to a recession (hard landing) during the next quarter, which in turn could harm demand for petroleum products and cap oil price gains above $120/b mark.

Global economies have already wrestled with high energy and food prices, expensive raw materials, and ongoing supply chain disruptions, which have deteriorated the investment and consumption spending sentiment.

Furthermore, a stronger U.S. dollar might also cap price gains of the oil prices, since the dollar-denominated crude oil contracts will become more expensive for buyers using other currencies.

However, we believe that the supply tightness, the lower OPEC output, the unrest in Libya, and the energy sanctions on Russia should put a floor under the price slide and prevent Brent oil prices to fall far below $100/b in case the recession fears bring a general market sell-off amid a risk aversion sentiment.