Commodities Monthly Update - May 2023
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TLDR
Developments this month:
Balance POV
We see the balance in both EoS tightening precipitously as OPEC production cut came into play and China demanded more crude. Balance in WoS also tightened moderately as Norwegian export fell.
Supply
OPEC
Supply from AG dropped sharply (-1413 kbd MOM), which is a signal of the OPEC production cut slowly kicking in. Reduction in AG exports contributed to tightening supply in EoS. As Saudi announced a unilateral cut at 1 million bpd taking effect from July, exports are expected to drop further.
Russia
Though Novak claims to have fully enforced the oil output cuts, Russian crude exports rose moderately (+391 kpd MoM), most of which has gone to East Asia (+387 kbd MoM). Nonetheless, revenue from oil and gas shrank by over a third in the past month. To finance its war on Ukraine, Russia may have exported as much crude as they could. Therefore, Russian exports have marginal room to rise, if it has not plateaued yet.
Venezuela
Chevron estimated that it can increase production to 200 kbd without new capex in May, but the number was later revised to 150 kbd. Venezuela has severe problems with infrastructure disrepair, which limit the production capacity. The navigation channel limits the oil tankers Chevron can employ to ship out the oil while the storage facility is also in poor condition.?
Iraq
Flows of kirkuk crude, which amounted to 400 kbd, were halted by legal dispute. And the prospect of resumption remains uncertain with Turkey’s runoff election, pending on the result of the 2nd presidential vote. Prolonged suspension may cause Iraq to ultimately cut crude production.
Demand
China
The rising demand in EoS is largely attributable to the surge in China exports (+1130 kbd MoM). This is in line with the better-than-expected Caixin PMI release which reflects the health of the private sector more truthfully than NBS PMI. The moderate recovery also suggests that the voluntary cut may be aimed at supporting oil prices rather than respond to further weakening demand.
US Gasoline Demand
Conventionally, the US’ summer driving season has brought about significant gasoline demand.? However, despite gasoline inventory levels in the US being lower than the 5-year average and refinery outages being at a seasonal low, the M1 RBOB cracks at $26.1/bbl are not nearly as high compared to $49.7/bbl during the same week last year. Furthermore, with Brent prices for August delivery falling further to $72.60 a barrel (at the time of writing), it is unlikely we will see RBOB cracks recovering to the heights of 2022.
Gasoline demand has also been restricted by the growing adoption of electric vehicles (2.3 million electric cars sold in the first quarter of 2023, representing a 25% increase compared to the same period last year). In tandem with a strengthening USD, owing to the certainty brought about by advancements in the US’ bipartisan debt ceiling bill, and a potential impending rate hike, foreign demand for US gasoline is likely to decrease.?
Additionally, with RON92/RBOB cracks growing more negative, we may see US increasing imports from the East, following the trend across the last 2 years. Furthermore, the East has seen increasing supply, primarily due to China’s new 9 million export quota. As long as freight rates allow for profitable arbitrage, we expect the US to continue importing Eastern gasoline, thereby driving down US gasoline prices further. Hence, we believe M1 RBOB cracks will continue being under pressure with little room for growth, as a result of an underwhelming summer season demand.
Macro POV?
US Debt Ceiling and FOMC Meeting Update?
What changed?
领英推荐
On 27th May 2023, the US administration made a deal to suspend the $31.4 trillion debt spending limit until 2025 but caps federal spending for the next 2 years. This deal is known as the Fiscal Responsibility Act of 2023. Initially, the Republicans wanted an overall freeze on the spending limit for 10 years except for a rise in defence spending. On the other hand, the democrats wanted more spending in non-defence areas. Both sides came to a conclusion and the bill passed the house on 31st May and the senate on 1st June. Brent futures rose by 2.49% to $76.13 a barrel and U.S. West Texas Intermediate (WTI) crude rose 2.34% to $71.74 a barrel. The bill extinguished a potentially catastrophic first-ever default on the US government bonds, in turn rejuvenating confidence in the market, as reflected by the increase in crude prices.?
Key points from the bill include modest steps to speed up reviews of federal permits under the National Environmental Policy Act and no changes to the $369 billion clean-energy incentives under the Biden’s Inflation Reduction Act. These steps would expedite both fossil fuels and clean energy projects such as the Mountain Valley natural gas pipeline project. However, the US debt is 115% of its GDP. A rapid rise in debt could create fictional wealth growth due to a rapid rise in liquidity, thereby causing inflated asset prices. Therefore, the money spent on assets does not increase real future value which will depress real income within the economy.??
Fed hikes due to high inflation
The US employment increased more than expected in May which signals a strong labour market. Furthermore, the yield on the two-year Treasury note was down 0.11% to 3.86%. This shows that investors are probably betting that the Fed might be reaching its end of their interest rate hikes. However, data from the FOMC meeting contradicts this view.?
The FOMC concluded that the economic activity expanded at a modest pace in Q1 2023 and that job gains have been sturdy over the months, as seen from Q1’s considerably low unemployment rate. With the stubbornly high inflation, they have decided to raise the target range for the federal funds to 5% - 5.25%. Ensuing credit conditions tightening for households and businesses are likely to weigh on economic activity.
In the long run, reduced demand for raw materials can be expected along with a downward pressure on oil prices. This leads to a more stable and predictable price movement, resulting in lower oil volatility.
Due to the decreased volatility in the oil market, we can expect reduced speculative trading. Such drop in volatility also influences hedging strategies as there would now be a lesser urgency to engage in hedging strategies to mitigate price fluctuations.?
June’s Expectations
Moving into June, albeit the strong job growth of 339000, well above the projected 294000, we do not expect the Feds to hike rates once more. While non-farm payrolls have risen, the unemployment rate has also increased to 4%. Such contradictory data can be accounted for by individuals switching to traditional jobs, instead of gig jobs or other forms of self-employment. Overall, there is a net increase in the number of unemployed individuals, which should limit the average individual’s spending power. Furthermore, with food and energy prices on the decline, inflation should come down naturally, as long as the Feds maintain their current interest rate levels. Given the expectation that the Feds plan to pause rate hikes, we expect crude prices to rally slightly.
OPEC’s Saudi Arabia voluntary production cut
During the June 4th meeting in Vienna, Saudi Arabia announced further voluntary output cuts of 1 million barrels per day in July, bringing down total output from 10 million bpd to 9 million bpd. This came after April’s surprise announcement by OPEC+ of cuts around 1.66 million bpd, driving Brent prices about $9 higher to $87 per barrel. However, prices were unable to sustain above $80 and fell to a low of $71.5 in May, on track for its worst month since September 2022.?
Crude oil prices surged initially following the Saudi announcement, but gave up most of its gains during the day, signaling cautious market sentiment as investors weighed the unilateral 1 million bpd production cut against persistent demand concerns. Furthermore, this price reaction could also mean that there is less confidence in OPEC’s ability to control the markets, due to disputes amongst members in the group and Saudi acting alone in cutting its own supply. Compared with the previous announcement in April whereby 1.66 million bpd cut is contributed by various members and would extend till 2024, the newly announced production cut by Saudi Arabia is only for a month in July. Therefore, this has caused optimism to fade quickly which is reflected in recent price movements.
The group also lowered targets for Russia, Nigeria, and Angola to ensure better alignment with actual production levels, while UAE was allowed to raise output targets by 0.2 million bpd to 3.22 million bpd. The 3.66 million bpd cuts that were initially valid till end 2023 will be extended into 2024, while also agreeing to reduce the cartel’s overall production ceiling by 1.4 million bpd to 40.46 million bpd starting Jan 2024.
This OPEC cut further tightens supply in the East of Suez, with China & India still large buyers of Middle Eastern crude, though relinquishing some market share due to cheap Russian crude.?
China
Shrinking manufacturing and services PMI numbers
China’s official manufacturing PMI numbers fell to a five-month low of 48.8, down from 49.2 in April and below the 50-point mark that separates expansion from contraction.?
Conversely, the Caixin PMI indicates manufacturing has entered the growth zone in May, rising from 49.5 in April, to 50.9 in May.?
We see a similar trend with China’s services data, as official services PMI fell to 54.5 in May from 56.4 in April, while the Caixin services PMI increased from 56.4 in April to 57.1 in May.?
The difference in PMI numbers stems from the different survey methodologies used. The official PMI is tilted toward larger state-owned enterprises (SOEs), while the Caixin PMI is more focused on the export sector and small and midsize enterprises (SMEs).?
This suggests that larger state-owned firms are facing the bulk of the economic headwinds. Given that state-owned firms account for a significant proportion of China’s crude demand, we expect China’s crude oil imports to decrease moving into Q3, especially in the midst of a global economic slowdown, where the demand for Chinese exports should see a consistent decline. Additionally, economists warn that pent-up demand for in-person services may be capped by slowing income growth and mounting unemployment, thereby painting a less optimistic picture for expansion in the services sector.
China industrial output falls short, economic recovery losing steam
China’s industrial outputs in April have fallen short of expectations, weakening China’s re-opening recovery narrative. Industrial production was up 5.6% from April 2022, well below the expected 10.6% rise. Furthermore, industrial profits tumbled by 18% in April as profits sagged for 27 of 41 major industrial sectors, with the ferrous metal smelting and rolling processing industry reporting the biggest slump at 99.4%.
A further decline in property investment also adds to concerns about the outlook for the economy. With the excitement of China’s reopening finally dying down, “hope of further sentiment repair could be diminishing in the absence of decisive government actions”, as mentioned by Citi’s chief China economist. This has resulted in certain investment banks revising down their 2023 China growth forecasts after the April data was released, with Nomura and Barclays lowering their predictions to 5.5% from 5.9%, and 5.3% from 5.6% respectively.
China's state banks told to lower cap on dollar deposit rates
A self-regulatory body overseen by the country's central bank has told major state-owned banks to lower dollar deposit interest rates. The interest rates are now capped at 4.3%, which is 100 basis points lower than the previous cap of 5.3%. This incentivises exporters to settle foreign exchange receipts in yuan instead of the dollar, increasing demand for and potentially strengthening the yuan. The interest rate cap was a rare attempt to bolster Chinese yuan, and could highlight the strong bearish sentiment over the yuan. This combined with weakening industrial outputs yield an overall bearish outlook on China’s economic recovery.