Q1 Starts With A Bang As Oil Inventories Draw (Commodity:CL1:COM)

Oil inventories are starting 2024 with a bang. Thanks to the cold blast last week, U.S. oil inventories fell ~21.4 million bbls.

To further fuel the oil bulls, U.S. commercial crude storage is starting off the year vastly different than last year.

Relative to 2023, we are now ~28 million bbls below last year. In our latest forecast, we are showing US crude storage falling to ~66 million bbls versus last year and 3.5 million bbls versus 2022.

Seasonally speaking, we normally see U.S. crude storage build in Q1. This was evident when this occurred last year, and we spent the rest of the year trying to eliminate that surplus.

With Q1 2024 likely to finish at a deficit and possibly below 2022 levels, it will be interesting to see what that means for: 1) U.S. crude exports and 2) where we finish the year. We know given the linefill additions since 2014, U.S. commercial crude storage doesn’t have the capability of falling below ~400 million bbls, so as we get close to that level, there’s a good chance Brent-WTI spreads will collapse, and U.S. crude exports will fall.

Translating that to the impact on the global oil markets, U.S. crude exports falling would imply tighter light sweet crude balances globally, which should translate to higher backwardation in Brent. As backwardation increases, commodity trading advisors (CTA) and quant funds alike will pile back into oil. And with positioning near record lows, this could be another tailwind for oil prices.

Source: Giovanni Staunovo, CFTC.

But what about products?

Despite the bullish changes we are seeing in crude, the most common question we seem to get is on the change in products.

Looking at gasoline, distillate, and jet fuel, you can see that 2024 is currently in line with the 5-year average, and above both 2022 and 2023.

Gasoline

Breaking down this further, gasoline and jet fuel are where the surplus is, while distillate is below the 5-year average.

Distillate

Jet Fuel

In my view, the current surplus in both gasoline and jet fuel is not of big concern.

1. Colder than normal weather influences mobility-related fuels like gasoline and jet fuel. Normalized weather will improve demand figures.
2. Seasonality explains most of the builds as year-end tax games being played by refineries.
3. Refining margins remain healthy implying that the market sees through the gimmicks going on.

Note: Please divide the figure above by 3 to arrive at 3-2-1 crack spread.

As a result, we wouldn’t be quick to judge and assume that demand is far weaker than expected. We think both the seasonality and weather have played a crucial role in boosting product storage higher. This will normalize soon.

More importantly, look ahead…

Fundamentally speaking, readers should look ahead. We see three meaningful variables that will determine the fate of the oil market going forward.

1. China’s economy.
2. U.S. shale oil production.
3. OPEC+ production compliance.

For China, the stock market has been the best sentiment indicator, and looking at the Hang Seng, it’s back near the lows we saw in 2022.

In my view, this best illustrates what’s going on in the Chinese economy. With the Chinese government now fixated on boosting the economy via stimulus, it will be important to see how the stock market reacts. For oil bulls, a recovering Chinese economy will be an important part of the 2024 demand thesis. While the expectation of growth is limited (~600k b/d), any upside surprise will be welcomed news both for the physical market and financial sentiment.

On the U.S. shale side, the current drop in U.S. oil production is temporary thanks to the freeze-off. But even if we exclude this factor, we saw U.S. oil production decline in Q1 to 12.9 million b/d.

Post-freeze-off, we see U.S. oil production recovering back to ~13.1 million b/d before gradually falling into the end of March. It will take a while before production picks back up to ~13.3 million b/d (July/August). When the consensus sees what we are seeing, sentiment will start to change about the idea that OPEC+ is losing control of the oil market.

Finally, OPEC+ compliance in Q1 is going to be better than expected.

With crude exports lower by ~800k b/d to start 2024, we think OPEC+ is committed to pushing Q1 balances to the deficit. With sentiment and positioning near all-time lows, we think the consensus remains skeptical about OPEC+ compliance. This will be resolved with time, and Q1 balances starting the year at a deficit is a good start.

Too Bearish…

As oil continues to climb the wall of worries, the consensus remains far too bearish. We think the combination of U.S. shale and OPEC+ production disappointing to the downside will further improve Q1 balances. In addition, with U.S. crude storage falling to start the year and increasing its deficit versus 2023 by mid-February, the market will start to pay attention. Fundamentally speaking, the oil market is moving in the right direction, so all that’s left is for the results to become obvious, and sentiment to change.