When in doubt, follow the numbers. As any good analyst will tell you, the headline is always scary until you actually do the underlying analysis. In the case of the SPR announcement, ~1 million b/d for 180 days sounds like a heck of a lot of crude. Yes, it’s ~180 million bbls, but what does this mean for the oil market?
Using the current implied balance in crude of roughly -0.38 million b/d, this is what US commercial crude storage would look like for the rest of the year if the SPR release hits from May 6 to Oct. 14.
As you can see, we will be showing builds in US crude storage starting in May. Keep in mind a ~1 million b/d SPR release equates to ~7 million bbls a week, an unprecedented amount. This is going to be a bearish headwind for crude going forward.
What will this do to the oil market?
- Brent vs. WTI will further widen pushing higher US crude exports. We are likely going to hit an all-time high in US crude exports this summer.
- Refining margins are going to go through the roof. This is going to be the most profitable summer period in history for refineries in the US and Canada.
- The oil price super spike won’t happen this year. The idea that oil prices will have to go to a demand destruction level won’t happen.
Now for those of you wondering why a super spike in oil won’t happen this year, it’s quite simple. Russia’s early April export figures are coming out and it looks like it will lose about ~1.5 million b/d. This is in-between our estimate of ~500k b/d and the ~3 million b/d IEA/Andurand estimated.
If SPR release is ~1 million b/d, then this only leaves a gap of ~500k b/d. In the grand scheme of things, the oil market can absorb an additional ~500k b/d deficit.
What will this do to overall US crude storage?
This is the largest SPR release in history. At ~180 million bbls, this is 31.7% of the SPR being released this year. You can see that we are likely headed for sub ~800 million bbls for US crude storage with SPR.
What’s more insane about this SPR release is that the Biden Administration is doing it right in front of the midterm elections. Possible price manipulation? For those of you that adhere to the theory of the invisible hand, government interventions seldom work, and by releasing SPR into a structural oil market deficit, you’re simply delaying the inevitable.
By preventing a price spike this year, they have sown the seeds for an inevitable price spike in 2023.
What does this mean for energy equities?
This is one of the best government interventions for energy equities. By preventing a super spike this year, oil prices will average around $100/bbl allowing energy companies to make an insane amount of money.
Most producers will be close to debt free by the end of this year at this oil price. The longer this price continues, the more money energy companies make, and the higher multiples energy companies will receive.
An oil super spike was one of the few ways this thesis would pause near term, and with this scenario materially reduced, we can thank the goldilocks pricing environment a bit longer.
Where is oil headed from here?
The market is going to remain bearish near term. This is the largest SPR release in history and the risks are now skewed to the downside. Russian exports are likely to lose ~1.5 million b/d disappointing many of the calls for 3+ million b/d. There is still the possibility JCPOA gets revived and Iran is back to producing an extra ~1.2 million b/d.
With the super spike scenario out of the window, the risks are now skewed to the downside in the near term. So readers should be aware of that because what we wrote here is bullish for the long term, not bullish for the short term.
How to play this?
Stay long energy equities as this will allow companies to milk this pricing environment for much longer than previously expected. Valuations remain cheap considering most companies have only priced in ~$70/bbl WTI.
In addition, you want to be long a lot of integrated oil majors. The refining segment is going to mint money this summer.
Tankers may also become a good trade with SPR release revitalizing US crude exports in a big way.
All in all, oil prices near term will remain under pressure. Energy equities, in general, should benefit significantly going forward.