Bearish News Is Mounting For Oil

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Oil prices remained fairly stable this week, with ICE Brent balancing slightly above the $100 per barrel mark. Fears of Russian supply disruptions were temporarily put on the back burner by the vast IEA-coordinated inventory release that greatly helped in flattening out the futures curves of all three key crude benchmarks. The extensions of COVID lockdowns in China, especially in Shanghai, have also helped the bearish cause, however it remains to be seen how long will it take for disruption fears to resurface again.


IEA to Release 60 Million Barrels of Strategic Stocks. Above and beyond the US’ 180-million-barrel stock draw, IEA countries agreed to release 60 million barrels over the upcoming six months, with Japan taking a prime role amidst the relatively timid commitments of others, pledging to release 15 million barrels.

EU to Ban Russian Coal, with Delay. According to media reports, the European Union’s approval of a ban on Russian coal imports would take full effect from mid-August, following internal lobbying from Germany to extend the deadline as far out as possible to allow usual buying in the four-month wind-down period.

Chile Sues Mining Giants over Atacama Water Use. The government of Chile is suing mining majors BHP (NYSE:BHP) and Antofagasta (LON:ANTO) over alleged environmental damage caused by their operations in the Atacama desert, draining the area’s aquifer by increased exploitation.

US EPA Denies 36 Refinery Biofuel Waivers. The US Environmental Protection Agency declined 36 exemption waivers coming from oil refiners for the 2018 compliance year, confirming a 2020 court decision that significantly narrowed the criteria on who could be eligible for blending exemptions.

Canada Approves $12 Billion Bay du Nord Project. The Canadian government approved the $12 billion offshore Bay du Nord project that would be operated by Equinor (NYSE:EQNR), having found no adverse environmental effects, marking the country’s first deep-water project that took years to greenlight.

Tight Oil Markets Are Sending Fuel Margins Through The Roof

The oil price rally has really cooled down over the past two weeks, with oil prices declining to levels last seen prior to Russia's invasion of Ukraine. Brent oil (CO1:COM) prices fell ~2% Thursday to trade below 1100/B, while the price for a barrel of Brent for June 2022 delivery has fallen from 1127/B one month ago to 999/B today. Pandemic-related lockdowns in Shanghai, slowing U.S. oil demand growth, and a historic strategic petroleum reserve release have all contributed to the selloff. Interestingly, medium-term prices have hardly budged as near-term oil prices have fallen by over 20%, indicating a still-bullish longer-term outlook.

That said, whereas it's crude markets that have been hogging the limelight, the most dramatic action in global oil markets has been happening in a more hidden corner of the market: distillate fuels.

The price of diesel and jet fuel in Europe hit a record in early March amid unusually tight supplies. Both commodities have since pared some of their gains, but refiners are still making a killing.

Indeed, in another sign of impending distillate fuel shortages, jet fuel traded at ~3320/B in New York on Monday (77.61/G), a massive ~$200+ premium to crude feedstock prices. The jet fuel premium is currently ~10x larger than any premium seen in the past 30yrs.

High Fuel Margins To Last

There's a good chance that high fuel prices will ultimately lead to demand destruction. However, Goldman Sachs says distillate fuel demand is likely to remain strong and margins to remain high due to these factors:

Diesel and jet fuel stocks are at historic lows, and seasonally-adjusted inventory draws are large and accelerating.
Jet fuel consumption is poised to accelerate into summer with a return to international travel.
High natural gas prices will lead to "gas-to-oil" switching in Europe and Asia.
The Russia / Ukraine war will reduce distillate supply, as Russia exports ~900kb/d of diesel fuel and ~900kb/d of residual feedstocks, which are largely upgraded into diesel by European and Chinese refiners.
Refinery operating costs are increasing, particularly in Europe.
In fact, Goldman sees current record margins sustaining through at least year end. In the U.S., names like Par Pacific (NYSE:PARR), Valero Energy Corp. (NYSE:VLO), Marathon Petroleum Corp. (NYSE:MPC )and Phillips 66 (NYSE:PSX) stand to benefit from higher refining margins while in Europe, Saras (OTCPK:SAAFY) is most exposed.

Meanwhile, during its Q1 earnings preview, Shell (NYSE:RDS.A) mentioned improving refining margins, with indicators nearly doubling quarter over quarter.

Falling Russian Exports



Another reason to be bullish about fuel margins: falling Russian exports.

Russia is a key source of distillate fuel for Europe and the world. Shortly after the war began, BP Plc (NYSE:BP) and Shell (NYSE:RDS.A) stopped selling spot diesel in Germany. Last week, Argentina’s YPF Sociedad Anónima (NYSE:YPF) cited diesel "scarcity" in the seaborne market. Jet fuel margins in New York harbor rose to 2200/B earlier in the week, a ten-fold increase from historic averages.

Attempts to measure the impact of self sanctioning on Russian exports have seen mixed results, with some studies suggesting that exports have largely continued to flow unchanged while others say they could have declined by as much as 3.0mb/d. Thus far, the only measurable impact on exports has come from a terminal outage—a terminal that primarily carries Kazakhstani crude to market.

So far, Russia's pivotal energy sector has been largely spared from sanctions. But damning evidence of serious war crimes coming from Ukraine suggests that Russia could very well face more severe sanctions, including a ban on its oil by European nations.

Related: Oil Rises As Videos Emerge Of Attack On Saudi Oil Facility

Since Russian forces withdrew from northern Ukraine, turning their assault on the south and east, grim images from the town of Bucha near Kyiv, including a mass grave and bound bodies of people shot at close range, have prompted international outrage.

Commodity analysts at Standard Chartered estimate that a move towards explicit EU sanctions on Russian oil imports would keep Russian output below 8.5mb/d for several years, good for a 3mb/d decline compared to pre-invasion levels, and introduce further downside to already low expectations for Russian oil output. According to StanChart, the EU's most likely immediate measure--i.e., imposing sanctions on coal--will do little to placate member states and public opinion for a significant ratcheting up of the pressure on Russia.

Further, EU sanctions on Russian oil and gas would send a strong signal that Russian oil is unlikely to regain its former market in Europe for an extended period, if ever. EU sanctions will also likely increase the pressure on key countries, and particularly India, not to increase their imports from Russia above pre-invasion levels; up to now, part of the pushback from other users of Russian oil has been that they could not be expected to refrain from extra purchases if EU governments were not explicitly limiting their own use.

In other words, fuel margins might remain elevated for many months, if not years.