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September 20, 2017

Market Voice: Hurricane Harvey Casts No Gail Force on Oil Markets but the Electric Car Just Might

by Thomson Reuters.

In addition to the devastating loss in life and property that Hurricane Harvey inflicted on the Gulf region, it also disrupted operations of several refineries creating shortages, particularly in gasoline production. As shown below, the wholesale gasoline price surged in response to the disruption briefly hitting a two-year high and sending retail prices across the nation up roughly 30 to 50 cents per gallon. As is also shown, crude oil prices dropped during this period on anticipation that the shortage of refinery capacity would dampen demand for crude oil. But the moves in both markets were short-lived with wholesale gas prices back at pre-Harvey levels and crude prices pushing back toward the summer highs. Even with the firming in oil prices, however, the bigger picture is prices in both markets are stuck in a stable flat range going back for more than a year. Is there anything that can get this market to move?

Crude Oil and Gasoline Prices

Source: Eikon

As shown in the chart on the following page, one important source of the oil prices rebounding through pre-Harvey levels is that the oil supply demand mismatch that has been weighing on prices recently disappeared for the first time since 2013. Based on International Energy Agency data, the oil dynamics hit balance in the second quarter. Since then, American Petroleum Institute monthly data has shown a mix of draws and additions to inventories which suggest the market balance is persisting. With the exception of the sharp price turmoil at the turn of 2013, the direction and magnitude of quarterly price movements seem to be sensitive to the demand vs. supply dynamic. The elimination of excess supply is definitely good news for the oil market. That said – it appears a substantial positive demand balance would be required to justify the current level of prices. Therefore, upside prospects for still higher prices are limited.

Net Global Demand Balance in Crude Oil and Crude Price Performance

Source: International Energy Agency

So While There is good News for Oil, Not Clear That it is Good Enough

Over course there are two sides to the elimination of the oil market imbalance; supply has been roughly stable since the middle of last year and a modest but steady growth in demand has converged on supply eliminating the surplus. The move by the Fed and other major central banks is reflective of more solid growth prospects and, as shown below, year-over-year global output growth is roughly a percentage point higher now than it was at this time last year – and this is the best level of output growth since 2011.

Stronger global growth typically leads to stronger demand for oil and this is likely why the supply/demand gap has been eliminated. Consistent with this relationship, oil price annual gains have shown a strong historic link to the pace of global growth so the pick-up in activity is constructive. But the overall picture remains that the news is good but not good enough; the price gains in oil seem to be running ahead of global demand. The outlook for now is that oil prices will, at best, remain firm and – assuming no major disruption in crude production – a bigger resurgence in global demand is required for significant upside in oil prices.

Global Growth and Oil Price Gains

Source: Eikon

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Electric Cars Already Casting a Shadow on Oil

As Tesla moves towards mass production of the Model 3, there seems to be growing acceptance that electric vehicles are the wave of the future. Even the major oil companies are now preparing for an electric future. Exxon and BP, among others, have announced they are planning for electric vehicle production reaching 100 million units per year within twenty years. And a strong link has emerged between Tesla stock performance and oil prices, as shown below, (note  the  oil  price  axis  is  reversed)  during  periods  of  downward  pressure  on  oil  prices,  Tesla  stock  generally outperforms the SPX index. But there has been recent divergence; despite the firming of oil prices, Tesla relative to SPX is near the highs of the year suggesting oil prices are headed back to below $45 bbl.

Tesla Outperformance a Crude Oil Prices

But Isn’t Oil Used to Produce Electricity?

The shift away from gasoline vehicles will, by necessity, create much higher demand for electricity. To the degree that oil continues to be a major source of power generation the shift to electricity should be fairly benign for the outlook on oil prices. But, as shown in the following chart, the US EIA is projecting that the bulk of increase in electric production will come from natural gas and alternatives with only marginal growth expected in the use of oil.

The near-term prospects for oil look modestly positive as long as the pickup in global economic activity persists but it looks unlikely that the year-old range top will be broken in the absence of a major supply disruption. As was proved in

2015, short-term oil demand is more elastic than supply so a slowdown in global growth would be devastating for oil prices (likely pushing the bottom of the range with risks of a downside break). The potential move toward electric vehicles paints a negative long-term structural picture for oil demand as sources of power shift to other sources. Natural gas should be a relative winner from the shift to electric given the outlook that it will be a chief source of future generation. Copper is also arguably a relative winner as it is going to take a lot of wire to transmit all the increased flow of electricity from the power plants to the consumers.

Projected Annual Growth in Sources of Electricity Generation to 2050

Source: United States Energy Information Administration

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