- At the current pace of inventory draw, we are headed for triple digit oil prices.
- China has been strategically draining crude inventory and shunning crude on the open market. But this won't persist and it presents a ~2 mb/d of tailwind.
- If global oil demand continues to recover, global oil inventories will decline below the 2010-2014 norm.
- If oil does reach $100, there will be a lot of FOMO in the market with generalists rushing in.
- This idea was discussed in more depth with members of my private investing community, HFI Research. Learn More »
Note: This was first published to HFI Research subscribers as part of our weekly flagship report.
This is not a prediction. Instead, we just want to highlight a few things with data and charts to illustrate our point.
As we highlighted already in our global oil supply & demand update for October, the key difference between our supply & demand forecast versus everyone else is the OECD oil demand assumption. This is very important because if demand stops recovering, then our assumption on the deficit will be off, which will then in turn prevent oil prices from going to $100. Hence why this report is not meant as a prediction report.
Now with that said, at the current rate of change in global oil inventories, there's a distinct possibility that $100/bbl oil is in the making.
Source: Kpler, HFI Research
Here is an overview of where we are with global oil inventories. Notice that global oil inventories have basically eliminated all of the COVID inventory builds. The big delta amongst the global oil inventories today is still residing in China.
Source: Kpler, HFI Research
As you can see, China is still ~125 million bbls above where it was back in 2019.
Now here's the interesting part about China. If you look at the crude import data versus the storage levels, you will note that China has been purposely buying less crude and draining its own storage.
Source: Kpler, HFI Research
We estimate that the amount the Chinese need to buy in order to keep crude storage flat is ~10 mb/d from the sea. Said in another way, China's lack of presence on the market by a factor of nearly ~1.75 to ~2 mb/d hasn't prevented global oil inventories from declining.
In essence, if China had kept pace with the crude buying of the past, we would've already seen $100/bbl oil. Yes, read that part again. If it wasn't for China trying to play games with the oil market, we would've already reached $100/bbl oil.
Knowing full well of this fact, we can conclude that China will eventually have to return to the oil market. From May to October of this year, China reduced its crude inventory by ~100 million bbls. In another 6-months, it will have completely eliminated all of the crudes it bought during COVID. Unless China wants to face a situation of having insufficient crude coverage days on hand (crude inventories divided by refinery throughput), then it will be forced to buy on the open market propelling what is already a tight oil market into even greater heights.
Implications for Energy Stocks
Energy stocks remain hated despite being the best performing sector in the market this year. As we've detailed numerous times, market participants are applying a zero terminal value to energy stocks and pricing them as if WTI is expected to fall back to $50/bbl. The psychological implications of seeing oil at $100/bbl will propel generalists to return to the market. This could see a considerable increase in multiples, which would see energy stocks return 2-3x from today's level.
Again, we are not making a prediction that this will happen, but instead mapping out the scenario if oil is to reach $100/bbl.
There will be a lot of FOMO (fear of missing out) in the market if this was to happen. So you will want to be long whatever you can get your hands on. We think as the near-term consolidation takes place, put your money in the right names and they should benefit significantly. Have investments spread out amongst large-cap names along with higher beta names like Baytex (BTEGF) to reap the maximum benefit. We would also suggest having call option spreads to take advantage of both the jump in implied volatility and stock price.
Portfolio management at the end of the day is not an exact science. You have to do whatever is comfortable for you, so feel free to reach out to us for questions.
HFI Research, #1 Energy Service
For energy investors, the 2014-2020 bear market has been incredibly brutal. But as the old adage goes, "Low commodity prices cure low commodity prices." Our deep understanding of US shale and other oil market fundamentals leads us to believe that we are finally entering a multi-year bull market. Investors should take advantage of the incoming trend and be positioned in real assets like precious metals and energy stocks. If you are interested, we can help! Come and see for yourself!
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