March 3, 2022

Rising energy costs to weigh on US consumer and economy

As oil prices soar to new multi-year highs, US consumers are having to deal with rising gasoline prices along with widespread inflation elsewhere. While the US administration appears unwilling to stimulate and incentivize domestic oil production, comparatively cheap natural gas is giving refiners one less cause for concern.

Record high US gasoline prices are likely within the next month or so if oil prices remain in triple digits, particularly if the US administration continues to favor an Iran nuclear deal instead of incentivizing US production. In combination with inflationary factors elsewhere, US economic growth is poised to slow more quickly than initial expectations ahead of the Midterm elections in November 2022, a disastrous scenario for the Biden Administration.  

Concerns about rising US gasoline prices have become even more acute after the IEA announced a decision to release 60 mb from Strategic Petroleum Reserves (SPRs) across the world. WTI crude still closed up 8% on the day, after rallying as much as 11.6% in the aftermath of the announcement.  

There are several reasons for the oil price rally in the face of the supposed bearish news. Firstly, the volume drawdown announced was simply viewed as inadequate. With the majority of Russian Baltic and Black Sea crude exports at risk as we move into April, the SPR release would likely only be enough to offset a month of lower exports from these two ports. We project Russian crude exports could drop by 2 mbd next month, with the only barrels leaving Russia being traded directly with China or perhaps India, and at a very, very steep discount.

Secondly, the biggest impact of an SPR release is always going to be via market sentiment given the staggered nature between an announcement and the barrels hitting the physical market. And thirdly, the US SPR is already at a 20-year low of 580 mb, with ~2 mb currently being drawn from it every week due to a prior SPR sale announced back in late November (when prices were considered too high at $78/bbl). The draws from November’s sale will continue through at least April, reducing the SPR to 560 mb. Remove a further 30 mb due to yesterday’s announcement, and this will leave the SPR at the lowest level since the late 1980s. Going forward, SPR releases will become gradually more bullish for prices, because every time the US Administration announces an emergency release, it means one less time they will be able to do so in the future as volumes are depleted.

The quicker that oil prices push higher, the sooner prices at the pump will reach a new record. The prior record was achieved back in the summer of 2008 when oil prices reached a record high near $150/bbl. Gasoline prices are much higher compared to crude prices this time around, given higher taxes applied at the pump. Retail prices are currently at $3.66/gal on the national average, up 7.6% from $3.40/gal a month ago – but are considerably lagging the recent rise in WTI, which has popped by 17% over the same period. An additional bullish element is that RBOB has just rolled onto the April contract, jumping 5% as retailers switch to the more expensive summer blend, as it contains additives that don’t evaporate at higher temperatures. Given the current backdrop, prices look set to break above $4.00/gal and push on to a new record before we reach May.  

The 321 crack spread is blowing out, closing in on $30/bbl versus Brent, as both gasoline and diesel outperform crude in recent days. This puts US refiners in an enviable position compared to other regions such as Europe. Not only are margins improving, but refiners are also in an advantageous position given supply-side dynamics. Triple-digit oil prices are driving domestic oil production growth, meaning greater crude availability as the year progresses. At the same time, crude imports are not under threat given the close proximity of key suppliers such as Mexico and Canada.  

US refiners also have one less thing to worry about when it comes to input costs - access to comparatively cheap, reliable, and plentiful natural gas supplies. Prompt month Henry Hub prices may be getting swept up in the upward price momentum seen across much of the global energy market, but compared to European natural gas prices, which are nearly four times higher, the cost for Henry Hub is far more manageable. US natural gas prices should continue to remain anchored below $5/MMbtu despite record LNG exports, aided by rising production – in no small part boosted by rising associated gas volumes coming from US shale plays.  

Despite US producers and refiners being in a relatively comfortable position, the US consumer is not. Rising prices at the pump are one more hit to pocketbooks along with rising inflation we are seeing across the board, from food to housing. This is why the February data from the University of Michigan show consumer sentiment at a fresh decade low. March numbers are likely to worsen further. With eight months to go before the Midterm elections, the US Administration must be very concerned about the economy – with very few tools with which to lower energy costs.

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