By Barani Krishnan
Investing.com -- The Federal Reserve is determined there will be no recession in America as it tries to curb the energy-fueled inflation coursing through the economy with the most aggressive rate hikes in a generation.
The central bank is unlikely to win; not because of OPEC and $100-plus oil, but because of a handful of U.S. fuel refiners determined to make super profits while the rest of the economy goes to hell in a handbasket.
To be sure, these refiners, made up of names such as Marathon Petroleum and Valero Energy, aren’t necessarily doing anything that’s illegal -- other than goosing returns for their shareholders and companies, which is perfectly natural in a current business cycle like the one in energy.
To understand it better, there’s a severe squeeze in the supply of gasoline, and particularly diesel, from the closure and downsizing of several refineries during the pandemic. Those who’ve stayed in the business are now milking the situation by providing only what they can -- or, more accurately, wish -- without putting any of the money they’re making into expanding their plants or acquiring the idled ones that can be reopened to provide some measurable relief to consumers.
Bloomberg estimates that more than 1.0 million barrels per day of U.S. oil refining capacity -- or about 5% overall -- has shut since the Covid-19 outbreak initially decimated demand for oil in 2020. Outside of the United States, capacity has shrunk by 2.13 million additional barrels a day, energy consultancy Turner, Mason & Co says. The bottom line: With no expansion plans on the horizon, the squeeze is only going to worsen.
“The oil market is projecting a false sense of stability when it comes to energy inflation,” Bloomberg’s energy analyst Javier Blas wrote in a commentary this week as gasoline reached record highs above $4.50 per gallon at some U.S. pumps while diesel got to an eye-watering peak beyond $6.
“The real economy is suffering a much stronger price shock than it appears, because fuel prices are rising much faster than crude, and that matters for monetary policy,” Blas said, referring to the problem swelling at the door of the Fed.
To give some real dollar idea of what he’s talking about, he says: “If you are the owner of an oil refinery, then crude is trading happily just a little above $110 a barrel -- expensive, but not extortionate. If you aren’t an oil baron, I have bad news: it's as if oil is trading somewhere between $150 and $275 a barrel.”
To break it down, U.S. crude’s benchmark grade, the West Texas Intermediate, or WTI, has ranged for weeks at between $95 and $110 per barrel. But jet fuel futures at the New York Harbor are trading at the equivalent of $275. Diesel? That’s at $175, while gasoline is around $155. All these are wholesale prices, prior to taxes and marketing margins. Add those, and it could get more dizzying for the consumer.
It wasn’t always like this, of course. For 35 years at least, the crack spread -- the industry term for the profit derived from “cracking” fuel products from crude -- was at an average of around $10.50 a barrel. Then, between the so-called golden age of refining, from 2004 to 2008, to be precise, the spread crossed $30. Last week, it hit record highs of nearly $55.
The gross difference now between crude and refined oil prices is the result of an exacerbated supply deficit coupled with demand that’s almost back to the pre-pandemic highs. U.S. East Coast stockpiles of diesel have fallen to 1990 lows. Outside China and the Middle East, oil distillation capacity fell by 1.9 million barrels a day from the end of 2019 to today -- also the largest decline in 30 years. Last but not least, global - or at least European - diesel supplies are being choked as well by the West’s sanctions on Russian energy products.
Saudi Arabia’s Energy Minister Abdulaziz bin Salman said last week the OPEC+ alliance of oil exporters under his watch had nothing to do with the U.S. refining crisis.
“I did warn this was coming back in October,” Abdulaziz said, adding that America wasn’t alone. “Many refineries in the world, especially in Europe and the U.S., have closed over the last few years. The world is running out of energy capacity at all levels.”
And the crisis is going to worsen -- not just in terms of price but also supply. Last week, billionaire refinery and fuel station owner John Catsimatidis of New York City warned that diesel rationing was on the cards on the East Coast.
Catsimatidis, whose company owns and operates 350 gas stations, however, doesn’t expect gasoline to become scarce, just very expensive. “Drivers will pay the highest gasoline prices ever paid for Memorial Day,” he said, adding that travel during the holiday should surpass numbers seen last year.
Truckers and haulers who ply U.S. roads to make deliveries said they are doing all they can to stock up on diesel, contrary to speculation that record-high prices eating into bottom lines could force purchasing delays.
“Demand is not that easily destroyed,” Shell Plc Chief Executive Officer Ben van Beurden told investors last week.
Some analysts, however, argue that at these prices or more, fuel demand has to be destroyed -- if not, the economy will be.
“Concerns over the economy are legitimate and real,” said John Kilduff, partner at New York energy hedge fund Again Capital. “The cost of diesel represents the real economy. At more than $6 a gallon, that’s cutting into the bottom line of companies and we could be on the precipice of a major demand destruction in diesel.”
“Already, there are fewer Amazon trucks on the road making deliveries, while there has been a huge uptick in credit-card spending, showing the consumer is getting rapidly tapped out. It’s all coming home to roost for those long-oil.”
The International Energy Agency cautioned on Thursday that soaring pump prices and slowing economic growth are expected to significantly curb the demand recovery through the remainder of the year and into 2023.
Analysts like Kilduff are also concerned over how far the Fed will go with rate hikes.
The central bank has so far approved a 25-basis, or quarter point, hike in March and 50 basis, or half point, increase in May. Money market traders have priced in an 83% possibility of a 75-basis, or three-quarter, point hike in June. Fed Chairman Jerome Powell, in an interview published Thursday, all but vehemently denied that there will be such a large increase for next month, citing his preference to continue with 50-bps hikes for two more months at least.
But Powell also said something worrying -- achieving a soft landing for the US economy from the Fed’s rate hikes will depend on factors beyond the central bank’s control. Slowing wage growth -- a key component of inflation now -- won’t be easy, he said. “It’s quite challenging to accomplish that right now, for a couple of reasons. One is just that unemployment is very, very low, the labor market’s extremely tight, and inflation is very high.”
After contracting 3.5% in 2020 from disruptions forced by the pandemic, the U.S. economy expanded by 5.7% in 2021, growing at its fastest pace since 1982.
But inflation has grown just as fast as the economy, or maybe a tad quicker. The Personal Consumption Expenditure Index, an inflation indicator closely followed by the Fed, rose by 5.8% in the year to December and 6.6% in the 12 months to March. Both readings reflected the fastest growth since the 1980s. The Consumer Price Index and the Producer Price Index, two other key gauges for inflation, rose 8.3% and 11%, respectively, in the year to April.
The Fed’s own tolerance for inflation is just 2% per year. Powell has indicated that a total of seven rate hikes -- the maximum allowable under the central bank’s calendar of meetings this year -- were on slot for 2022. More rate adjustments could follow in 2023, until a return to the 2% inflation target is achieved, he said.
“My fear is that the Fed might overdo it,” said Kilduff. “With the Covid-related physical stimulus already abandoned by the federal government, there will be a lot less liquidity in the system in the coming months. If the Fed brings an ax to the system via excessive rate hikes, we might end up chopping up entire arteries of the economy.”
Blas of Bloomberg concurs about the train wreck that could be coming for the U.S. economy.
“The longer the refiners make super-profits, the harder the energy shock will hit the economy,” he said. “The only solution is to lower demand. For that, however, a recession will be necessary.”
Oil: Weekly Settlements & WTI Technical Outlook
London-traded Brent, the global benchmark for crude, settled at $111.22 a barrel, up $3.77, or 3.5%, on the day on Friday. For the week, it was down 0.7%.
Brent rallied on reports that China might start easing up soon on coronavirus lockdowns in Shanghai, which has seen limited economic activity over the past seven weeks from strict movement curbs placed by the authorities.
Gains in Brent were, however, capped by the European Union’s continued delay in reaching consensus for a ban on Russian oil, particularly after resistance from Hungary, which fears finding itself in an energy crisis without supplies from Moscow.
New York-traded West Texas Intermediate, or WTI, the benchmark for U.S. crude, settled at $110.16, up $4.03, or 3.8%. For the week, it rose 0.7%.
WTI rallied on an apparent crunch in U.S. oil refining capacity, which has sent pump prices of fuel to record highs this week, with diesel reaching all-time highs above $6 a gallon and gasoline record highs above $4.50.
The divergence between Brent and WTI is "a story of two oils”, said Kilduff.
“The holdout on a European embargo of Russian oil, particularly by Hungary, is limiting Brent’s upside, while WTI is basking in bullish glory from the refining crunch in fuels that’s sent U.S. pump prices to record highs,” he added.
As for WTI’s technical outlook, the weekly settlement at just above $110 indicated that oil bulls were positioned for the next leg higher at between $116 and $121, said Sunil Kumar Dixit, chief technical strategist at skcharting.com.
“So far, $98 has proven to be hard floor, while $104-$106 keeps the momentum up,” Dixit said. “Volatility-induced mild consolidation from $106 to $104 will attract more buyers, while weakness below $104 will press oil towards $101 - $99.”
He added that a decisive break below $98 will invalidate the bullish momentum. “That can trigger a correction of $18 - $20, exposing WTI to $88 and $75 in the mid-term.”
Gold: Weekly Market Activity & Technical Outlook
All that glitters isn’t gold, is the saying. Yet, the yellow metal itself is barely glittering these days.
In Friday’s session, gold plunged briefly beneath the key $1,800 level on New York’s Comex, accelerating a selloff that began in mid-April.
Although it did recapture that level after finding support in $1,700 territory, it wasn’t enough to undo the damage from earlier in the week that left it on the path to a fourth straight weekly loss that’s dinged roughly $165, or 8%, from its value since the week ended April 8.
Gold’s tumble on Friday, as in recent days, came on the back of a resurgent dollar, which scaled fresh 20-year highs. The Dollar Index, which pits the U.S. currency against six other majors, did retreat to a session low of 104.5 after peaking at 105.05 earlier in the day.
While that helped gold retrace some of its losses, the change barely impacted the directional charge in the dollar, which analysts expected to chart new two-decade highs in coming days on speculation over how hawkish the Federal Reserve could get with its next U.S. rate hike.
“Only a sudden U.S. dollar sell-off is likely to change the bearish technical outlook” of gold, said Jeffrey Halley, who oversees Asia-Pacific markets’ research for online trading platform OANDA.
Front-month gold futures for June on Comex settled at $1,810.30 per ounce, down $14.30, or 0.78%, on the day. The session low was $1,797.45 -- a bottom not seen since Jan. 30. Week-to-date, June gold was down 4%.
Despite Friday’s rebound from the lows, gold could revisit $1,700 territory if it fails to clear a string of resistance from $1,836 to $1,885, according to Dixit of skcharting.com.
“Since the current trend has turned bearish, sellers are very likely to come at the test of these resistance areas,” said Dixit, who uses the spot price of gold for his analysis.
“As gold has turned bearish short term, bearish pressures will attempt for $1,800 and then $1,780 - $1,760. A decisive close above the range can extend the recovery to $1,880, failing which bearish pressures will push gold down to $1800 - $1780, and extend the decline to $1,760 in the week ahead.”
But if gold breaks and sustains above $1,848, its recovery can extend to $1,885 and $1,900, he added.
Disclaimer: Barani Krishnan does not hold positions in the commodities and securities he writes about.