A Perfect Storm: Behind Crude’s Historic Month

Matthew Carr By Matthew Carr
Emerging Trends Strategist, The Oxford Club

Oil & Gas

Mother Nature has left her mark lately…

Hurricanes Harvey and Irma lashed Florida, the Gulf Coast and Texas. Hurricane Maria obliterated Puerto Rico.

This past month, temperatures across the Midwest and Northeast broke century-old records.

It’s October, and in my town it’s 90 degrees.

As is often the case, the devastation is leading to shortages. And whenever there are shortages, prices surge.

Now, you probably noticed the huge advance in the price of U.S. crude recently.

At the end of last month, the price of West Texas Intermediate (WTI) surged to more than $52 per barrel, a 13% increase over the August 30 price…

This rally in crude has taken place during a time when the U.S. dollar has also spiked higher. Commodities and currencies typically move inversely to one another.

So investors are asking once again if this rally is for real.

And it is… for now.

But maybe not for the reason you might think, which I’ll explain in a moment.

First, let’s look at the facts: Despite crude’s September surge, the Energy Select Sector SPDR ETF (NYSE: XLE) is still down a little more than 9% year to date.

Of course, since the start of September – when crude turned around – the ETF has gained 8.5%.

But this is a situation where more ampersands mean better returns… at least in the short run.

What I mean is that the SPDR S&P Oil & Gas Equipment & Services ETF (NYSE: XES) and SPDR S&P Oil & Gas Exploration & Production ETF (NYSE: XOP) have left the ampersand-less Energy Select ETF in the dust…

The Equipment & Services ETF has skyrocketed 22% in the past month. Meanwhile, the Exploration & Production ETF has shot up 15.3%.

Those are tremendous short-term moves – even for volatile ETFs.

In fact, the Exploration & Production ETF is having its best month since November 2016. And the Equipment & Services ETF hasn’t looked this good since October 2011.

But we shouldn’t forget that they’re rebounding from what I thought were excessive lows. Despite the herculean gains over the past month, both are down more than double the Energy Select ETF’s loss for 2017.

So what’s causing all this enthusiasm in crude and oil-related shares? It’s not OPEC, which has been the headline maker all year with its production cuts. And it’s not President Trump or anything out of Washington, D.C.

Believe it or not, it’s about diesel.

Diesel and large-scale infrastructure and construction projects go hand in hand – as do diesel and transportation.

This year, India budgeted a record amount of the fuel for infrastructure projects. And in turn, the world’s third-largest oil consumer is driving unprecedented demand for diesel.

In August, South Korea’s diesel demand rose to record levels.

Also in August, European imports of diesel also hit record levels. Back at the end of July, Royal Dutch Shell’s (NYSE: RDS.A) Pernis refinery in the Netherlands – the largest refinery in Europe, with a capacity of 404,000 barrels per day – suffered a devastating fire.

So to keep up with demand, U.S. refineries were running at all-time highs. And U.S. exports of crude and distillates were at record levels.

I hope you see where this is going… because this has been a perfect storm…

In late August, Hurricane Harvey tore its way through the Gulf Coast and slammed into Texas’ refining hub, knocking a dozen refineries offline.

The impact was dramatic and swift.

The week before Harvey made landfall in Rockport, Texas, U.S. refineries were operating at 96.6% capacity, consuming 17.725 million bpd of crude. A week later, they were at 79.7% capacity and using 14.472 million bpd of crude. And by the week of September 8, U.S. refineries were down to just 77.7% capacity.

That’s the lowest level that U.S. refineries have operated at since September 2008.

This also meant exports to Europe were derailed.

Leading up to this point, there was already a strain on supply. But Harvey was the final straw. And in the blink of an eye, global diesel stocks were vaporized…

With the U.S. offline, Europe was forced to buy fuel from Asia and Latin America, putting pressure on inventories there.

And now, the global market may be looking at a distillate deficit.

This perfect storm of events has woken up investors to just how strong the distillate market has been in 2017. No one can overlook the fact that during the second week of September, U.S. distillate demand rose 24% year over year to 4.26 million bpd.

That’s the highest seasonal level in two decades.

The massive rebuilding efforts in the aftermath of hurricanes Harvey, Irma and Maria will require significant amounts of diesel. And those are far from the only disasters that need cleaning up after.

U.S. refiners will have to quickly return to their record-setting pace to keep up, which means more crude.

That’s what’s driving the surge in oil prices – as well as shares of oil companies. And it’s what we as investors need to be aware of.

Good investing,


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