The correlation between banking turmoil and plunging oil prices is undeniable, states Phil Flynn of PRICE Futures Group.
Oil prices weakened after the second biggest bank failure in the United States, First Republic, and melted down yesterday as regional banks plunged even after JP Morgan picked up the pieces left over by First Republic. Things got worse for oil when PacWest Bancorp plunged along with Western Alliance Bank and Metropolitan Bank which saw their stocks halted sometimes multiple times during the day.
The regional bank stocks plunged into a panic “run on the bank” type of selling, drying up liquidity for the oil market which gets hit harder by bank failure woes than even the stock market. The correlation between weak oil and banking turmoil is solid whether we are talking about yesterday’s regional bank plunge or when Silicon Valley Bank failed in March or the ‘big short” in 2008. Crude oil, because its production and distribution are so capital intensive, shudders when they fear that credit can get tied up. And yesterday is an example where oil was the canary in the coal mine which eventually took down other risk assets as well.
The drama surrounding the banks will put more focus on the Federal Reserve, which by their admission was largely to blame for the banking turmoil. Not only were they to blame for underestimating inflation, thereby forcing them to embark on the most aggressive rate hiking cycle in a generation, but for ignoring red flags at banks like Silicon Valley Bank. The Federal Reserve failed to “take forceful enough action” to address the red flags that regulators reported well before the bank's March tenth collapse. Fed Vice Chair Michael S. Barr said the Fed’s, “Regulatory standards for SVB were too low, the supervision of SVB did not work with sufficient force and urgency, and contagion from the firm’s failure posed systemic consequences not contemplated by the Federal Reserve’s tailoring framework”.
The Biden administration, which spends more time working on ways to blame other people for the failures on their watch than they spend time on fixing them, of course, blamed the Trump administration for loosening banking regulations. Yet the question becomes that if Biden thought that was such a bad thing, why did he not reverse them? I mean this president is the king of executive orders. As of May 1, 2023, Joe Biden had signed 113 executive orders, 135 presidential memoranda, 428 proclamations, and 85 notices, yet the banks still failed. Is giving the Federal Reserve more power to regulate going to do any good if they missed the fact that inflation was not transitory, and they failed to see obvious problems with the balance sheets of these banks? Are you telling me that they don’t have the regulations right now to look at these issues when it comes to the duration of the instruments where they put depositors' money? Of course, they do, but they missed it.
When fed chairman Jerome Powell was giving testimony to Congress right before Silicon Valley bank failed, he seemed oblivious to any concerns about the banking sector when he tried to come up hawkish as far as his rate hiking was concerned, he didn’t seem to have a care in the world that the sharply increasing interest rates were causing stress in the banking sector or the overall economy. He also of course said that beating inflation was more important than potential job losses and the country. Yet still there is nothing to worry about as Bharat Ramamurti currently serves as Deputy Director of the National Economic Council says, “The banking system has demonstrated a lot of resilience the US emerges from this with the banking system in good shape.” So we have that going for us.
Behind all this banking trauma, what we’re seeing in the oil sector is this significant tightening of supplies. Consider the fact that yesterday the American Petroleum Institute reported that US crude supplies fell once again by 3.939 million barrels even after the US released two million barrels from the Strategic Petroleum Reserve.
Last week the Energy Information Administration (EIA) said that US commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) decreased by 5.1 million barrels from the previous week. At 460.9 million barrels, US crude oil inventories are about 1% below the five-year average for this time of year. Now consider that SPR supplies are 189.1 million barrels below a year ago, which means that if we have a significant supply disruption it will be almost impossible to calm the market. The API product numbers did not help to give us confidence that product supplies are ample, reporting a 400-thousand-barrel increase in gasoline supply and a one-million-barrel increase in distillate supply.
Yet are we going to follow the oil supply and demand fundamentals or banks or the Fed? Even with the latest banking turmoil the Fed is looking to be one and done. They are expected to raise rates by a quarter and then pause saying they are still worried about inflation but want to assess the damage they have already caused. In the short term well, we’ll focus on what the Fed does, the strength of the regional banks, and if at any point the market starts to believe that this regional banking crisis will become contained, then these oil prices are going to look wildly attractive.
HFI Research agreed and said that “The current oil sell-off is creating a sense of false security for the bears and pushing the oil bulls to the brink of exhaustion. Similarly, this time last year, the oil kept rallying despite disappointing demand and no production loss from Russia. This time? Demand is better.” Shorts have a huge position in the market, the largest in over a year, and that shouldn’t be too comforting especially because liquidity is low. The possibility of a short squeeze at some point is real but it may never happen unless the Fed can regain control of the banking crisis and confidence. The problem is that the Fed and this administration, as far as inflation being transitory and banking regulations, have been wrong on every count. Perhaps they should spend more time focused on depositors’ money and the stability of the banking system before they make the Fed the climate change and equity and inclusion police.
While we could see oil prices soar, the good news is that gasoline at the pump may not go up as dramatically. Global refining capacity is on the rise and thank goodness because it has been way too low.
The EIA put a report out that said, “On March 16, ExxonMobil announced the beginning of operations at the expansion of its Beaumont refinery, adding 250,000 barrels per day (b/d) of capacity, according to the company’s announcement. The expansion makes the oil refinery one of the largest in the United States as measured by crude oil distillation capacity. According to ExxonMobil, the total capacity of the Beaumont facility is now 630,000 b/d.
The Beaumont expansion is the first major refinery capacity expansion to come online since the Covid-19 pandemic, which caused several refinery capacity closures throughout 2020 and 2021. US refinery distillation capacity decreased from 19.0 million b/d at the start of 2020 to 17.9 million b/d at the start of 2022. In June, we expect to update our Refinery Capacity Report with information about refinery capacity at the start of 2023. That report will not include the Beaumont capacity addition because it was not operational at the start of 2023.
Increased refinery capacity and, as a result, increased gasoline and diesel production, should reduce fuel prices this summer compared with 2022. At the same time, more refinery production may be offset, at least in part, by a combination of higher crude oil prices, increasing consumption, and low fuel inventories.
Learn more about Phil Flynn by visiting Price Futures Group.
