The transportation of the world is becoming one of the most interesting trading places in markets as we clearly have a structural long-term change coming as the world moves from the black stuff (oil) to electricity. 

But the trader question is – what’s happening in these markets now?

The black stuff – Oil

Oil prices have softened due to several bearish factors impacting demand, inventories, and refining margins in the last few week and despite some easing of geopolitical risks, concerns remain. 

Lets run through the key issues.

Inventories and Demand

• Global Inventories: April restocking has continued into May, with a nearly 10 million barrel increase last week alone, bringing the month-to-date (MTD) build to over 17 million barrels. The US, Europe, and Japan all recorded stock builds in crude oil and refined products. However we need to put this into perspective – total stockpiling is sit well below historical averages across all major regions.
• US Inventories: US crude oil inventories increased by 1.8 million barrels last week, expectations were for drawdown as we approach peak driving season. While gasoline and ethanol saw modest draws, other products experienced large stock builds – this likely comes down to demand.
• Demand: US oil demand remains weak on a four-week moving average (4WMA) basis, though there was a slight uptick in weekly gasoline demand. However, this needs to be consistent to impact overall demand positively. Couple that with the fact International Energy Agency (IEA) has revised its 2024 oil demand growth forecast down to 1.07 million barrels per day (b/d), a decrease of 0.14 million b/d. This slower growth trajectory is expected to continue into 2025, with demand growth predicted to decelerate to 0.7 million b/d.

Prices positioning

• Price Activity: Money managers have been liquidating net long positions in crude oil, with ratios of gross longs to gross shorts for Brent and WTI significantly declining. This reflects a bearish outlook the but speculative bearish view has closed to a holding pattern.
• The Outlook: Pricing and forecasting suggest a continued decline in prices, with Brent expected to average $86 per barrel in Q2 2024, but dropping to the $70s in the second half of the year and into the $60s by 2025. WTI is expected to average $82 per barrel in Q2 2024 then $66 by year end and as low as $51 by the end of 2025.

Refining Margins and Seasonal Factors

• Refining Margins: Geopolitical risks and seasonal factors like summer heat and potential hurricanes pose upside risks for refinery margins in the near term. However, the overall trend is towards weakening fundamentals and thus further margin squeezes.
• Seasonal Demand: With the Memorial Day weekend approaching, traditionally the start of the US driving season, there is hope for increased gasoline demand. However the longer term demand trend for gasoline remains soft as explained. This remains uncertain and dependent on consistent weekly data.

Other Factors

• Technical Support: Given the bearish fundamentals and the current positioning, technical support for oil prices appears weak. Options market data show declining interest and implied volatility has softened as the match lower has become more ordered. 

Overall, the oil market is facing bearish pressures from high inventories, weak demand indicators, and reduced speculative interest, with only limited near-term upside risks. The focus remains on potential demand increases during the summer driving season and any unexpected geopolitical developments that could disrupt supply. 

The elephant in the room as ever remains OPEC. With its 27% control of global oil markets further cuts to supply that have taken effect over the past 24 month will only get bigger.

The Battery Stuff – Lithium

Before we dive into the lithium story in depth, we need to first dive into the geopolitical impacts on the market and their effects on not just price but future developments.

Let us review the impact the Inflation Reduction Act (IRA) is having on the lithium Supply Chain

The IRA is attempting to reduce dependence on China for electric vehicle (EV) battery production by incentivising the sourcing of critical minerals, such as lithium, from Free Trade Agreement (FTA) countries and non-Foreign Entities of Concern (non-FEoC) supply chains. 

Here are some of the additional parts of the IRA that are augmenting the market 

• EV Tax Credit: tax credit of up to $7,500 for EVs, with half of this ($3,750) contingent on sourcing critical minerals (like lithium) from countries with which the U.S. has a Free Trade Agreement (FTA), – Australia, South Korea, and Chile.
• 45X Tax Credit: Lithium chemical producers benefit from a 10% production tax credit applied to all operating expenses (opex), significantly supporting their operations and potentially lowering costs.

The thing is – China has shown it is still the most efficient player in developing, manufacturing and producing EVs’. That however hasn’t stopped the Biden Administration ploughing on with the IRA.

China currently dominates the downstream EV battery production market, controlling around 80% of gigafactory production. However, China’s upstream control of raw minerals is limited to about 17% of the global supply. By incentivising the sourcing of lithium and other critical minerals from FTA countries, the IRA aims to diversify and secure the supply chain away from Chinese dominance.

However, this immediately puts a price premium in ex-China sources as it incentivises and realistically forces firms to seek FTA and non-FEOC so they comply with the IRA.

There is also an argument that Independence Group (IGO) for example used the IRA as rationale for the Kwinana downstream project as the pricing of the project was partially based on ex-China price premiums. A price premium of $3,000 per ton for lithium hydroxide (LiOH) could make projects with higher capex but lower internal rates of return (IRR) financially viable. 

The flip side.

The strict IRA rules E for the tax credit may result in fewer EVs meeting the criteria, as they must source a significant portion of their battery components from specified countries. This could reduce the number of qualifying EVs in the market, influencing manufacturers to adapt their supply chains to meet the new standards.

In short, the ex-China price premium is likely to increase, reflecting the growing demand for compliant minerals. This strategic move is expected to have significant implications for the global EV market and the positioning of the United States within it.

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