U.S. Distillate Stocks are Historically Low

The chart above exhibits the relationship between inflation and oil demand in the U.S. It raises several intriguing questions. Finding answers to them could help form a view as to what to expect regarding U.S. oil consumption and oil prices. Why are inflation and oil demand positively correlated? Why has this seemingly staunch relationship fallen apart in 2023? And finally, how long this anomaly could potentially last?

The answer to the first question is relatively simple. Energy prices weigh significantly in the consumer price inflation basket. And prices are at elevated levels when demand is healthy and vice versa. Growing consumption will inevitably push prices higher and consequently consumer prices will increase. Oil demand and prices set the direction of consumer prices and inflation most of the time. As for the second part of the dilemma, the inflationary pressure experienced in the last three years, which is the product of the health crisis and the Ukrainian war, has forced central banks, including the Fed, to increase borrowing costs to levels not seen for 15 years. It helped inflation retreat and should have dampened oil use, but it did not. The explanation is that pent-up demand from pandemic-related government support ensured solid oil consumption, embodied in a stellar 2023 [KK1] [KK2] holiday season, which provided invaluable support to jet fuel and gasoline. This, coupled with artificially low supply from major oil producers, sent oil prices to multi-month highs recently despite consumer price growth easing.

Thirdly, this aberration is plausibly unsustainable. Further mitigation of consumer price rise will be coupled with moderating oil demand growth as interest rates might stay higher for longer than anticipated just a few months ago and as savings from three years ago dry up. Under this scenario oil prices would also retreat. Alternatively, in the unlikely case of persistently tight oil balance stable oil prices would reignite inflationary pressure. Both demand and consumer prices would increase or at least remain high. This year’s anomaly, the outcome of unforeseen circumstances of the last three years, should gradually vanish one way or the other going into 2024.

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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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