This has to be the strangest year I’ve ever seen in energy markets and last week was a perfect example why.

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On Wednesday morning, the Energy Information Administration (EIA) announced the biggest weekly inventory draw on record. For the week ending July 31, the EIA reported that U.S. crude inventories dropped by a whopping 17.049 million barrels as exports rose to more than five million barrels per day and refineries boosted demand. What did oil do? It sold off by more than two per cent on the day, and no one I spoke to in the industry could explain why. It took OPEC stepping up a day later announcing that it is extending its million-barrel-per-day voluntary production cut into September — and warning the cuts could be “extended or extended and deepened” — to backstop oil prices.

This is a market where paper traders and speculators have completely stopped counting barrels, holding the least net-long U.S. crude position since April, leaving those in the physical markets shaking their heads. However, I’ve learned that the longer this goes on, the worse the situation gets and the greater the ultimate reaction in price.

Here is a sample of some of the fundamentals being ignored that are keeping the price of crude oil below pre-COVID levels.

First, global air traffic is the highest it’s been in years and according to Rystad, jet, diesel, and gasoline demand is 1.3 million barrels a day higher than last year. The EIA recently made a massive revision to its U.S. oil demand estimate for May increasing it by 973,000 barrels a day to 20.776 million barrels. For some perspective, this is the highest level ever for total U.S. oil demand in May. Meanwhile, U.S. exports to China are the second highest on record. Interestingly, this lines up with the reports on Friday that the U.S. Minister of Energy has been coordinating the release of oil from the Strategic Petroleum Reserve (SPR) with Chinese officials.

These moves come as energy giant Exxon Mobil Corp. says it sees a record level of oil demand this year. According to the IEA, global oil demand is projected to climb by 2.2 mb/d in 2023 to reach 102.1 mb/d, a new all-time high. Goldman Sachs is also increasing its global oil demand estimate for 2023 by 550,000 barrels per day from their previous forecast and now see a 1.8 million barrel per day supply deficit in the second half this year.

On the supply side, we find it very encouraging that OPEC is aggressively defending the commodity, throwing fewer and fewer barrels at the paper market bears. The response for now has been, ”Who cares?” OPEC already cut 840,000 barrels per day in July up from the 460,000 barrels per day cut in May and will continue cutting in the months to come.

Meanwhile, the Biden administration is still stubbornly refusing to refill the SPR on fears it will drive prices higher ahead of the upcoming 2024 U.S. presidential election. As a result, they have drained the SPR down to 1985 levels, leaving little room for future supply shocks. Instead, they are apparently choosing to sell to the Chinese who have been stockpiling crude reserves on their end. At the same time, global oil inventories continue to be drawn down and according to estimates from energy fund manager, Eric Nuttall, at the current pace they are on track to fall to the lowest level in at least five years by the end of 2023.

All of this means that barring a deep global recession, which doesn’t look likely based on recent economic data, things are lining up for a large and sudden rise in oil prices. This isn’t a good thing for central bankers who are doing their best to fight inflation.

As an investor, I think now couldn’t be a better time to add some inflation protection back into one’s portfolio to protect against such an event. In my opinion this is one of the best opportunities I’ve seen in the sector in my career. We currently have a 13 to 15 per cent direct weighting to energy in our portfolios, which served us very well last year and we think will serve us well in the months to come.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.