by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

After making a run at $95 per barrel last week, prices are correcting; we suspect rising interest rates are increasing fears of an economic slowdown.

(Source: Barchart.com)

Commercial crude oil inventories fell 2.2 mb compared to forecasts of a 1.5 mb build.  The SPR rose 0.3 mb, which puts the net draw at 1.9 mb (difference due to rounding).

In the details, U.S. crude oil production was steady at 12.9 mbpd.  Exports rose 0.9 mbpd, while imports fell 1.0 mbpd.  Refining activity fell 2.2% to 87.3% of capacity.  We are clearly heading into the autumn refinery maintenance period which should reduce demand.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s decline is contra seasonal and thus is bullish for crude oil prices.  The continued drop in stockpiles while refinery maintenance is underway is profoundly bullish for oil prices.

(Sources: DOE, CIM)

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $76.55.  The continued draw in commercial inventories is supportive for oil prices, but there is a geopolitical risk factor that is boosting prices as well.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1984.  Using total stocks since 2015, fair value is $95.21.

Market News:

• Although there has been a clear trend by U.S. oil companies to focus more on profitability and less on production, surveys of oil executives suggest that they see oil demand continuing. So far, this hasn’t necessarily led to a major production boom.  However, if these attitudes about demand begin to affect behavior, we could see renewed investment.
  • At the same time, government hostility toward oil and gas continues. The Biden administration has reduced the number of offshore oil drilling leases to a record low.  It should be noted that this stance could shift with a GOP White House, but the industry must consider the fact that power could shift back in later years.  Policy uncertainty tends to dampen investment.
  • Hedge funds are providing funding for environmental lawsuits. Although the funding, so far, has applied to mining firms, these lawsuits tend to raise the costs of production and reduce supply.
• U.S. product exports have hit a new record, and the same goes for U.S. exports of natural gas. As the global energy market restructures, the U.S. is benefiting.
• China is increasing its imports from the Arctic route.

Geopolitical News:

• With the spike in oil prices, the G-7 oil price cap has collapsed. This development is boosting Russian oil revenues.  It should be noted that the vessels carrying Russian oil are not using Western insurance.  So far, that hasn’t stopped their shipments.  At the same time, Russian production of natural gas is falling as the loss of European markets and Western technology is undermining production.
  • Turkey continues to play its role as a borderland nation. The number of Russian and Iranian firms locating to Turkey has surged since sanctions have been implemented in the wake of the war in Ukraine.
• Despite high oil prices, rising fiscal spending is expected to generate a deficit in the Kingdom of Saudi Arabia in 2024. It is unclear whether the Saudis will press for even higher prices to increase revenue.  Obviously, this only works if the demand for Saudi oil is price inelastic.
• Saudi and Chinese energy ties are deepening. China is the world’s largest oil importer, and the Saudis are investing in China’s downstream industry.  By doing so, it should increase China’s dependence on Saudi oil.
• There are reports that Iran has opened direct nuclear program talks with the U.S. Although getting to a deal would be difficult, the fact that Iran has moved on this issue could be significant.
  • We also note that Tehran has been engaging in talks with various Gulf States.
  • It’s looking increasingly likely that Robert Malley was involved in supporting Iranian diplomatic and intelligence efforts in Washington. As we note above, the Biden administration has been trying to resurrect the Iran nuclear deal; the revelation of a spy in the administration won’t help in this process.

Alternative Energy/Policy News:

• As we discussed last week, Ford (F, $12.54) has put a battery plant on hiatus due to uncertainty surrounding the facility’s profitability. Another issue looms regarding legislation on EV tax credits, which rests on how a “domestic” EV is defined.  Foreign EVs or those with foreign components sourced from a “foreign entity of concern” will no longer be eligible for the credit.  Ford is using Chinese-licensed battery technology, but the rest of the car is considered domestic.  It is unclear whether Ford EVs will qualify if they use these batteries.  Thus, the government’s decision on subsidies is a major issue for future domestically built EVs.
  • Although the U.S. and increasingly the EU are using trade restrictions to support their domestic EV industries, there will be a cost to this protection in the form of higher prices. It’s a classic example of economic tradeoffs—if you want a rapid EV transformation, importing cars from China is probably the quickest path, but if  you want to refashion the domestic auto industry, then consumers will pay more.
  • EV makers outside of China are struggling to turn a profit. Tesla (TSLA, $245.26) has reported lower sales due, in part, to factory upgrades for next year’s models.  The company has been trying to expand market share at the cost of margins, which has depressed revenue.  Other firms are struggling as well.
  • There is a near-constant debate as to whether EVs are better for the environment. Although they clearly reduce emissions, the mining of metals and the source of electricity can clearly affect the environmental situation.  A new study suggests that even with assumptions that the electricity source is “dirty,” EVs are still a plus for the environment.
  • Battery technology is evolving as research efforts increase. This research could change the types of metals needed for EV batteries over time.
• Emerging markets, in general, and China, in particular, are expanding nuclear power at a rapid pace. This development is bullish for uranium.  In developed markets, permitting and other issues are undermining development.
• Nucor (NUE, $158.25) is looking to manufacture steel using fusion energy.
• As costs rise, growth in wind power is starting to stall.
• Global shipping firms are investigating the use of sails on vessels to reduce fuel consumption.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices are breaking out, raising the potential for a move toward $95 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories fell 2.2 mb compared to forecasts of a 2.0 mb build.  The SPR fell 0.3 mb, which puts the net draw at 2.4 mb (difference due to rounding).

In the details, U.S. crude oil production was steady at 12.9 mbpd.  Exports fell 1.1 mbpd, while imports rose 0.7 mbpd.  Refining activity fell 1.6% to 89.5% of capacity. We are clearly heading into the autumn refinery maintenance period which should reduce demand.

(Sources:  DOE, CIM)

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s decline is contra seasonal and thus is bullish for crude oil prices.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $74.92.  Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1984.  Using total stocks since 2015, fair value is $95.49.

Market News:

• The IEA issued an updated report detailing what would be necessary to reach carbon reduction goals by 2030. Generally speaking, it is still possible to reach these goals, but the path is narrowing.  The IEA claims that fossil fuel demand will need to decline 25% by 2030; we suspect that isn’t likely.
  • Oil execs claim that without more support for shale drilling, oil is headed to $150 per barrel. We don’t think that is probable in the near future because OPEC+ has significant excess capacity.  However, over time, it could occur.  The idea that demand must fall by 25% will likely temper investment activity in oil and gas.
  • One of the key factors in shale production is water. There are concerns that Texas is consuming so much water that it may eventually curtail output.
  • U.S. oil production is steadily rising and is offsetting some of the production cuts from OPEC+.
• As oil prices continue to rise, the G-7 cap on Russian oil prices has become irrelevant. The restrictions on Western insurance remain in place but are increasingly being ignored as Russia is managing to acquire insurance from other sources.
  • Russia has banned product sales in a bid to ensure ample domestic supplies. Russian domestic prices have declined in the wake of the restrictions.
• Although there is still talk about phasing out fossil fuels in the West, China’s climate envoy has made it clear that Beijing isn’t ready to give up on these fuels anytime soon. This comment makes the idea of “peak oil demand” appear a bit premature.
• It was a warm summer, and September has also been warm. The combination of undersea volcanic activity, the emerging El Niño, and the peak of the solar cycle have all combined to lift summer temperatures.  We will now be watching to see if we have a mild winter as a continuation of these trends.
• Russia banned the export of distillate products earlier this month, but as prices have increased, it has lifted its ban on bunker fuel, the high-sulfur fuel usually burned by ships.
• Despite high prices, U.S. E&P company capex remains constrained.

Geopolitical News:

• In the wake of the Iran/U.S. prisoner swap, there is hope that the two parties will use this event to improve relations. Although we have our doubts that this will work, there are parties trying to foster negotiations.
  • Qatar is offering to facilitate talks between the U.S. and Iran about moving forward on a new nuclear deal.
  • On the other hand, Iran’s foreign minister, who was in New York for the UN General Assembly meetings, was unable to visit Washington for talks.
  • Robert Malley, who we discussed in an earlier Weekly Energy Update, appears to be part of a deep influence campaign by Iran.
  • President Raisi of Iran is calling for the U.S. to leave the Middle East.
  • Iran claims to have thwarted a massive bombing campaign. Tehran blames Israel.
• In a bid to conserve foreign currency reserves, Iraq will restrict all internal transactions to the IQD. Usually when a central bank puts such restrictions in place, the action reduces trade.
• Over the past few weeks, we have discussed Saudi/Israeli normalization. The barriers to a deal remain high, but talks appear to be continuing.  As a potential deal looms, Iran is trying to figure out how to respond.  A KSA/U.S./Israel deal would create a formidable obstacle to Iran’s goal of dominating the region.
  • As negotiations continue, we note that the new Saudi envoy to the Palestinians has visited the West Bank. Also, Israel’s tourism minister has visited the KSA, which makes the minister the highest ranking official to actually visit Saudi Arabia.
• One of the key elements of the geopolitics of oil is that Europe lacks enough oil and natural gas to be energy independent. Thus, it needs imports to meet its energy needs.  The U.S. wants Europe to be dependent on America.  Europe, obviously, wants diversity of sources.  Washington has historically tolerated Europe getting supplies from the Middle East and Africa but has consistently opposed Europe getting oil and gas from Russia.  As the war in Ukraine has disrupted Russian supplies, the EU is finding itself increasingly dependent on the U.S., especially for natural gas.
  • Mexico is planning to join the ranks of LNG export nations.
• Chevron (CVX, $170.23) announced it will resume drilling activity in Venezuela. The country has been under sanction for some time, but in the wake of the war in Ukraine, Washington has gradually lifted sanctions in a bid to keep oil prices under control.
  • At the same time, Citgo, the large U.S. refiner that is a subsidiary of the Venezuelan state oil company PDVSA, will be auctioned off to pay Venezuelan debt. So far, the Maduro government hasn’t taken measures to stop the sale.

Alternative Energy/Policy News:

• European officials warn that the region must diversify its solar panel supply chains away from its dependence on China. The U.S. industrial policy is attempting to support a domestic solar panel industry.
  • The EU is getting increasingly aggressive in protecting its auto industry, threatening not only China but also U.S. EV producers with trade restrictions.
• China is also dominant in rare earths mining and processing. Vietnam is vying to compete with China in this market.
  • Vietnam is also making headway in the EV market and hopes to become a source for the EU now that Europe is considering restricting Chinese EVs.
• Ford (F, $12.55) halted work on a battery plant in Michigan. The plant, which uses Chinese licensed technology, has been controversial.  The UAW, which is currently striking, has claimed that this halt was designed to influence the union’s wage efforts.  However, the company claims it isn’t sure it can “competitively” operate the plant.
  • Chinese firms are investing in Moroccan phosphate, which they use in batteries.
  • Looking for a good primer on EV batteries? This report from The Economist lays out the different battery technologies and where new developments are going.
• Geothermal energy remains an attractive alternative energy. So far, it has mostly been restricted to regions with volcanic activity but there are hopes that it can be deployed more broadly.  In addition, there is research under way to make current geothermal power more efficient.
• There is also research in progress that could transform CO² into synthetic natural gas.
• The U.S. is aiming to build a nuclear fusion facility within the next decade.
• Microsoft (MSFT, $310.65) is funding small modular reactors to provide energy to the company. This energy is designed to, in part, provide electricity for its AI efforts.

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by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA | PDF

Oil prices have continued their rise, with Brent trending toward $95 per barrel.  Recent extensions of the production cuts by the Kingdom of Saudi Arabia (KSA) have boosted prices.

(Source: Barchart.com)

Commercial crude oil inventories fell 2.1 mb compared to forecasts of a 1.7 mb draw.  The SPR rose 0.6 mb, which puts the net build at 1.5 mb.

In the details, U.S. crude oil production was steady at 12.9 mbpd.  Exports rose 2.0 mbpd, while imports fell 1.1 mbpd.  Refining activity fell 1.8% to 91.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s decline is mostly consistent with expected seasonal patterns.  However, we should start to see inventories rise in the coming weeks, but if they fail to do so, it could give another lift to oil prices.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $74.10.  Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in late 1984.  Using total stocks since 2015, fair value is $95.20.

Market News:

• Last week, we reported on the IEA’s position that peak oil demand is near. We note that this week, skeptics to this idea have responded.
• Société Générale (SCGLY, $5.16) announced it is scaling back its lending to the fossil fuel industry. Reducing available capital to the energy industry is bullish for crude oil prices.
• Although we remain concerned about European natural gas prices this winter, current inventory capacity is essentially full, meaning that LNG cargos destined for Europe have no place to go. Thus, in the near term, prices could come under pressure.
• It appears that China is rapidly building crude oil inventories. Although we don’t know the prices at which the oil was acquired, we are surprised China has been aggressively buying oil in a highly priced environment.  We do note that the largest exporter of oil to China is Russia; Moscow has likely given Beijing favorable prices and is allowing China to purchase oil in CNY.
• Ireland has rejected plans to build an LNG terminal, citing its goal of reducing greenhouse gases. It remains to be seen if Ireland can meet its energy needs through other means.
• Although overall U.S. production has been rising, the DOE says that output from leading shale oil areas has fallen for three consecutive months.
• California is putting restrictions on diesel semis starting next year, which is leading trucking companies to aggressively acquire rigs before the deadline.

Geopolitical News:

• The five Americans held in Iran have left Tehran. Despite this diplomatic effort, tensions with Iran remain elevated.  Iran has expelled around one-third of IAEA inspectors in what is being called an “unprecedented” action.  The move will likely slow, or even prevent, further improvement in relations.  We note that European nations have decided to maintain sanctions, suggesting the prisoner swap was a one-off.  At the same time, there are hopes that this confidence-building measure could lead to improved relations.
• The Saudi oil minister claims that the recent cuts in production were required to “stabilize” the oil market and were not about raising prices. If so, the oil price chart shown earlier would suggest this effort was an abject failure.
• As tensions rise between Armenia and Azerbaijan in the Nagorno-Karabakh region, there are worries that the Baku oil flows could be interrupted. Fortunately, it looks like a ceasefire has been negotiated.
• There are unconfirmed reports that the KSA has ended talks with Israel on normalizing relations. Israel says negotiations continue.
• Meanwhile, the U.S. is trying to facilitate talks between the KSA, the UAE, and the Houthis on a ceasefire in the Yemen Civil War. Although the KSA and UAE both endorse suppressing the Houthis, they support different groups in Yemen.  Thus, the negotiations will be difficult.  A ceasefire in Yemen could help stabilize the region.
• In the U.S., as the Democratic Party supports the expansion of green energy, the GOP appears to be increasing its support for the fossil fuel industry…and looking for campaign donations.
• We have noted that the Russian oil and gas embargo has led to a restructuring of global energy flows. This report details recent trends.

Alternative Energy/Policy News:

• Wind energy has recently come under strain as rising costs are leading to projects being postponed or cancelled. Governors on the Atlantic Seaboard are asking for federal help to keep the projects afloat.
• Last week, we noted that the EU is starting to push back against Chinese EVs in a bid to protect their own auto industry. It looks like this pushback is gaining momentum.  As the EU starts to close its market, China is eying Japan as a target for its EVs.
• The state of California is suing major oil companies for damages caused by climate change, alleging the firms covered up evidence that fossil fuel consumption would have adverse climate effects. We have no position on the merits of the case, but would suggest that its existence alone could have a dampening effect on future oil production.
• Although the long-term outlook for lithium is bullish, in the near term, supply exceeds demand. Thus, we may be in for a period of falling lithium prices.
  • Oil companies are looking to extract lithium from fracking wastewater.
  • Researchers at Princeton have developed a new lithium extraction process that promises to enhance the productivity of the metal.
• One important hurdle for EVs is range anxiety. Energy Secretary Granholm’s recent EV demonstration trip was a mess; securing recharging venues was hard and they were not in the most convenient spots.  However, it should be noted that we are in the early days of the EV era.  Next generation batteries could go a long way toward addressing current problems.  Toyota (TM, $187.86) claims its next generation battery will have a range of 497 miles, which rivals gasoline engines.  The company says that it will offer solid state batteries by the end of the decade with ranges around 920 miles and 10 minute recharges.
  • U.S. EVs have reached two million on the road.
• To acquire key minerals for the energy transition, Norway wants to mine the seabed. We suspect this will be controversial.

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