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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 1.7 mb compared to a 1.9 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production declined 0.1 mbpd to 12.2 mbpd.  Exports fell 2.3 mbpd, while imports rose 0.1 mbpd.  Refining activity rose 0.2% to 86.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We have been accumulating oil inventory at a rapid pace, even without SPR sales.  This week, while there was a modest drop in inventory, we remain well above normal seasonal levels.

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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $93.31.

The Unaccounted Problem

The DOE’s weekly report is a combination of survey data and estimates.  Although traders focus on the weekly reports, the government views the monthly reports as the most accurate.  Unfortunately, the monthly reports are issued with a two-month lag. For practical purposes then, the weekly data, though imperfect, is what moves markets.

Line 13 of the petroleum supply section of the petroleum balance sheet is a plug number called “adjustment.”  It was previously called “unaccounted for crude oil” as it balances the known sources of crude oil (production, net imports, stock change) with the level of crude oil consumed by the domestic refining industry.  Lately, this number has been rising.

When the reading is above zero, it indicates that more crude oil was refined that week than was identified in the surveys or estimates.  What we know is that there is more crude oil (and/or associated products) available, but what is being missed is quite important.  The DOE argues that blending components used by refiners are possibly being included in the count of crude oil.  However, it is also possible that (a) production is higher than estimated since production in the lower 48 is an estimate, (b) imports are higher, (c) exports are lower, or (d) there is more oil being moved from inventory.  Obviously, how this unaccounted crude oil is accounted for matters a great deal.  Our guess is that it’s likely a combination of blending stocks being counted as crude oil and, perhaps, lower exports.  In any case, the monthly numbers should provide some clarity…in May.

Market News:

• The Columbia University Center on Global Energy Policy released a report on investing in a market that is transitioning away from fossil fuels. The report notes that not only are investments in oil and gas production falling, but the investments still occurring are increasingly being made by state-owned oil companies, most of which are in the Middle East.  The private sector isn’t investing for several reasons, one of which is a history of low returns in the industry as investors are demanding better returns.  If these trends continue, it suggests that oil prices will tend to be elevated even as demand weakens.  The CEO of Saudi Aramco (2222, SAR, 34.95) warns that persistent underinvestment will keep oil supplies tight.
• U.S. LNG is filling the gap caused by the end of Russian natural gas sales to Europe. The EU is moving to consolidate purchases in a bid to lower prices.
• It’s CERA week in Houston. One of the key topics is the lack of spare capacity in oil production.  Another important item emerged from the shale patch which warned that the best days may be behind the industry, meaning that OPEC+ can reassert control over oil prices.
• This map shows European fuels of choice for electricity production.
• The DOE is preparing to refill the SPR…next year.

 Geopolitical News:

• We have been monitoring the ongoing speculation surrounding the sabotage of the Nord Stream pipelines. A recent New York Times article suggests that a Ukrainian group, not directly affiliated with the government, was likely responsible.  Although Seymour Hersh caused a stir recently when he suggested that it was a U.S.-led attack, most analysts felt that Ukraine had the strongest incentive to carry out this attack.  If the Ukrainians turn out to be responsible, it would adversely affect the country’s relations with Germany.  A proxy group would give Ukraine plausible deniability, which would help with this issue.  As expected, the Ukrainian government has denied responsibility.
  • Russia has decided to mothball the remaining parts of the Nord Stream 1 & 2 in light of last year’s sabotage.
• This week’s BWGR discusses the potential emergence of a “petroyuan” structure to create an alternative to the dollar/Treasury reserve system. Reports indicate that Russian oil exports are being paid in a variety of currencies.  Since Russia has been excluded from the dollar system, it makes sense that Moscow would accept various currencies for payment.  On an interesting note, even the use of other currencies hasn’t been completely successful in avoiding U.S. sanctions.  Some sort of digital payment mechanism will likely be required in order to avoid the U.S. banking system completely.
• There has been a spate of apparent poisonings in Iran, which seem to be targeting girls’ schools. It is not clear whether these attacks are related to the hijab protests or are coming from elements in the Taliban who oppose educating women.
  • Iran is promising to cooperate with the IAEA after the recent findings of enriched uranium particles at near-weapons-grade levels. The fact that Tehran is trying to at least portray it is working with the IAEA suggests that it is not ready to declare itself a nuclear power.
  • Iran announced that the “questions” of enrichment have been answered, although the IAEA hasn’t confirmed this assertion.
  • On the other hand, Iran has agreed to reinstall monitoring cameras at its nuclear facilities.
  • Interestingly enough, the U.S. has not responded strongly to the news of enrichment, while Europe, on the other hand, has been calling for censure.
• The U.S. fears that Iran is using Iraq to acquire dollars and evade sanctions. In response, the Treasury Department is tightening transfers.  Unfortunately, this decision is adversely affecting Iraq’s economy.
• Russian tax revenue from oil and gas sales fell 48% in February. Lower prices and reduced volume led to the drop.
  • Uzbekistan is reluctantly turning to Russia for natural gas.
  • Russia is exporting oil to the UAE, and it is likely that this oil is being “laundered” for sale to areas that are observing sanctions on Russia.
• As Russia and Iran draw closer, the Gulf Nations and Israel are pressing Moscow not to sell arms to Tehran. Russia, like China, has been trying to woo all parties in the Middle East, but it is finding that deep divisions exist.  Although both China and Russia have interests in developing closer relations with Iran, building a coalition will, almost by necessity, exclude the Gulf States and Israel.  As Europe and the U.S. have learned over the years, managing differences in the region is difficult.  At the same time, the U.S. is expressing greater concern over the growing Iranian/Russian ties.
• The Kingdom of Saudi Arabia has sent $5 billion to Turkey to bolster Ankara’s foreign reserves.

 Alternative Energy/Policy News:

• The IEA released its CO₂ emissions report for 2022. Although emissions reached a new record high, the pace of emissions growth is actually declining.
  • Carbon capture projects are continuing to develop, but the pipelines that carry CO₂ to storage are unregulated at this point.
• Agroforestry is the practice of planting trees around farm fields. The idea is that the trees will help prevent soil erosion and can provide shelter for livestock.  Government funding for increasing agroforestry is being considered.
• The anti-ESG movement has begun to target insurance companies that may be denying coverage due to climate change concerns. The industry is pushing back, but it may be impossible for the government to force firms to cover areas adversely affected by climate issues.
• In the early days of the auto industry, firms often attempted to vertically integrate operations. As the industry matured, it decentralized, which led to multiple firms supplying all sorts of inputs.  Due to insecurity of supply, EV makers are attempting to follow the early founders of car manufacturers by vertically integrating.
• Volkswagen (VWAGY, $18.99) will build a battery plant in North America to take advantage of the subsidies offered by the Inflation Reduction Act. This news will likely trouble EU policymakers, who have been critical of the “buy American” elements of the act.
• One of the problems with the transition to clean energy is that China dominates the production of the needed components. As the world devolves into blocs, the U.S.-led bloc may, in the short run, either continue to use fossil fuels or import clean energy components from China.
• China is reportedly building “breeder” nuclear reactors. Although such reactors can be used to generate power, they also create plutonium which can be used for nuclear weapons.
• Geothermal power is attracting attention from industry and government.
• Environmentalist groups have been trying to curb oil and gas production by restricting pipeline expansion. Data from the DOE suggests that they were remarkably successful.  Meanwhile, oil companies are preparing the groundwork needed to acquire subsidies for investments in carbon capture.

  View PDF

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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 1.2 mb compared to a 1.8 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd.  Exports rose 1.0 mbpd, while imports fell 0.1 mbpd.  Refining activity fell 0.1% to 85.8% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We have been accumulating oil inventory at a rapid pace, even without SPR sales.  The primary culprit is low refining activity, which should pick up later this year.  The rapid rise in stockpiles is a bearish factor for oil, and current stockpiles have already exceeded the five-year average peak normally seen in early summer.

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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $94.18.

Natural Gas Update:

Natural gas prices have been under pressure this winter, mostly due to mild temperatures.

This chart shows the deviation of population-weighted heating degree days[1] for the U.S. compared to the average from 1981 through 2010.  A negative reading suggests warmer-than-normal temperatures, meaning fewer heating degree days.  Although this January was not the mildest on record, heating degree days were clearly below normal.

In looking at the trend of supply and consumption, currently the market is oversupplied (indicated by the balance variable being greater than zero).  Interestingly enough, consumption remains robust but so does supply growth.

Because of the warm winter, current inventories are above normal.

The previous chart shows seasonally adjusted working natural gas storage.  As the deviation line shows, stockpiles are above normal.  We have one more month of storage withdrawals.  In April, the inventory injection season begins.

Market News:

• As Russian oil flows to Europe decline, we are seeing the U.S. gain market share. Throughout history, the U.S. has, at times, been a major supplier of oil to Europe.  Often, these flows have occurred due to wars or other such events.  History seems to be repeating itself.
  • Reports suggest that Venezuelan crude is also going to Europe.
  • Meanwhile, China has been an aggressive buyer of U.S. crude oil as well.
  • Last month, the Europeans ended the purchase of Russian oil products, and it appears that these products are now flowing to North Africa. It is not out of the question to assume that some of these products may “leak” to Europe.
  • Russia has halted oil flows to Poland.
• Platts (SPGI, $341.51) announced it will include WTI in its Brent basket for calculating prices. This decision may narrow the Brent/WTI spread.
• OPEC February production rose 150 kbpd. Two-thirds of this rise came from Nigeria.
• The IEA has released its annual natural gas report. One key finding is that Europe is rapidly building out LNG receiving capacity.
• Despite the recent decline in EU natural gas prices, chemical firms continue to exit Germany due to high costs.
• Saudi Aramco (2222, SAR, 31.55) is considering an investment in a foreign LNG plant as demand surges.
• After three consecutive La Niña events, the World Meteorological Organization says the odds of an El Niño in 2023 are elevated. The following maps show the possible global impact on temperatures and precipitation.

(Source: NOAA)

The below map shows likely winter temperature effects from El Niño.

(Source: weather.gov)

• Although strong pricing of oil should support increased drilling activity, shale producers have been raising output slowly. Rising production costs and less attractive fields are capping production growth.
• After more than 70 years, BP (BP, $39.87) announced that it will cease publishing its Statistical Review of World Energy. The report will now be compiled by the Energy Institute.

 Geopolitical News:

• After a couple months of operating the price cap on Russian oil sales, the data suggests that the cap hasn’t led to lower prices but has succeeded in fragmenting the global oil market. That doesn’t mean the cap will never work, but as of now, the cap hasn’t affected prices.  In the wake of this research, there are calls for tighter sanctions.  The problem with this approach is that consumers must accept the tradeoff of higher prices.
  • Indian buyers report that complying with G-7 sanctions has become complicated and burdensome and may lead to less Russian oil imports.
  • Sanctions are degrading Russia’s refining industry. Some sanctions ban purchases of Russia’s refined products, but problems go beyond just the loss of market access.  Personnel losses due to the war or emigration are also having an adverse impact.
• Two weeks ago, we discussed the report from Seymour Hersh that accused the U.S. of attacking the Nord Stream pipelines. We note that even before the sabotage, natural gas flows had been interrupted on several occasions.  It appears that German firms are beginning to take legal action against Russian firms for failing to meet their contractual obligations.
  • In the wake of the Nord Stream attacks, we are hearing of increased Russian activity in the North Sea. This region is not only an active oil and gas region, but it is also laced with fiber optic cables that could be severed.  The fear is that Russia may begin its own sabotage operations in the area.
• Iran appears to be preparing for a broader rupture with the West over uranium enrichment. Meanwhile, the Iranian rial (IRR) is depreciating rapidly; it is reportedly trading at IRR 575,000/USD 1.  An iPhone now costs over one billion IRR.
  • General Hossein Salami, the commander of Iran’s Islamic Revolutionary Guard Corps, claims that Iran is “at war” with Europe. It’s not clear what triggered this statement, but one likely reason was the EU’s reluctance to break with the U.S. over the JCPOA.
  • Iran is claiming it has a hypersonic missile, and the country is working to expand its footprint in space by collaborating with Russia. Russia is also helping improve Iran’s missile program.
  • Brazil allowed two Iranian naval vessels to make a port of call despite U.S. objections. The “global south” is increasingly opposing U.S. and European policy goals.

  Alternative Energy/Policy News:

• China has been able to expand its mining and processing of rare earths and other minerals by accepting lower environmental standards. However, Beijing has been steadily implementing stricter environmental standards in recent years.  It appears this rolling crackdown may reduce lithium by as much as 10% of global supplies.  We do note that production appears to have resumed, but the fact that it can be closed quickly will likely lead EV producers to hold more inventory.
  • China is looking to invest in Bolivia’s troubled lithium industry.
• Chinese auto battery makers are reducing costs to their domestic EV industry, which could give them an advantage in the global EV market. Among other EV producers, there is a clear attempt to vertically integrate to secure supply chains.
  • Lithium prices are falling due to declining battery prices in China.
  • Auto unions are beginning to realize that the shift to EVs will mean fewer jobs.
• China is reportedly boosting its wind energy capacity.
• One, albeit controversial, way to address climate change is with geoengineering. Geoengineering encompasses a wide range of interventions designed to cool the planet.  One idea is to mimic volcanic eruptions which spew particulates into the upper atmosphere.  After major eruptions, temperatures tend to fall for several months.  We note that a startup firm claims it is using weather balloons to disperse particles into the stratosphere in a bid to cool temperatures.  The practice is controversial because it is cheap enough for private actors to perform but various tactics could have unanticipated side effects.  Scientists have been calling for more research on geoengineering as a way to slow implementation until we can get a better idea of what various practices will actually do.
• Lurking in the background of clean fuels is hydrogen. The gas burns cleanly in a fuel cell with high efficiency.  The problem is getting the hydrogen.  In general, it comes from two sources:  electrolysis and by splitting natural gas.  The former breaks down water into oxygen and hydrogen, usually at a great cost, and the latter isn’t much cleaner than just burning natural gas.  However, there may be a direct source as there are pockets of hydrogen available in free form.  These sources have mostly been ignored by the industry, but there is now growing interest in free hydrogen which may prove to be a cheap, clean, and abundant source of energy.
• Direct carbon capture could conceivably reverse climate change. The problem is that current methods are either too small to matter or consume too much energy.  Researchers are working to tap thermal energy to address the problem.
• Japan is starting commercial production of “semi-solid” batteries. Although they have less capacity, they are considered safer and less polluting.
• Japan is also returning to nuclear power, reversing policies enacted after the Fukushima disaster.
• China’s purchases of Russian uranium are raising fears of a new arm’s race. In addition, as nations expand their nuclear weapons capacity, it could drive up the price of uranium used for power production.
• Biochar comes from heating biomass in the absence of oxygen.  The resulting charcoal-like lumps can be applied to soil and will absorb carbon.

[1] Heating degree days (HDD) are a measure of how cold the temperature was on a given day or during a period of days compared to 65^oF. For example, a day with a mean temperature of 40°F has 25 HDD. Two such cold days in a row have a total of 50 HDD for the two-day period.

  View PDF

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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 7.6 mb compared to a 2.0 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd.  Exports rose 1.5 mbpd, while imports rose 0.1 mbpd.  Refining activity fell 0.6% to 85.9% of capacity.

 (Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We are accumulating oil inventory at a rapid pace, even without SPR sales.  The primary culprit is low refining activity, which should pick up later this year.  The rapid rise in stockpiles, though, is a bearish factor for oil, and current stockpiles have already exceeded the five-year average peak normally seen in early summer.

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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $94.35.

Market News:

• Environmentalists have been using the courts to prevent oil companies from building pipelines, effectively bottling up supplies. Canadian oil and gas from Alberta have been especially vulnerable to transportation issues.  The most logical direction of travel would be south into the U.S., but pipeline capacity issues around the Keystone pipeline limit exports.  Attempts to expand the pipeline have been thwarted by regulators.  In response, oil interests in Alberta are looking to use rail to expand sales into the U.S.  While there is some interest, the recent tragedy in Ohio may present some opposition to this expansion.
  • Pipelines to Corpus Christi are reaching capacity, which could cap U.S. oil exports.
  • Oil companies are increasingly caught between the pressure to increase output and environmentalists attempting to reduce oil and gas supplies. Overall, this situation will increase costs and will likely reduce supply.
• Natural gas prices have had an epic decline over the past several months. High prices in the wake of the war in Ukraine have led to reduced demand and have moderately increased supply.  However, a mild winter reduced seasonal demand and the need to reduce storage has caused a sharp drop in prices.[1]  The EU’s natural gas consumption fell 19.3% in the period from August 2022 to January 2023 as compared to the same period last year.  Price signals matter, and we note there are reports of reduced gas drilling in the U.S.
  • The IEA warns that the current low prices for natural gas do not necessarily mean that supply problems won’t emerge in Europe later this year. EU inventories will be elevated going into the spring when inventory injections begin.  Nevertheless, high stock levels at the end of winter won’t necessarily guarantee ample supplies for next winter.
  • Heat pump sales in Europe are rising rapidly. Although heat pumps are not necessarily ideal for very cold temps, they do reduce heating demands under normal circumstances.
• Analysts are becoming increasingly worried that the world’s remaining oil reserves will be of lower quality, requiring higher levels of investment to produce usable oil. If so, this means that costs will rise which will likely lead to higher prices.
• Although Saudi Arabia continues to post optimistic demand forecasts for oil, the lack of investment suggests that the country doesn’t believe its own estimates.
• One behavior that we often see when supply concerns rise is hoarding. Nations with a key commodity or product will restrict exports to keep prices low in the home country.  This is something of a dubious policy since export controls often lead to underinvestment and lower supplies over time.  It can also increase smuggling in an attempt to arbitrage the usually higher prices abroad.  However, just because a practice doesn’t always yield optimal results doesn’t prevent it from happening.  We note that Australia is considering export caps on natural gas, and if this occurs, it could trigger panic buying by consumers who would lose access to this product and drive the prices even higher.
• A subcontractor to the CFTC that provides the commitment of traders’ data was hacked; the report has been delayed.

 Geopolitical News:

• Although the war in Ukraine and subsequent sanctions have not ended Russia’s oil and gas sales, it has caused serious disruptions to trade flows. Natural gas flows from Russia to Europe have been curtailed.  Russian oil shipments are increasingly flowing to Asia, and especially China.  Increased Russian oil sales to Asia are affecting Middle East oil sales to the region, putting the two oil regions into competition for market share.  Despite increased flows from Russia, China continues to show interest in Middle Eastern We commented last week that the Iranian president traveled to Beijing to solidify relations, and China is also attempting to acquire Iraqi oil.  However, China remains a significant buyer of Russian crude oil as well.  We also note that China usually buys Russian oil at deep discounts.
  • Kazakhstan is starting to export crude oil to Germany through the Druzhba pipeline which is owned by Russia. Technically, this oil isn’t under sanction, but it may be difficult to prevent Russian oil from being sold to Europe under the guise of Kazak oil.
  • Essentially, we are moving away from a global oil and gas market to one with regional divisions. Commodity markets adapt, but the way markets are dividing is less efficient.
• The recent uproar over the Chinese spy balloon has raised questions about how well the CPC actually controls its companies and bureaucracy. In this vein, we note that Chinese officials are talking to refiners, both state-owned and private sector firms, about their oil purchases from Russia.  It is unclear exactly what the government is trying to discover, but it is likely that Beijing doesn’t want to get surprised by news of Russian purchases.
• China is easing its import ban on Australian coal. The ban was initially implemented when Australia supported an international investigation into the origins of COVID-19.  The ban is being lifted now that COVID has fallen from the news and China needs coal.
• Dutch intelligence is warning that Russia is targeting energy and internet infrastructure. Reports suggest the Russians are likely to use espionage to disrupt energy and data flows.
• The IAEA has indicated that Iran has enriched uranium to 84%, just under the 90% required for nuclear weapons. This level would suggest Iran is at the nuclear threshold, but, so far, there have not been any reactions to this news.  Israel has indicated in the past that it views a nuclear-armed Iran as an existential threat, so this news could trigger a strong response from Israel.  We note Iran has disputed the IAEA’s report as we suspect that the country does not want this news to become public.
• An Iranian drone has struck an Israeli-owned tanker in the Arabian Sea.

 Alternative Energy/Policy News:

• One of the elements of the Reagan/Thatcher revolution was the discreditation of industrial policy. The idea that government could “pick winners and losers” seemed doomed to fail.  The collapse of communism, which epitomized planned economies, further undermined industrial policy.  However, as geopolitics is increasingly affecting economics, industrial policy is returning.  The Inflation Reduction Act’s provisions to support the buildout of green energy is a clear example of industrial policy.
• Tesla (TSLA, $198.39) has cut prices to such an extent that the Model 3 is now the cheapest new car in America.
• The IEA is pressing governments to tighten rules on methane emissions. Methane is a greenhouse gas, and although it doesn’t last long in the atmosphere, it is much more potent than carbon dioxide.  Tightening these rules will add costs to oil and gas exploration and development, which will likely lead to lower production.
• Rare earths are critical in the transition away from fossil fuels. EVs and wind turbines use these minerals, and they are also part of certain tech products such as smart phones.  China is not only the world’s leading miner of rare earths, but it also dominates ore processing.  The U.S. has reopened a rare earths mine in Mountain Pass, CA, but has exported the ore to China for processing in the past.  Japan has built a processing plant and the U.S. has decided to move away from China and export the ore to Japan, further evidence that the U.S. is delinking from China.
• Battery technology really doesn’t work well for semitrailers. The need for power is great, and the battery weight becomes prohibitive.  There are some efforts to use hybrid technology (going downhill with a semitrailer can generate significant power), but it’s hard to replace diesel.  However, fuel cells and hydrogen may be a better alternative over the long term.
• On the subject of batteries, for stationary needs, such as utilities, gravity storage may become a solution.
• The U.S. is expanding its charging network, and U.S. regulations are requiring the installations to be U.S. made, riling trading partners.
• Mexico is planning to nationalize its lithium reserves. Bolivia is wooing China to help it develop its lithium industry.  Bolivia has the world’s largest lithium reserves but doesn’t register as a producer due to years of government mismanagement.  Although China has the wherewithal to build Bolivia’s industry, the infringement on sovereignty will be a problem.
  • Chinese lithium prices are down 30% due to falling demand for EVs.
• China is continuing to expand its solar capacity.
• China’s leading EV producer BYD (BYDDY, $57.03) is now exporting and selling cars in Germany.
• For those keeping score, the map below shows the nations (and states) that have target dates to phase out the sale of internal combustion engines. Automakers remain divided on how fast EVs will replace gasoline-powered cars.

[1] Most natural gas storage is housed in depleted wells.  To maintain well integrity, gas must be injected and withdrawn at a steady pace.  During mild winters, current production and required storage withdrawals tend to cause significant price weakness.

  View PDF

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

Crude oil prices appear to have based but so far have failed to break above resistance at around $80-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose a whopping 16.3 mb compared to a 2.0 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd.  Exports rose 0.2 mbpd, while imports declined 0.8 mbpd.  Refining activity fell 1.4% to 86.5% of capacity.

 (Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We are accumulating oil inventory at a rapid pace, even without SPR sales (see below).  The primary culprit is low refining activity, which should pick up later this year.  The rapid rise in stockpiles, though, is a bearish factor for oil.

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.  With another round of SPR sales, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $95.37.

The Nord Stream Issue:  Seymour Hersh, a long-time investigative reporter, released a blockbuster allegation a few days ago, suggesting that the U.S., along with Norway, attacked the Nord Stream pipelines.  According to his report, U.S. Navy divers from the Diving and Salvage Center based in Panama placed explosives on the pipeline and were responsible for the damage.  If these allegations are true, it would create a crisis.  Arguably, this action is a casus belli and could put the U.S. and NATO into a direct conflict with Russia.  Although, before we take the report at face value, caution should be exercised.

Hersh is an 85-year-old investigative reporter who won a Pulitzer Prize in 1970 for uncovering the Mỹ Lai massacre.  However, over the years, a good bit of his reporting has been increasingly discredited.  He wrote a large piece for the London Review of Books that suggested the Obama administration’s account of the assassination of Osama bin Laden was essentially a lie.  He faced strong criticism for that report, which relied heavily on unnamed sources.  Later, he seemed to side with the Assad regime over chemical weapons, but the allegations he made were not entirely refuted either.  Our take is that Hersh, at least at one time, was an important journalist.  Over the years, though, his reporting seems to have become increasingly erratic.

As we noted, Hersh isn’t a crackpot, but likely due to his experiences in dealing with the U.S. military and intelligence agencies, he seems to have taken a position more recently that the benefit of the doubt should go to foreign interests.  Thus, there is a potential bias to his reporting.  At the same time, even though there is a notable lack of sourcing in the report, there are solid geopolitical reasons for the U.S. to want to end Nord Stream.

The age of oil has been difficult for Europe, mainly because the continent doesn’t have much oil of its own.  Although Europe is blessed with ample coal resources, the superiority of oil as an energy source meant that without secure sources of oil, European dominance of the world was in trouble.  There is a bit of production available in Romania, and of course, after oil prices spiked in the 1970s, oil was extracted from the North Sea, but Europe was never going to achieve oil and gas independence.  The European powers attempted to expand their colonial reach into the Middle East and Asia to acquire oil, but those areas proved difficult to secure.  The Dutch lost the oil in Southeast Asia to Japan during WWII.  After WWII, when the U.S. fostered independence for European colonies, Europe lost controlled access to oil in North Africa and the Middle East.  Until the early 1970s, Europe was mostly dependent on the U.S. for oil.  Not wanting to be fully dependent on Washington for energy, Europe, and especially Germany, turned to Russia.  Naturally, this reliance on Russia wasn’t popular with the U.S.  Consistently, American administrations criticized Europe for its increasing reliance on Russia oil and gas.  The Nord Stream projects were especially galling because they directly linked Russia to Germany.

Thus, the destruction of the pipelines is arguably in American interests.  That’s why this narrative will likely be hard to quash, even if the Hersh reporting is false.  It is natural to assume that if a party benefits from an event it might have had a role in causing it.  However, that is about as far as this goes.  It is quite possible that Hersh received this information from someone that would also benefit from increased tensions between the U.S. and Russia.  And since no sources are named, it may be impossible to really prove anything.

We will continue to monitor developments and reporting around this issue.  We doubt that we will see anything definitive on this in the near term, so the most likely outcome is that it won’t cause an escalation directly involving the U.S. and NATO against Russia.  But we could see “tit-for-tat” actions, such as sabotage of LNG facilities, cutting of fiber optic cables, etc.

Market News:

• The big news this week, although maybe it shouldn’t be, is that the U.S. will sell an additional 26 mb out of the SPR. This sale was previously mandated by Congress.  Over the past couple of decades, Congress has, on occasion, used the SPR as sort of a “slush fund” to address budget issues that couldn’t be met with taxes or by borrowing.  This is a rather small sale given the scale of recent withdrawals, but the market didn’t take the news well by selling on fears of further sales from the reserve.  In fact, the administration considered canceling the sale, but doing so would have required an act of Congress, probably difficult to do in the current environment.  We don’t think this sale matters all that much, but our Twitter feed lit up with all sorts of commentary about how irresponsible the SPR sales were, and “look, they are at it again.”   We don’t disagree about the risks from earlier sales, but this one isn’t all that big of a deal.
• The IEA is forecasting oil demand will reach a new high this year due to China’s reopening.
• In response to the G-7 price cap, Russia announced a 0.5 mbpd oil production cut. There are two concerns beyond the obvious one that this action will lift prices. The first is that Russia may not be making this cut voluntarily but is finding that demand for its oil is falling.  Announcing a cut may be a measure to save face.  Second, cutting production is always a risky idea because once a well is shut in, in a short amount of time that production is lost without having to redrill.  Complicating matters further is that Russia was dependent on Western expertise to drill and maintain technically difficult oil fields.  Sanctions and disinvestment may lead to further output losses.  Oil prices initially rose on the report but failed to hold gains.  Oil markets are most likely worried about global recession weakening demand rather than the loss of supply.
  • As the Russia Urals discount widens, the Duma is considering legislation to limit the discount. If put into practice, it would likely lead to a lower supply.  There are reports suggesting that Russia’s discounts may be worse than the official price spreads indicate.
• China is working on an LNG deal with Qatar. As Qatar develops its North Field, it is apparently looking for long-term contracts to finance the development.
• Although Freeport began exporting LNG this week, regulators report that the plant has systemic safety concerns.
• The U.S. natural gas market is dealing with increased demand, especially from LNG, and rising production. However, inventory capacity is mostly fixed, meaning that price volatility is rising.  Complicating matters is that most U.S. inventory facilities are depleted gas wells where, to maintain integrity, gas is injected and withdrawn at a mostly steady pace.  This factor leads to a seasonal pattern of storage where gas is injected from April to October and withdrawn from November to March.  Storage seasonality is why price lows usually occur in January; however, if temperatures are moderate, stored gas must still come to market.  Exports come with their own set of difficulties.  Although European gas prices have declined due to mild temperatures, once the European refill season begins, export demand will likely increase.  Volatile natural gas prices will make planning difficult and could increase volatility for fertilizer and chemical prices as well.
• We are hearing of increasing concern over the future production from the Permian Basin. In some respects, this is nothing new.  A few years ago, some analysts were sounding the alarm that drilling practices were damaging reservoirs.  Now, firms operating in the region are considering consolidation which is rational if production has peaked.
• A growing number of long-term forecasts suggest that U.S. oil demand may be close to peaking. If true, the case for investing in future production would be hard to make. At the same time, the lack of refining investment could lead to strong margins for the foreseeable future.
• A warming trend over the Arctic may bring much colder temperatures to Europe and North America. If it persists, it could lead to a cold spring which could delay crop planting.

 Geopolitical News:

• Iran’s President Raisi is visiting China this week after being invited to Beijing by President Xi. This is the first visit to China by an Iranian president in more than two decades.  China and Iran have been increasing ties in recent years.  China has been willing to break with sanctions on Iran by purchasing Iranian oil (although at discounts).  China’s willingness to refuse to cooperate with U.S. sanctions has led to China becoming Iran’s largest trading partner.  China and Iran have a 25-year cooperation agreement, although little of the arrangement has been implemented so far.  We suspect Iran was keen to meet with Xi in the aftermath of the Chinese president’s recent visit to Riyadh.  Iran and Saudi Arabia have been at loggerheads since the Iranian revolution and, even before the revolution, both countries vied to dominate the Middle East.  Iran was likely concerned about China’s wooing the Saudis, even proposing to price oil in CNY.  China has also recently sided with the UAE on a five-decade dispute over three islands in the Persian Gulf that Iran seized after the British had left the region.  China is likely to find that managing relations in the Middle East is difficult as there are age old rivalries in play and showing favor to one party can infuriate another.

 Alternative Energy/Policy News:

• Ford (F, $13.07) has announced a $3.5 billion battery plant in Michigan. Stimulating such investments was a goal of the Inflation Reduction Act.  However, there is a complication.  Ford intends to license the battery technology from Contemporary Amperex Technology (CATL, CNY, 451.05), a Chinese company.  The plant will be a wholly owned subsidiary of the U.S. automaker and will create 2,500 jobs.  The licensing of Chinese battery technology, though, is quite controversial.  Ford was considering building the plant in Virginia, but Governor Youngkin withdrew his state’s bid due to the  connection to China.
  • To a great extent, Ford’s decision to license a Chinese company’s technology is an example of the difference between the business class and the political class when it comes to China. In simple terms, opposition to China is perhaps the only bipartisan issue.  No politician wants to be outflanked or seen as being “soft” on China.  On the other hand, business interests continue to want to work with China and take advantage of their manufacturing prowess.
  • Recently, China appeared to be working hard to improve commercial relations. The balloon controversy has scotched that effort and will make business interests wanting to work with China more difficult.
• Although EVs continue to dominate the news, fuel cell/hydrogen vehicles remain a potential competitor. Using hydrogen would avoid the range concern which plagues EVs, but the problem is that the hydrogen is derived from fossil fuels and isn’t all that environmentally friendly.  There is a whole “color coding” system for hydrogen, and oil firms are pressing regulators for more open rules on “green” hydrogen to capture tax credits.  However, the determination of what qualifies various colors of hydrogen  remains controversial.
• The search for EV metals is leading to the Arctic. The U.S. has even appointed an ambassador to the region.
• Electric car trips of any distance require careful planning. This account shows just how much planning is required.
• Commodity markets are notorious for boom/bust cycles. Although the long-term outlook for EV metals is favorable, we are seeing increasing inventories which could lead to a period of price retrenchment.  China’s solar sector is facing issues of overcapacity as well.
• Saudi Arabia is launching a domestic EV industry in part to reduce its own demand for oil to allow for greater exports. Indonesia, a major nickel producer, is considering developing a battery industry.
• China’s wind and solar industry generates enough electricity to meet its household demand.

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