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 2.4 mb compared to a 2.0 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production rose 0.1 mbpd to 12.3 mbpd.  Exports fell 0.6 mbpd, while imports declined 0.2 mbpd.  Refining activity increased 2.2% to 87.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s increase was contra-seasonal.  So far, crude oil inventories have been rising this year, mostly because refinery operations have been weaker than normal.  As refining activity accelerates, we would look for commercial inventory accumulation to slow.

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.  For the next few months, we expect the SPR level to remain steady, so changes in total stockpiles will be driven solely by commercial adjustments.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $107.07.

Summer:

We don’t usually start thinking about summer until pitchers and catchers report to spring training.  By then, the Super Bowl has been played and we are only a couple of weeks away from the kick-off of the NCAA’s “March Madness” tournament.  However, we have been watching the gasoline markets and there are some concerns lurking around the bend.

Gasoline inventories are running about 14 mb below their five-year average.  Scaled to consumption, inventories are in line with normal, but that’s only because consumption has been weak.  We are approaching the usual peak in gasoline stockpiles, since inventories usually decline as refiners clear their winter grade gasoline from surplus to prepare for summer.  If we experience the usual drop in the coming weeks, stockpiles could be lower than normal and may trigger higher prices.  High gasoline prices are politically sensitive and may trigger another round of SPR releases.

At the same time, we are in the midst of a secular drop in gasoline consumption.  The following chart shows annual miles driven by passenger cars and light trucks.  In general, the trend in miles driven rose steadily from the early 1970s until the Great Financial Crisis in 2007.  We use gray bars to highlight periods when we did not hit a new high in the number of miles driven and note the number of months until a new peak occurred.  There was a small dip from 1973 to 1975, which was a product of the Arab Oil Embargo (which pushed up gasoline prices), and a more notable dip in the uptrend from 1979 to 1982, triggered by two U.S. recessions and a spike in prices caused by the disruptions from the Iran/Iraq War.  From 1983 until 2007, the rise in driving was relentlessly higher, with only short interruptions typically due to recessions or periods of high prices.  After 2007, though, we had a long gap before a new high was reached and the underlying trend clearly declined.

There are likely multiple reasons for the overall change in trend.  First, social media has led to friends being able to interact online, rather than needing to drive to meet in person.  Working from home and increased urbanization have also likely played a role.  Driving less, coupled with steady efficiency improvements, is leading to lower demand for gasoline.

The underlying factors reduce the chances of a gasoline crisis this summer, although the lack of inventory bears watching.  Probably the biggest factor that could push gasoline prices higher is crude oil pricing.

Market News:

• The tragic earthquake in Turkey has closed the Ceyhan oil export terminal in southern Turkey. The terminal moves about 1.0 mbpd, with two-thirds coming from Azerbaijan and one-third from Iraqi Kurdistan.  Coupled with news that the KSA increased prices to Asia, oil markets were supported this week.  We do note that the port of Ceyhan has reopened, but it’s unclear just how long it will take for oil flows to resume.
• The IEA has released its annual report on electricity. The report suggests that carbon emissions from electricity are trending lower as wind, solar, and nuclear power expand.
• As we have noted in earlier reports, the Biden administration has approved a drilling project in Alaska over the objections of environmentalists. Although the president campaigned on restricting drilling activity on federal lands, he has found that the courts have not sided with this goal.  At the same time, high oil prices tend to soften opposition, so we do expect this project to go forward.
  • The administration has been struggling with dissonant objectives on crude oil production. On the one hand, the White House tends to criticize oil companies for not increasing output to quell oil prices, but then on the other it talks about a possible windfall profits tax, which would tend to reduce the incentive for investment.
  • This is not just a U.S. issue. EU climate goals, which hope to reduce natural gas imports, are stifling investment in U.S. production and LNG capacity.  It may be adversely affecting investment in the Middle East as well.  The Qatari energy minister mused recently that the EU will eventually return to buying Russian gas.  If that is the expectation, it is foolhardy to expand capacity.
• The EIA is projecting record U.S. crude oil production (on an annual average basis) this year and next, although the growth rate is rather modest (0.1 mbpd this year and 0.4 mbpd in 2024). Much of that production is coming from the Permian Basin.
• Japan is trying to cut coal import costs by burning lower grade coal (which is almost certainly dirtier).
• Colombia’s President Petro made it clear during his campaign that he wanted to curtail the country’s oil and gas industry for climate change reasons. He has moved to ban oil exploration, a risky decision given that crude oil exports accounted for 34% of Colombia’s exports (excluding illegal substances).  Because oil is a depleting asset, cutting exploration will lead to falling output in the coming months.  Not only will this move hurt Colombia’s economy, it could also reduce global oil supplies.
• Asian oil imports hit a new record in January, and that has occurred before the full effects of China’s reopening have been felt.
• Oil and product prices have been stable recently, but much of that improvement is tied to a mild winter, which has reduced demand. Europe remains short of diesel, so prices could rise in the spring.
• Despite the recent drop in natural gas prices, fertilizer supplies remain tight and could lead to widespread grain shortages.

 Geopolitical News:

• The Senate has introduced a bill to block the sale of U.S. SPR oil to China. Although we understand the sentiment, in reality, one of the reasons for creating the reserves was to discourage hoarding.  Laws like this signal to China that it might not be able to get oil in a crisis, thus triggering stockpiling, which is then bullish for demand.
  • On the topic of hoarding, the EU’s demand for natural gas is reducing supplies available for emerging economies.
• Russia’s fleet of oil and product vessels is said to have reached 600. However, without Western insurance, Russia will still struggle to export oil and products.  For example, Turkey is requiring tankers moving through the Bosporus Strait to carry proper insurance.
  • Although the current price cap on Russian crude oil is far from perfect, there is some evidence that it is having an impact. Russia is considering taxing oil exports based on the price of Brent crude instead of the Urals price.  The latter has typically carried a hefty discount, and in January, the price averaged $49.48 per barrel.  Taking this step would clearly harm Russia’s oil companies.  This approach may be due to Russia’s widening budget deficit.
  • As Russia’s revenues decline, the margin loss is being captured by “middlemen” who facilitate Russian exports.
  • The G-7 has increased its sanctions on Russian energy by putting a price cap on Russian petroleum products. This measure coincides with the EU ban on importing Russian oil products.  It is likely that Asian nations will begin re-exporting product from Russia to Europe.
  • Russia is managing to evade many import restrictions through re-export arrangements with friendly nations. Iran has become a major trading partner for Russia.  Since Iran has been under sanctions for decades, it has become adept in circumventing them.  Russia is learning from Tehran’s experience.
  • However, restrictions on investment may lead to an over 40% decline in Russian oil output by 2035.
• Russia is said to be developing weapons to target underseas cables and pipelines.
• A recently leaked IAEA report suggests that the Iranian nuclear processing plant at Fordow is changing operations in a manner inconsistent with the 2015 JCPOA, but Iran has disputed the findings. In general, there is little doubt that Iran is increasing its uranium enrichment capabilities, but apparently the country doesn’t want to be called out on that by the UN.
  • Iran has detained “tens of thousands” of its citizens who engaged in the recent protests. Recently, the government unveiled a pardon process, but the terms appear rather restrictive.
  • In an attempt to stop the smuggling of dollars from Iraq to Iran, the U.S. has been restricting dollars going to Baghdad, causing harm to the Iraqi economy. The Iraqi dinar (IQD) has been depreciating, which will increase inflationary pressures on Iraq.

 Alternative Energy/Policy News:

• Although there is a rush to build battery capacity, the industry is not known for being all that profitable.
• There is a growing realization that the energy transition away from fossil fuels toward electric will require all sorts of minerals that simply might not be available.
• The Inflation Reduction Act (IRA) has subsidies designed to promote EVs, but the subsidies are restricted to U.S. automakers. Congress is looking to further restrict Chinese components from the supply chain and the subsidies, which may end up restricting overall supply.
  • Government programs limit EV subsidies to $55k for sedans and $80k for SUVs. The government is generally treating crossovers as SUVs.
  • The IRA subsidies may “price out” the EU and compel European companies to move operations to the U.S.
• Although the outlook for the metals critical to energy transformation is bullish, commodity markets are prone to short-term cycles of shortages and gluts.  A glut is apparently developing in cobalt.

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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 4.1 mb compared to a 1.0 mb draw forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.2 mbpd.  Exports fell 1.2 mbpd, while imports rose 1.4 mbpd.  Refining activity declined 0.4% to 85.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s increase was contra-seasonal.  Generally, we expect this year to follow last year, meaning that the usual rise in inventories isn’t likely.

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.  For the next few months, we expect the SPR level to remain steady, so changes in total stockpiles will be driven solely by commercial adjustments.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $107.01.

Market News:

• BP (BP, $36.31), has released its annual energy outlook. The research indicates that peak demand for fossil fuels will occur by 2035 at the latest but could occur by 2030 if policy leans against carbon emissions.  There are a number of factors behind the expected peak, but one of the most overlooked areas is improved consumption efficiency.  Research such as this makes it more difficult to argue for aggressive investment into future production.
• A normal response to supply shortages is hoarding since insecurity over supply leads consumers to build stockpiles to protect against future outages. Paradoxically, this activity can cause its own supply problems as this stockpiling becomes a source of additional demand.  We note that there are periods when U.S. commercial crude oil inventories are positively correlated to price.  If inventory is simply a residual of supply and demand, then a positive correlation would not be expected.  On this note, the German natural gas inventory manager says it intends to maintain a “buffer,” which we suspect means keeping a higher level of inventory than it would otherwise maintain.  Also, the German government is considering a “strategic” natural gas reserve, which would be another source of demand.  We have postulated, for some time, that as American hegemony wanes, one of the consequences would be insecurity of commodity supply, which would boost prices.  These reports from Germany provide evidence of such activity.
• The White House criticized Chevron (CVX, $187.30) for its decision to repurchase shares. The administration would prefer the company expand production, but once an environment is created that calls for the replacement of fossil fuels, rewarding shareholders rather than boosting output is a rational outcome.
• Whenever the price of an important commodity rises, politicians usually charge firms in those industries with “price gouging.” Although further investigation rarely confirms that suspicion, it persists.  Recently, Italian PM Meloni criticized gas station owners by accusing them of price gouging.  In response, they held a one-day strike.  Although closures of stations are rare, this event does highlight the potential for unrest due to high oil prices.
• One of the consequences of the war in Ukraine has been a restructuring of global oil flows. We also note that the EU is placing a ban on Russian product imports on February 5.  It is not obvious if the markets are ready for this action.
• Local governments in China have exhausted their funds in the battle against COVID and now find they lack the resources to buy natural gas.
• One of the side effects of fracking is earthquakes. Although none of these earthquakes are of a high magnitude,[1] they are enough to be felt and raise fears among homeowners that the quakes will trigger structural damage.  Tremors have been reported in Oklahoma and also now in Texas.  It is thought that the primary culprit is fracking wastewater.  Sand, water, and other chemicals are injected into the ground when a well is fracked.  The water usually surfaces and needs to be disposed of, and a cheap solution is to reinject it into the depleted well.  The water is thought to act as a catalyst for these earthquakes.  The solution is to force energy companies to dispose of the wastewater in another fashion, and although possible, changing the regulations would lift costs and eventually raise energy prices.
  • It should be noted that oil activity is said to be in a “boom” in Texas and New Mexico. It is having ripple effects outside of the oil and gas industry by lifting salaries and employment in other sectors of the economy.
• One of the bright spots for oil production is Guyana, which is expected to steadily boost production.
• The Biden administration’s decision to aggressively sell oil out of the SPR has been controversial. Although it is arguable that there are still ample supplies, as the previous chart showed, combining both the SPR and commercial stockpiles indicates that inventory levels have notably declined.  The House of Representatives has passed a bill that would limit the Department of Energy’s ability to tap the SPR. While it has no chance of passage, it does reflect the current level of concern.
• Warm weather has not just lowered natural gas prices in Europe, but it has also taken U.S. prices below $3.00 per MMBTU. Although inventory levels are rather close to their five-year average, we are in the period of the year with the strongest drawdowns, but because of mild temperatures, we actually saw a build in U.S. stocks.  Even if temperatures turn cold, it is likely we will begin the refill season in April with adequate stocks.  We do look for prices to recover in the spring and summer as LNG exports increase to ensure Europe has adequate supplies.
  • Despite low natural gas prices in Europe, ammonia producers on the continent have not responded with production increases. Ammonia is a critical element in fertilizers.

 Geopolitical News:

• Over the weekend, Iran was hit with a series of aerial attacks. Oil refineries and defense infrastructure were reportedly hit by drones.  The U.S. is suggesting that Israel was behind the widespread attacks, and apparently the U.S. was apprised of the operation.  Iranian media reported that the damage was light, but the fact that the attacks occurred is notable for a few reasons.  First, Israel has been reluctant to support Ukraine due to relations with Moscow (Russia and Israel cooperate in Syria); however, Iran is supplying arms to Russia so by attacking its defense infrastructure Israel could both help Ukraine and attack an avowed enemy.  Second, Israel must believe that Iran has limited scope to retaliate, likely assuming that it probably can’t do much in response between the protests and a weak economy.  Third, although there isn’t evidence that the U.S. directly participated, Washington appears to have abandoned a return to the JCPOA and thus is working on other ways to contain Iran.  This cooperation may include the actions Israel took over the weekend.  Still, the attacks on Iran create conditions where the war in Ukraine could expand.
  • Israel also attacked an arms convoy that was crossing from Iraq into Syria.
• Even with the lack of progress in Iran and the U.S.’s return to the JCPOA, diplomats haven’t completely cut off contact, mostly because they don’t perceive any other available options to restrain Iran’s nuclear program.
  • Despite this hope, there have been numerous reports recently that Iran has enough fissile material to make several nuclear weapons.
  • The EU is considering naming the Islamic Revolutionary Guard Corps as a supporter of terrorism. Iran is threatening the EU if it adopts that position.
• The U.S. has accused Iran of a “murder for hire” plot to assassinate an Iranian-American writer living in New York.
• Iraq is dealing with increased currency smuggling, which has led to the Iraqi dinar’s depreciation. It is suspected that Iran is using its allies in Iraq to acquire dollars and the drain is weakening the Iraqi currency.
• Although Russia and China have publicly declared their strong alliance, in reality, the two nations don’t necessarily align in certain areas. One of the more contentious areas is in central Asia.  Since these regions were formerly part of the Soviet Union, Russia tends to think of the “stans” as part of its sphere of influence.  However, China’s goal of building a Eurasian bloc, expressed by its “belt and road” project, means that China would like these nations to align with Beijing.  China has been using its economic heft to build relations, and we note that Russia is also making overtures to the stans by offering to sell natural gas in return for influence.  So far, the stans have been reluctant to fully sign on.  The central Asian nations are open to joint ventures but are reluctant to give Russia control of infrastructure.
• The EU has agreed on a price cap for natural gas, while the Intercontinental Exchange is creating a parallel contract in London to match the TTF price in Amsterdam ostensibly to skirt the cap.
• As Venezuela begins to emerge from sanctions, it is attempting to normalize its trading relationships. While under sanctions, it had used middlemen trading firms, likely for selling oil and to evade U.S. sanctions.  As conditions normalize, it is now demanding cash up front for exports in a sign that it is moving on from sanctions trading.

 Alternative Energy/Policy News:

• Polls show that the German public now supports nuclear power. Former Chancellor Merkel tried to phase out nuclear power after the Fukushima disaster, but high natural gas prices have changed public sentiment.
• We are beginning to see price discounting of EVs. Tesla (TSLA, $169.34) started the process, and now Ford (F, $12.94) is following suit.  Some of this action is due to rising inventories, especially at Tesla, but another factor is that the cars may simply be too expensive to compete against gasoline-fired vehicles.
• China is considering banning the exports of its solar technology. Since it dominates this industry, such an action would send up the cost of solar energy outside of China.
• Researchers at the University of Illinois Urbana-Champaign have taken an abandoned oil well and turned it into a geothermal energy storage system. The researchers injected 120^oF water into the well, and it maintained the temperature, suggesting that other abandoned wells could be repurposed for similar uses.
• In response to U.S. subsidies in the Inflation Reduction Act, the EU is planning to use tax credits to offer European businesses support for green energy.

[1] Californians would not be impressed.

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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 0.5 mb compared to a 3.0 mb draw forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.2 mbpd.  Exports rose 0.8 mbpd, while imports fell 1.0 mbpd.  Refining activity rose 0.8% to 86.1% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s mostly steady injection is consistent with last year and seasonal patterns.  We expect this year to mostly follow last year, meaning that the usual rise in inventories isn’t likely.

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.  For the next few months, we expect the SPR level to remain steady, so changes in total stockpiles will be driven solely by commercial adjustments.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $107.07.

Market News:

• We are just over 11 months into Russia’s invasion of Ukraine. At this juncture, we don’t know what the outcome of the war will be.  Ukraine has proven itself to be a formidable opponent and is clearly leveraging its “home field advantage.”  At the same time, Russia is a larger nation and still has ample resources to throw at the conflict.  But even with this uncertainty, it looks like global energy markets are unlikely to return their pre-war state.
  • Europe now knows that Russia is an unreliable supplier of energy. Moscow would need to discount prices heavily to retake the European market share.  After all, Russia used to supply 40% of EU natural gas, but now that number is down to 14.4%.
  • Putin obviously wagered that the EU would not be willing to absorb the pain from the loss of Russian oil and natural gas. He might have been right, but in a fascinating twist of fate, a mild winter has allowed Europe to see a sharp drop in natural gas prices.  Russia, for centuries, has relied on winter as its ultimate defense against invaders.  Now, winter has, at best, postponed Russia’s leverage over Europe.  As supply chains adjust, Moscow’s leverage may be permanently reduced.
  • Russian oil has to go somewhere, and it has mostly flowed to India and China in a clear benefit to those nations. This has, however, reduced market share for Middle Eastern oil producers, and we wait to see their response.
  • Even with these expanded markets, it is highly likely that Russia will lose market share on global markets and eventually be forced to shut-in production. Complicating matters further is that that the price cap is beginning to reduce Russia’s revenues.  Washington’s goal with the price cap was this reduction in revenues, but it was also meant to keep oil supplies ample.  Thus, it set a price high enough to keep Russia producing, but low enough to “hurt.”  It’s quite possible that the price is set too low.
• On February 5, the EU will begin a price capping system on Russian oil products, along with an outright ban on Russian diesel. However, the actual setting of the caps hasn’t been resolved.
• Although the U.S. still imports crude oil and products, the net figure is increasingly positive, meaning that the U.S. is a net exporter of oil and products. As exports increase in importance, the goals of domestic energy security will clash with the oil industry’s revenue and profitability.
• OPEC+ is expected to keep production targets unchanged when it meets next Tuesday. The cartel is taking a “wait and see” approach to the crosscurrents of China’s reopening and a looming global slowdown.
• There are increasing reports that drilling activity is beginning to increase as high prices may finally be triggering a supply response. The DOE is forecasting that U.S. production will average 12.4 mbpd this year and 12.8 mbpd next year.
• Freeport LNG has announced its plant repairs are complete and the company is preparing to restart operations. Last year, the plant suffered a major accident which reduced operations for several months.  The return of this liquification plant is a bullish factor for U.S. natural gas prices.
• China’s electricity officials warn that economic recovery in the post-COVID era will boost electricity needs. This will lift demand for coal and LNG.
• China oil trading firm Unipec, the trading arm of Sinopec (6000028, CNY, 4.54), is reported to be aggressively buying crude oil. It isn’t clear if it is buying the crude for China or merely reselling it.  In 2022, China’s oil imports declined from the previous year, but with COVID restrictions being lifted, we may be seeing Chinese firms prepare for higher consumption.  Imports from Malaysia have recently hit a new record.
  • Japan’s oil imports have increased for the first time in a decade.
  • China has a large, but mostly inefficient, refining industry. Unlike most areas of the world, it is increasing its refining capacity, which could mean China will become a critical source of refined products.  Meanwhile, U.S. refining margins are rising, in part due to the continued slow recovery from the late December cold snap.

 Geopolitical News:

• Pakistan and Russia, Cold War enemies, are looking at an agreement where Russia would supply Pakistan with oil. Pakistan has suffered from being outbid by Europe for oil and LNG.  Russia would not only supply oil to the country but has also hinted that it would take payment in a “friendly” currency, likely CNY.  As U.S./Pakistan relations have cooled, the country has suffered a dollar shortage.  However, Pakistan appears to want Russian oil under the price cap regime, which may not appeal to Moscow.  This deal highlights the emerging blocs that we have been discussing over the past year.
• The U.S. has added additional sanctions on elements of the Islamic Revolutionary Guard Corps for the body’s suppression of recent protests. The U.S. is also increasing pressure on China to end its purchases of Iranian oil.  We doubt China will comply, but the pressure might cap the amount of oil China purchases from Iran.

 Alternative Energy/Policy News:

• There are reports that wind turbines are falling over as structural problems are emerging.
• This chart shows the impact of France’s nuclear power on fossil fuel consumption. It shows that, at least for electricity, nuclear power can displace fossil fuels.

• The U.S. is extending the life of its aging nuclear power plants.
• Recently, there was a reported breakthrough in fusion energy. Although we think the new information is interesting, it will be a long time before such power could be commercialized.  However, the U.S. is offering subsidies for firms working on this potential power source, and European companies are considering moving to the U.S. to capture this support.
• Although the U.S. and other nations are taking steps to build a domestic auto battery industry, in reality, China is expected to maintain its dominant position.
  • Another metal that has been overlooked in battery production is graphite. It comes from two sources—man made and mined.  The former is produced from oil, mostly in China (again!), while mined sources have mostly been underdeveloped.  There is growing interest in the mined sources, which are in short supply.
  • Lithium miners remain optimistic about demand and future earnings.
• In response to the Inflation Reduction Act’s (IRA) green energy subsidy measures, EU industries are asking for similar subsidies. This is partly in response to U.S. governors wooing European green energy firms to build factories in the U.S. to take advantage of the subsidies in the act.
  • An interesting political sidelight to the IRA is that much of the green industry subsidies are benefiting Republican-controlled states. It’s simply a matter of geography as ample wind and solar resources are found across the southern tier, which are mostly GOP states.  Although the GOP coalition includes extractive industries, the green subsidies may stay in place even with a change in government in the White House since the affected states won’t want to lose the support.
  • The IRA also has generous subsidies for EV buyers, but they are limited to domestically produced cars and batteries. There has been growing pressure on Washington to ease these restrictions, but Manchin (D-WV) is opposing such changes and is pushing to delay the implementation of the subsidies.

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