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

Crude oil prices have been mostly holding steady this week.

(Source: Barchart.com)

Crude oil inventories fell 1.0 mb compared to a 2.1 mb draw forecast.  The SPR declined 6.0 mb, meaning the net draw was 7.0 mb.

In the details, U.S. crude oil production was unchanged at 11.9 mbpd.  Exports rose 0.8 mbpd, while imports fell 0.1 mbpd.  Refining activity rose 1.4% to 93.2% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  This week’s report is consistent, showing a partial reversal of last week’s rise, with rising crude oil exports and increased refinery activity offsetting the continued draw from the SPR.  Seasonally, the draw begins in earnest in June.

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 seen in late 2008.  Using total stocks since 2015, fair value is $90.65.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $60 per barrel, so we are seeing about $40 of risk premium in the market.

To scale the impact of high gasoline prices, we calculate the number of gallons a non-supervisory worker can purchase with one hour of work at the average national retail price of gasoline.

As the chart shows, we are approaching six gallons, which isn’t the all-time low but getting close to that level.  In general, low readings tend to track consumer confidence and presidential approval ratings.

Market news:

• Coastal diesel fuel prices have moved above $6.00 per gallon, new highs for this product. Although there has been a focus on crude oil inventories, perhaps the real story all along was tight diesel supplies.  In response, the administration is considering a release of inventory from the Northeast Heating Oil Reserve.  This is more of a symbolic measure; the reserve isn’t large, holding only 1.0 mb.  It was designed to provide emergency heating fuel for the Northeast, which uses the fuel for home heating.
  • Washington state is reporting gasoline station outages.
  • There are increasing fears of even higher gasoline and diesel prices this summer.
• One potential problem from reduced flows of Russian oil is that as Russian storage facilities fill up. Oil producers will have no option other than to start shutting in production.  Rosneft (NK Rosneft’ PAO, RUB, 366.15) reported a decline of 0.56 mbpd, two-thirds of the overall Russian decline in output.  Much of the company’s production comes from Siberia, which is considered an area requiring geophysical expertise, something that may be lacking as western oil service firms have evacuated Russia.
  • There are reports that some 62 mb of oil Russian crude oil is floating on the high seas, about three times normal. It may be that selling this oil has become difficult due to financial sanctions, or it’s on its way to Asia and simply hasn’t made the trip yet.
  • Increased Russian oil sales to Asia are displacing Iranian crude.
• Record temperatures have been seen in Pakistan and India recently. Studies suggest that climate change was a factor in the record heat and raises the concern that higher temperatures will boost the demand for air conditioning and electricity.
• As LNG demand eases in Europe, flows are rising to Asia. However, China is reducing its imports of LNG due to weak demand.
• The WTI-Brent spread has narrowed recently.

This chart shows the long-term history of the Brent-WTI spread.  Until the shale revolution, WTI regularly was priced higher than Brent.  Restrictions on exports and the explosion of shale production led the spread to flip violently around 2011.  As the U.S. increased oil exports, the spread narrowed, but Brent tended to hold its premium over WTI. The recent narrowing is likely signaling rising export demand from the U.S.

• Despite high oil prices, U.S. production growth has been slow. Although there are many reasons for this lack of output (e.g., high input costs, labor shortages, unfriendly regulatory environment), one particular reason is that oil executives are being paid based upon profitability and less on production.
• Meanwhile, U.S. natural gas prices are elevated in a period where prices are usually weaker. Seasonal demand usually weakens in the spring and falls as temperatures moderate.  This year, prices are elevated, in part, due to LNG exports.  The LNG isn’t quite as global as oil, but it continues to expand.
• The North American Electric Reliability Corporation released its Summer Reliability Assessment. The risks of outages this summer are elevated.
• Another factor limiting energy supplies is the skyrocketing cost of transportation.

 Geopolitical news:

• The U.S. is facilitating talks between Egypt, the KSA, and Israel over the sovereignty of two small islands near the Gulf of Aqaba. The islands are controlled by Egypt but would be returned to their original owner, Saudi Arabia.  But, for this action to occur, Israel would have to approve.  The thinking is that if Israel signs off, it will create a framework for normalizing relations between Israel and the KSA.  Such an event would further expand the Abraham Accords.
  • This may be part of an attempt by the administration to heal relations with the KSA.
• UAE President Sheikh Khalifa bin Zayed Al Nahyan died earlier this month. The leader is credited with the UAE’s economic development but has been mostly a figurehead since his stroke in 2014.  Crown Prince Mohammed bin Zayed Al Nahyan will take over as president.  Like the KSA, the founder of the UAE intended to pass leadership through his sons.  However, as this first generation ages, there is increasing speculation that MBZ, as he is known, will pass power to his son, one of the grandsons of the founder.  Like in KSA, this generational transition is fraught with risk, because the pool of potential leaders is large, and thus, there are many who will be disappointed.  This worry isn’t imminent; MBZ is only 40 and could easily rule for three decades.
• Despite high oil prices and fears of insufficient supply, the KSA signaled it would not increase production beyond the current plan. The KSA also reiterated support for Russia, highlighting the growing rift between the U.S. and the KSA.
  • The KSA plans to use the increased cash flows from high oil prices to increase its sovereign wealth fund.
• Finland’s decision to apply for NATO membership has prompted Russia to halt natural gas flows to the Nordic nation.
• China is said to be increasing its purchases of Russian crude to build its strategic reserve by “quietly” buying Russian crude oil at deep discounts. These purchases would seem to violate sanctions, but the S. is giving Beijing a pass, perhaps wanting to avoid a confrontation with China.
  • China has also halted work on the Russian Arctic LNG project, worried about violating sanctions.
• We consider the negotiations to revive the Iran nuclear deal as dead, much like the Monty Python skit, yet talks, mostly fostered by the EU, continue. Even the Europeans acknowledge the talks are nearing their end. The Iranians deny they have made any concessions, increasing the odds the deal isn’t going to happen.
• Hassan Sayad Khodayari, an officer of the Iranian Revolutionary Guard Corps, was assassinated at his home in Tehran over the weekend. Although no one has claimed responsibility, the general suspicion is that this is the work of the Israelis.  Israeli media is reporting that Khodayari was involved in planning attacks against Israelis, including kidnappings.
• Yet another CEO of Petrobras (PBR, USD, 14.51) has been sacked, the third in recent months. Jose Mauro Ferreira Coelho has been replaced by Caio Mario Paes de Andrade.  Why is President Bolsonaro so angry with the company?  Because fuel prices keep rising and he wants the company to fix prices and lose money.
• Even though the U.S. has been in talks with the Venezuelan regime, Caracas continues to work with Iran. In fact, the Iranians are working to repair Venezuela’s largest refinery.  The Paraguana refinery complex, which has a capacity of 955 kbpd) is only producing at 17% of capacity; it is unclear if Tehran has the expertise or the funds to fully restore production.
• The EU is struggling to build a consensus on embargoing Russian oil, with Hungary being the major stumbling block. However, there are reports that the state oil firm MOL (MOL, USD, 4.14) is taking at least initial steps to process non-Russian oil.
  • Germany and Italy plan to pay for Russian energy with RUB after getting approval from the EU.
  • German industrial firms are preparing for natural gas rationing.
• The U.S. is making it clear that one of its policy goals is to “cripple” Russia’s oil industry. As part of this goal, the U.S. is considering secondary sanctions on buyers of Russian oil.  The Russian economy continues to struggle.

 Alternative energy/policy news:

• The incumbent automakers are banding together to build a robust supply chain for batteries. From its description, much of the initial effort appears to be in lobbying.
• Another group, mostly NGOs, is looking to coordinate efforts on direct carbon capture. Pulling CO2 out of the atmosphere will likely be necessary to bring greenhouse gasses to acceptable levels.
• The Abu Dhabi National Oil Company (ADNOCDIST, AED, 4.00) and BP (BP, USD, 32.28) are partnering on a project to make green hydrogen.
• Interest in EVs is growing around the world, far exceeding interest in the U.S. This difference may be due to higher fuel prices abroad.
  • The shift to EVs could be a problem for Central Europe, which has become a key part of the supply chain for EU automakers. As the transition occurs, these supplies will need to adapt.
• Although higher oil and natural gas prices are leading to calls for increased output, it is also encouraging increased investment in energy alternatives.
• A lithium mine auction in China drew an extraordinary number of bids.
• China has been increasing its use of coal, and it is also boosting its investment in solar, doing an “all of the above” approach.
• The EU has plans to reduce carbon emissions but admits it will burn more coal as it reduces flows of Russian natural gas.

  View PDF

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

Crude oil prices have moved higher this week, touching technical resistance at $115 per barrel.

(Source: Barchart.com)

Crude oil inventories unexpectedly fell 3.4 mb compared to a 1.6 mb build forecast.  The SPR declined 5.0 mb, meaning the net draw was 8.4 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.9 mbpd.  Exports rose 0.6 mbpd, while imports rose 0.3 mbpd.  Refining activity rose 1.8% to 91.8% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a partial reversal of last week’s rise, with rising crude oil exports and increased refinery activity offsetting the continued draw from the SPR.  Seasonally, the draw begins in earnest in June.

Refinery utilization is ramping up early this year, reflecting attractive refining margins.

Seasonally, refining activity reaches its peak in early June and remains elevated into Labor Day.  We expect strong demand for product to keep refinery activity at peak levels through the 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.

Total stockpiles peaked in 2017 and are now at levels seen in late 2008.  Using total stocks since 2015, fair value is $89.15.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $60 per barrel, so we are seeing about $40 of risk premium in the market.

Market news:

• The Biden administration continues to struggle to craft a clear message regarding oil supplies. Reports revealed the administration canceled auctions for oil and gas drilling leases in the Gulf of Mexico (GOM) and Alaska.  To be fair, drillers have not shown strong interest in Alaska, and legal complications have made bidding a problem in the GOM.  The lack of bidding undermines the ability of the industry to boost production.
  • Despite the chilly relations between the oil and gas industry and Washington, company profitability remains strong.
• As supplies of energy tighten, regional shortfalls are being reported, ranging from wider jet fuel margins on the East Coast to the Texas grid operator pleading with consumers to conserve as high temperatures boost air conditioning demand. So far, the Texas grid has continued to function, but we do note it’s May, and the hottest part of the summer lies ahead.  Rising diesel costs are pressuring the transportation industry.  Jet fuel is becoming increasingly scarce.
• In Europe, Spain and Portugal are capping natural gas prices; the EU is also thinking about a cap on Russian gas prices. Often, capping prices leads to supply shortfalls.  Talk of price caps is occurring while the EU is attempting to rebuild natural gas inventories before next winter.  To date, natural gas stocks are rising in Europe, with inventories at normal levels for this time of year.

• Spain has natural advantages for LNG distribution. Its ports are generally sheltered from weather issues, and being a peninsula, it can create facilities on three sides. However, its pipeline network is not developed enough to support increased LNG capacity.
• As lockdowns in Shanghai ease, China has been making inquiries about LNG supplies. Even though this news suggests the economic fallout from zero-COVID may be easing, it also could lead to stronger demand for LNG, which is bullish for prices.
• The most recent IEA report is more optimistic that markets could absorb the loss of Russian oil, mainly due to falling consumption.
• Energy leaders suggest Russia will be “permanently decoupled” from the Western energy system. If true, this will likely lead to permanent price differences that won’t be arbitraged away.
• Higher energy prices are leading commodity clearinghouses to lift margin requirements dramatically on derivatives. The rising costs of margin are reducing liquidity and potentially lifting risk in the commodity markets.
• China is aggressively lifting coal production. At the same time, to keep inflation under control, it has price controls in place, leading China’s coal futures markets essentially to stop trading.
• Saudi Aramco (2222, SAR, 42.50) now has the largest market capitalization of any publicly traded company in the world.

 Geopolitical news:

• Italian PM Mario Draghi has proposed creating a consumer cartel for oil. Although we doubt this will work, such consideration suggests high oil prices are straining Western economies.
• So far, the EU has not banned Russian oil, as Hungary wants to continue to receive Russian supplies for at least two more years. A deal may not be reached for several weeks.
• European negotiators continue to express optimism that the U.S. and Iran can return to the JCPOA. We continue to harbor serious doubts.
• In a bid to improve the oil supply situation, the Biden administration has offered to ease some sanctions on the Maduro regime. The relief offered isn’t substantial, and the proposal is more about opening negotiations.  We don’t expect Venezuelan oil to flow to the U.S. anytime soon.
• Last week, we noted Iran was cutting subsidies on key foods. Pasta prices have jumped nearly 2.5x over the past month as support has been reduced.  Rising food prices are politically unpopular.
• As the West implemented sanctions on Russia that excluded some elements of energy, there has been concern that Russia would retaliate by restricting supplies to Europe. We are seeing growing evidence that Moscow is starting to disrupt oil and gas flows.  Recent analysis suggests that ending the importation of Russian gas and oil would cost the EU €195 billion.
• Treasury Secretary Yellen has suggested the EU could create a package of tariffs and a price cap on Russian oil in an attempt to reduce dependence on Russia and make the trade less favorable for Moscow.
• Shell (SHEL, USD, 58.16) has announced it has sold its Russian gas stations to Lukoil (LKOH, RUB, 4523.50).

 Alternative energy/policy news:

• As CO₂ concentrations continue to rise, it is becoming clear that mere reduction programs probably won’t be enough to slow accumulations of the gas. One area attracting attention and funding is carbon capture and storage.  This process takes the CO2 generated by various processes, captures it at the source, and sends it into underground storage or some other disposal method.  BP (BP, USD, 31.49) and Linde (LIN, USD, 371.18) announced a venture to capture greenhouse gases in Houston.
• Another potential action is geoengineering, which can cover everything from directly cooling the earth to other forms of carbon storage. However, governments are leery of private actors or other governments essentially conducting climate experiments that may have uncertain outcomes.
• Although commodity demand will always be cyclical, the structural demand for metals required for transitioning to EVs will likely support prices for an extended period. EVs are starting to have an impact on easing demand for gasoline.
• EU companies are supporting a measure that would outlaw the sale of new gas and diesel vehicles by 2035. Policies such as these have a dampening effect on oil and gas investment.
• One solution to expanding hydrogen use is to send the gas, along with natural gas, using existing natural gas pipelines.

  View PDF

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

Oil prices have been volatile over the past few days.  A number of factors have been at play. However, the chart suggests a price range is developing between $100 to $110 per barrel.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 8.5 mb compared to a 1.0 mb draw forecast.  The SPR declined 7.0 mb, meaning the net build was 1.5 mb.  This draw from the SPR is the largest single-week withdrawal in history.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.8 mbpd, although the decline is somewhat exaggerated due to rounding.  Exports fell 0.1 mbpd, while imports declined 0.7 mbpd.  Refining activity rose 1.6% to 90.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a sharp rise, reflecting the large draw in the SPR.  As refining operations expand, the SPR sales should prevent a large draw in commercial stocks.  Seasonally, the draw begins in earnest in June.

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 seen in late 2008.  Using total stocks since 2015, fair value is $87.23.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $60 per barrel, so we are seeing about $40 of risk premium in the market.

Market news:

• Despite high prices and requests from the U.S. to lift output, OPEC is maintaining its modest production increases. Why OPEC isn’t increasing output is unclear.  One reason is that relations between the KSA and the U.S. have become strained, and Riyadh may purposely be keeping supplies tight.  It is also possible the KSA may not have the capacity it claims and may not be able to lift production.
• Natural gas prices are rising on reports that Ukraine may close parts of the pipeline network that moves gas from Russia to Europe. Germany is reportedly preparing for sudden disruptions of Russian gas flows.  All this news will tend to increase prices.
  • Even with higher prices, U.S. drillers remain reluctant to boost supplies. Investor demands for capital discipline and rising costs dampen the attractiveness of expanding output.
  • Rising natural gas prices are boosting ammonia prices as well; ammonia is a primary feedstock for nitrogen fertilizer.
• U.S. utilities warn that electricity shortages may develop this summer. Tight natural gas supplies and less available coal generation, along with transmission bottlenecks, could lead to blackouts this summer.  The expansion of electric vehicles is adding to demand, exacerbating the supply crunch.
  • The DOE has enacted a $2.5 billion fund for expanding electricity transmission.
• The SPR release (which was apparently a surprise to Europe) has increased the supply of crude oil. However, with a few exceptions, most consumers can’t directly use crude oil.  Thus, the oversupply of crude oil relative to product has created favorable conditions for refiners.  On the futures market, the nearest 3-2-1 crack spread[1] has soared to record levels.

(Source:  Bloomberg)

Complicating matters further is that product demand has been robust as much of the developed world emerges from the COVID-19 pandemic.  High gasoline prices are a politically sensitive issue.  This report is a primer on the gasoline market and why efforts to bring prices down will likely be less effective than hoped.

• Part of the goal of the SPR release was to boost oil exports to support EU efforts to curtail Russian imports. However, the U.S. export infrastructure is being stretched by the surge in supply.
• Last week, the Biden administration surprised the market by announcing a plan to refill the SPR. The DOE has released some details on the refill plan. We still harbor doubts this oil will ever be restored.
• Although Europe is still struggling to create a unified policy concerning Russian oil and gas (see below), the expected demand for U.S. LNG has boosted American natural gas prices. We are in a “shoulder period” for demand; as summer temps rise, demand for natural gas generated electricity will rise.  The fact that prices are high now is not a good sign for consumers.
  • Higher natural gas prices have boosted the demand for coal.
• The restrictions on Russian oil flows are starting to affect production. Russia has limited ability to store oil, and once there is no room to ship, wells will be shut in.  In many cases, these wells will never be reopened.  Russia is attempting to reorient oil exports away from the EU (India is a favored destination), but, of course, these other destinations lack the pipeline infrastructure that has been constructed in Europe.
• German/Qatar talks on boosting LNG supplies have become strained. Germany is demanding long-term contracts, while Qatar, wanting to take advantage of favorable market conditions, is balking at this idea.
• China’s COVID-19 lockdowns have weakened energy demand.
• Fuel shortages have led Nigeria to ground flights.
• One area of concern has been the financing of oil and gas production and shipping. Reports suggest energy hedgers face massive trading losses due to market volatility.  Some of these losses will probably be recouped in the future, but the immediate need for cash could crimp available supplies.  There is also evidence suggesting market depth in oil futures is under strain due to price volatility.

(Source:  Federal Reserve)

Geopolitical news:

• The EU is failing to formulate a plan to embargo Russian oil and gas. The EU structure requires unanimous approval for most measures, and Hungary has objected to sanctioning Russian oil.  Although we expect some sort of restrictions to be developed, it isn’t going to occur in the near term.  A plan to effectively ban Russian oil shipments by denying tankers insurance has also failed due to objections from Greece.
  • It should be noted that bans would adversely impact Europe. Germany could see a 12% decline in GDP if Russian natural gas is banned.
• The odds of an Iran deal appear to be lengthening. There is rising pressure in Congress to raise obstacles to an agreement, and the overall political costs are increasing.  In addition, the benefits of a thaw are falling; more Iranian crude oil is leaking into the global economy as India and China increase purchases.  Our position has been that a deal would never occur.  Increasingly, it appears one won’t.
  • Iranian President Raisi has announced subsidy cuts on bread. As wheat prices have risen, the costs of subsidies have soared.  However, such cuts are risky.  Most of these subsidies offer sustenance to the poor.  Cutting subsidies could trigger civil unrest if inflation rises further.

 Alternative energy/policy news:

• Renewable energy output continues to expand. A recent IEA report shows how renewables are slowly offsetting conventional energy.

(Source:  Axios)

• It is becoming increasingly evident that the world won’t be able to reduce carbon emissions fast enough to meet temperature goals. We are seeing increased interest in atmospheric carbon capture.  The key to progress will be pricing carbon in such a way as to foster a return on investment.
• One challenge of renewable electricity is that it is intermittent. When the sun doesn’t shine or the wind doesn’t blow, electricity isn’t generated.  Creating storage for electricity will be necessary for renewables to replace conventional energy supplies.  Although batteries are one answer, creating gravity storage, such as lakes that move water up during the day, and allow it to flow through turbines at night, is another.  A third option is to create kinetic systems that allow electricity to be generated.  China is building a commercial gravity project to store wind power.

• On the topic of batteries, a number of new technologies are being tested. These include molten salt, among other materials.  China’s Contemporary Amperex Technology (CATL, CNY, 379.17) is looking to build a battery production facility in the U.S.
• Since the Fukushima tragedy, sentiment toward nuclear power has been negative. However, fuel shortages and higher prices appear to have changed that opinion, and for the first time since the accident, a majority now supports nuclear power.  The government plans to restart nuclear facilities to reduce the dependence on Russian natural gas.
• Miners are starting to use hydrogen in their trucks.
• The battle between solar panel installers and producers continues.
• The U.S. is starting to mine lithium to meet the demand for EVs. Needless to say, those affected near mining sites are generally opposed.

  View PDF

[1] This spread is (2 gasoline * 42 + 1 heating oil * 42)- 3 crude oil.  Multiplying by 42 converts the gallon price to a barrel.  This spread roughly mimics the output of a U.S. refinery.

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

It appears oil prices are attempting to create a trading range between $105 to $95 per barrel.  That may hold until the SPR release is complete.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 1.3 mb compared to a 0.2 mb draw forecast.  The SPR declined 3.1 mb, meaning the net draw was 1.8 mb.

In the details, U.S. crude oil production was unchanged at 11.9 mbpd.  Exports fell 0.1 mbpd, while imports rose 0.4 mbpd.  Refining activity slipped 1.9% to 88.4% of capacity.  The decline in refinery operations is a surprise and will likely be reversed in the coming weeks.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week’s report is consistent with last year.  Also, note that in the average data, we are at the point where the seasonal build period has ended.  Over the next few weeks, we will see if we follow the average path or track last year.

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 seen in late 2008.  Using total stocks since 2015, fair value is $85.90.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $60 per barrel, so we are seeing about $40 of risk premium in the market.

Market news:

• The EU is moving closer to a full embargo on Russian oil. It will likely be phased in, with Hungary and Slovakia getting an entire year to implement the plan.  Oil prices have increased on the news.
• The EU is also looking at making it impossible for Russia to ensure oil shipments, which would severely hamper its ability to sell oil. Moscow could self-insure, but if a shipment is lost, Russia would be responsible for replacing the loss.
• As the two points above show, there is a clear goal among EU nations to reduce the group’s dependence on Russian energy. But the method to achieve this goal is important.  Embargos reduce available supply.  If the demand curve is inelastic (price-insensitive), revenue rises (price x quantity), and the supplier usually benefits.  Ricardo Hausmann argues that while EU oil demand is inelastic, demand for crude oil from Russia doesn’t necessarily have that characteristic.  Thus, instead of an embargo, Hausmann argues the EU should apply a high tariff on Russian oil.  The higher price of Russian oil from the tariff would mostly go to the Treasuries of EU nations, denying the revenue to Russia.  More complicated embargo programs that include escrow accounts and a “demand cartel” are also being floated, which would endanger Russia’s cash flow from energy.  Targeting tankers is another way to reduce Russian oil sales.
  • We are seeing some elements of this disruption in supply chains. Both China and India are buying Russian oil but at deep discounts.
  • The EU is making progress on reducing its consumption of Russian energy, but a sudden break would likely lead to a wrenching recession.
• The Russian gas cutoff we reported last week is yet another example of the breakdown of globalization in commodity markets. This breakdown will tend to bring supply shocks and inflation.
  • The debate over pricing Russian oil and gas sales in RUB
• Although high commodity prices and a widening of destination spreads offer opportunities for commodity trading firms, price volatility increases the financial risk for these firms. We recommend this podcast for a deeper dive into this issue.
• A late spring snowstorm has reduced natural gas output from North Dakota. However, the three largest areas of U.S. natural gas production were mostly unaffected.
• The Calcasieu Pass LNG terminal has started production. Also, France has decided to enter into a long-term LNG contract with NextDecade (NEXT, USD, 6.31) to provide natural gas.
• Despite high oil prices, the latest read on U.S. oil production shows a modest decline. The monthly data is considered the official report compared to the weekly data that is released.  February production was 11.3 mbpd; the estimated output from the weekly data in February was 11.6 mbpd.  Still, the general expectation is that U.S. oil production will rise in the coming months.
• With energy companies reporting strong earnings, the idea of a “windfall profits tax” is being floated. In general, economists tend to oppose such measures, fearing that the announcement of a tax will thwart what the market really needs, which is more supply.  Raising taxes would likely lead to less investment.  The oil companies may find they can avoid these taxes only by promising to boost investment.

 Geopolitical news:

• The EU has realized its dependence on Russian oil and gas was a mistake. Over time, LNG, piped gas from North Africa, and the development of natural gas from the eastern Mediterranean will ease supply issues.  But, as noted above, immediate loss of Russian gas would be problematic.
  • Germany has softened its opposition to an oil embargo but requires it to be phased in over months.
• India has rather close relations with Russia. During the Cold War, India was a major buyer of Soviet military equipment that has continued in its aftermath.  But the war in Ukraine has made the Modi government uncomfortable.  Watching an authoritarian regime invade a democracy is difficult for the world’s largest democracy.  So, we are starting to see some degree of “pushback” from India.  Steelmakers are shunning Russian coal.  At the same time, however, Indian state firms are considering buying Russian oil assets.
• There are reports that President Putin is going to undergo surgery for cancer
• Efforts to revive the Iran nuclear deal continue, although we still think the odds of an agreement are low. The EU would like to see a deal go through with the hopes of tapping Iranian oil and, at some point, its natural gas too.  Iranian oil exports, despite sanctions, have been rising.
• CIA Director William Burns made a surprise trip to the KSA last month. Relations with the kingdom have been strained during the Biden presidency, and we suspect the visit was an attempt to repair the breach.
• The U.S. has made overtures to Venezuela as well, but Caracas’s support of terrorist groups will make the easing of sanctions difficult.
• As the Ukraine War raises commodity prices, a new bout of Arab unrest is possible.
• Tensions between Turkey and the KSA are rapidly easing as the former looks for economic support.

 Alternative energy/policy news:

• Nuclear power has a bad reputation. Three disasters—Chernobyl, Three Mile Island, and Fukushima—have made nuclear power unpopular.  Despite this reputation, it is undisputable; nuclear power emits no greenhouse gases.  Environmentalists are noticing that when nuclear power plants close, they tend to be replaced with “dirty” fuels.  We note Gov. Newsom (D-CA) is apparently “reconsidering” closing the Diablo Canyon nuclear plant, scheduled for closure in 2025.
  • If nuclear power is going to make a resurgence, uranium from Russia probably won’t be in the mix. The idea that U.S. output may rise has raised worries in the American West.
  • Europe needs to acquire key metals to make the energy transition.
• In China, we are seeing a resurgence in coal consumption and plans for nuclear power expansion. The country is also the world’s largest importer of LNG.  Solar installations appear to be lagging.
• Temperatures in India have been reaching unbearable levels, triggering rising electricity demand. This factor is lifting the demand for coal.
• Hydrogen has been something of the “Holy Grail” of clean fuels. Having no carbon associated with the gas, it is very clean and efficient.  Nevertheless, producing it can be problematic.  “Green” hydrogen is usually made from electrolysis from clean energy, e.g., solar or wind.  “Blue” hydrogen is usually derived from natural gas.  “Gray” hydrogen comes from using electrolysis from conventional electricity.  However, less talked about is the lowest cost “gold” hydrogen.  This gas occurs naturally and can be captured similarly to natural gas.  It isn’t clear how much gold hydrogen is available, but exploration efforts are beginning.
• The major U.S. political parties are forced coalitions. They house disparate groups that may not have many characteristics in common.  The GOP is generally considered more friendly to extractive industries, but there is an emerging Conservative Climate Caucus that wants to modify the perception of Republicans on environmental issues.  Some of this new group could be based on age; younger voters tend to be more supportive of climate issues.
  • In something of a surprise, DeSantis (R-FL) vetoed a utility-supported measure to reduce the attractiveness of home solar installations.
• Rising input costs are hurting the earnings of battery manufacturers.
• The U.S. solar power industry is divided between manufacturers, who want tariffs on Chinese imports, and installers, who want to have the foreign product available. The lack of policy clarity is “freezing” the industry.  A number of senators are calling for an end to the solar study.
• Fidelity (FNF, USD, 39.29) has decided to support bitcoin in 401(k) accounts. The company faces criticism due to the massive energy consumption that occurs in the mining process.
• Although ethanol is considered “green” because it is made from renewable inputs, the process of fermentation creates a surprising level of CO₂. This report discusses efforts to capture the gas and pipeline it to disposal sites.  Interestingly enough, plans to build pipelines for the gas have struggled to get approved.
• The Niskanen Center argues that tax credits for EVs are targeting the wrong drivers. Instead of a system that seems to be attractive to higher-income drivers (who tend to opt for greater fuel efficiency anyway), the think tank argues the incentive should target high-mileage drivers.  In other words, the EV credits should go to drivers who have long commutes.
  • Volkswagen (VWAGY, USD, 21.54) announced its EVs are “sold out.”
• Manchin (D-WV) is considering supporting carbon tariffs on high carbon imports.
• Entrepreneurs are working on “green” cement. Cement is a surprisingly high contributor to greenhouse gases.

(Source:  Axios)

  View PDF