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

After breaking above $90 per barrel late last week, prices have modestly retreated.

(Source: Barchart.com)

Crude oil inventories unexpectedly fell 4.8 mb compared to a 1.4 mb build forecast.  The SPR declined 1.4 mb, meaning the net draw was 6.2 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.6 mbpd.  Exports rose 0.7 mbpd while imports fell 0.7 mbpd.  Refining activity jumped 1.5%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a definitive shift towards tracking last year.  If that continues, we can expect falling oil inventories for the next three weeks.

Based on our oil inventory/price model, fair value is $71.33; using the euro/price model, fair value is $55.34.  The combined model, a broader analysis of the oil price, generates a fair value of $64.08.  Current prices exceed our model projections by a wide margin, but price momentum and worries about future supply constraints will like keep prices elevated.

 Market news:

• Oil prices have been correcting this week as the market discounts a potential deal between Iran and the U.S. to restart the JCPOA; we discuss the detail in the Geopolitical news section.  Technically, oil prices were elevated and ripe for a bout of profit-taking.
• The Permian Basin may see a surge in production.  One advantage to shale oil drilling is that there is a short time between investment and production.  The decline rates are rapid, meaning the payoff comes rather quickly.  In an era of long-term uncertainty, these characteristics make the region attractive.  However, it should be noted that a side effect of fracking, the process used to extract oil from shale, is an increase in seismic activity.  Such increases and related regulations may undermine future production.
• There is an uptick in anti-oil litigation at the state level, which may add to costs or reduce future production.
• For reference, here is a site that tracks power outages across the country.

Geopolitical news:

• There is growing hope that the U.S. and Iran will return to the 2015 nuclear deal. Negotiators suggest that talks are entering their “final stages.”  If any deal is struck, it will mostly be a matter of convenience.  Iran has made important progress in generating nuclear materials to the point where it is unlikely it will return fissile inventories back to 2015 levels.  Thus, the U.S. would simply have to accept that this part of the deal won’t be maintained.  One reason for optimism is that the U.S. has allowed Iran access to funds it holds in Iraq, a good-faith gesture.  The U.S. has also rescinded a sanction on third-party firms working on nuclear non-proliferation and safety projects in Iran.  Easing sanctions would likely bring a modest increase in oil supplies.  Given the political pressure that comes with high oil prices, any reduction would be a welcome relief.  At the same time, there is no political benefit in the U.S. for appearing “soft” on Iran.  On the Iranian side, there is a deep distrust of the U.S. and opposition to any sort of agreement.  Meanwhile, the Iranian economy has suffered greatly from sanctions and the pandemic, and internal tensions are increasing.  Leaks from hacks suggest rising internal dissension within the regime as well.  It is possible Iran will take a deal to reduce pressure.
  • Nonetheless, the idea that easing sanctions will dramatically increase global supplies is probably misplaced. Iran has been seeing oil surreptitiously for some time, and the chance that a new U.S. administration could reverse the current government’s policy on Iran is high.  Thus, it is unlikely that new foreign investment will be forthcoming.
• Mongolia has large solar and wind capacity, which may eventually reduce demand for Russian natural gas.
• Australia is supporting rare earths mining within its borders to reduce China’s market power over these key metals. However, it isn’t clear if processing capacity will expand, which is another area where China dominates rare earth metals.
• Turkey has been taking a mediating and supportive role in the Russian/Ukraine situation. Turkey is also trying to improve relations with Iraq.
• The EU is considering steps to shield households from a spike in natural gas prices if a war in Ukraine breaks out.
• The U.S. bombed a house where the leader of IS, Abu Ibrahim al-Hashimi al-Qurayshi, was residing. The leader of the insurgent group died in the exchange.  Although removing the leader of IS is favorable news, it probably won’t curtail the group’s activities.

Alternative energy/policy news:

• One area of alternative energy that doesn’t attract much attention is geothermal energy. Tapping heat from the nether regions could provide clean and abundant power.  Recently, firms in the industry have started raising money for projects.
• Another area that has attracted attention is nuclear fusion. This energy source would generate power in the same way the sun does, potentially creating massive levels of energy at a low cost.  Scientists recently announced a significant development in making fusion a practical energy solution.
• China is building a new hydrogen electrolyzer plant, importing the technology from the West.
• One problem of solar and wind power is the issue of intermittency. Increasingly, utilities are deploying banks of batteries to ensure a steady flow of power.
• Pumped hydro storage is another old alternative energy. In most cases, utilities pump water up a hill to a reservoir when electricity demand is low, and then allow the water to flow down the hill through dams into another reservoir to generate cheap hydropower.  A new design is putting vessels within a body of water and using excess power to push any water in the vessel out.  When power needs to be generated, the vessel is opened, and water rushes in to eliminate the vacuum.
• The EU has designated natural gas and nuclear energy as “green.”
• Russia is a major oil and gas producer; it is also a source of metals. Siberia has large copper reserves, but mining in the region is a challenge.  Recent high copper prices are leading to renewed interest and investment in the region.

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

Since troughing in early December, oil prices have been steadily rising due to tightening supplies.  We are approaching the highs set in November.

Crude oil inventories unexpectedly fell 1.0 mb compared to a 1.8 mb build forecast.  The SPR declined 1.9 mb, meaning the net draw was 2.9 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.5 mbpd.  Exports fell 0.4 mbpd while imports rose 0.8 mbpd.  Refining activity fell 1.0%.

This chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a pattern more consistent with average and less with last year.  Last year, we had a sharp drop in stockpiles in a period where inventories usually accumulate.  So far, it looks like we will see inventories rise rather than decline.

Based on our oil inventory/price model, fair value is $69.62; using the euro/price model, fair value is $53.34.  The combined model, a broader analysis of the oil price, generates a fair value of $61.72.  Current prices exceed our model projections, but price momentum is likely to push prices higher.

 Market news:

• OPEC+ announced it would lift its production quotas by 0.4 mbpd.  Although this news is bearish, there are strong doubts the cartel can meet this goal.  Several of the group’s producers are effectively at full capacity, and thus, it is unlikely that there will be a significant rise in OPEC+ production.
• One concern of oil producers is that the shift away from fossil fuels will create “stranded assets,” which is oil and gas investments that become lost due to falling demand.  A recent study warns that if the industry attempts to boost production through investment in reaction to current high prices, it risks stranding $500 billion in wasted investment.
• Los Angeles has banned new oil and gas wells in its city proper and will phase out current wells over the next five years.
• The DOE announced it would sell 13.4 mb of crude oil from the SPR this year.
• Investors are trying to map out how energy equities will fare in the coming years in the face of falling demand.  Increasingly, they are using the tobacco industry as a model.
• Initially, the Biden administration wanted to ban new oil and gas leases on federal land and offshore.  That ruling was reversed, but a recent court order is banning offshore leases.  However, even with this ruling and the initial goals of the administration, in reality, the current administration is approving drilling permits faster than the Trump administration did.

Geopolitical news:

• It is no secret that the U.S. is trying to reduce its involvement in both Europe and the Middle East.  As the U.S. steadily lowers its involvement with the region, China is attempting to extend its influence.
• The U.S. claims that it has crafted a deal with Iran, which now is dependent on the Raisi government to decide if it wants to resurrect the 2015 pact.  We doubt a deal will be made.
• Europe has been facing a natural gas crisis which has partly been affected by the tensions between Russia and Ukraine.  Before the crisis, the U.S. tried to boost natural gas sales to Europe but was mostly rebuffed.  Now, as the EU scrambles to find sources of natural gas from venues other than Russia, Qatar has emerged as a potential source, but it appears unlikely it will be able to offset the loss of Russian supplies.
  • Tensions with Ukraine are also lifting coal prices.
  • Russia has put an LNG tanker in place to supply natural gas to its enclave in Kaliningrad in case war disrupts supplies.

Alternative energy/policy news:

• General Motors (GM, USD, 52.79) is planning to accelerate its EV production and potentially sacrifice earnings.
• Range anxiety is one factor that slows the adoption of EVs. The gasoline/diesel infrastructure is widespread, and there is less concern about “running out of gas” compared to “running out of juice.”  One way to address this problem would be to build electrified roads that could charge the battery while the vehicle is in motion.  Testing programs are being developed to see if this solution would be possible.
• EV could prove very popular with construction workers. An EV could provide electricity to power tools, turning a pickup truck into a power hub.  If this trend develops, it could accelerate the move toward EVs.
• Although creating alternative energy supplies is still the focus of the industry, energy conservation remains a key element in reducing fossil fuel consumption.
• Solar power continues to lag in the U.S. A key reason is the decentralized nature of the U.S. political system.  Without a national standard for distributed power, adoption will remain spotty.
• The NY Senate is considering a 3-year moratorium on bitcoin mining. Energy consumption is the primary concern.
• We continue to monitor development in geoengineering, which is the deliberate use of aerosols and other measures to reflect energy back into space and lower temperatures.
• ESG investment remains a popular topic; however, defining what it means is far from consistent. It turns out the arbiters of what constitutes ESG are conflicted.
• Nature is a carbon sink. This graphic shows how well various environments absorb carbon.

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

Since troughing in early December, oil prices have been steadily rising due to tightening supplies.  We are approaching the highs set in November.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 2.4 mb compared to a 1.0 mb build forecast.  The SPR declined 1.3 mb, meaning the net build was 1.1 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.6 mbpd.  Exports rose 0.2 mbpd while imports fell 0.5 mbpd.  Refining activity fell 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a pattern consistent with average and last year.  Next week has a clear divergence between average and last year.  We had a massive cold snap last year, so it is more likely we will see inventories follow the average instead of last year.

Based on our oil inventory/price model, fair value is $70.04; using the euro/price model, fair value is $53.89.  The combined model, a broader analysis of the oil price, generates a fair value of $69.30.  Current prices exceed our model projections, but price momentum is likely to push prices higher.

 Market news:

• Despite promises to increase output, OPEC+ is running almost 0.8 mbpd below target.  The shortfall does not appear to be driven by deliberate actions to reduce output, but by production problems among some smaller member producers.  In addition, as we note below, both the UAE and the KSA have been suffering from missile and drone attacks, which may affect output as well.
• Bitcoin mining consumes massive amounts of power.  Miners get the right to verify transactions by cracking complicated puzzles and are rewarded with bitcoin for their efforts.  To solve these puzzles, tremendous computing power is required. The rating agency Fitch (HTV, USD, 108.35) warns that as mining activity rises in the U.S., utilities could struggle to meet the demand for power.

Geopolitical news:

• Last week, we reported on the Houthis drone attacks on the UAE.  This group, based in Yemen and aligned with Iran, released new attacks this week on the UAE, but the missiles were intercepted by the U.S. military.   The KSA and UAE are encouraging the U.S. to blacklist the Houthis due to the recent missile strikes.  The Biden administration had removed the Houthis from the terrorist blacklist in February 2021 but is apparently considering putting them back on the list because of the recent attacks.
  • Although Iran supports the Houthis, Tehran is trying to distance itself from recent missile attacks, especially against the UAE, which with Iran has positive relations.
• In light of rising tensions in Ukraine, there are increasing worries that a military incursion will lead to a disruption of natural gas supplies into Europe.  Concerns about supply problems could make EU nations reluctant to enforce punitive sanctions or take other steps.  The U.S. is trying to address these worries by securing natural gas supplies outside of Russia.  In particular, the U.S. is working with Qatar to be a source of supply.  One problem, however, is that more than 80% of Qatari gas is currently tied up in contracts with Asian states.  Although contracts can be broken, there are usually costs involved, and making this gas available might relieve shortages in Europe but create supply problems in Asia.  Higher prices may be unavoidable.
• Russia has proposed an interim agreement regarding the JCPOA, where Iran would scale back some of its nuclear activities in return for a partial withdrawal of sanctions.  We don’t think the U.S. would agree to such an arrangement, but Iran has clearly stated it rejects the idea.  Nevertheless, Iran has opened the door to direct talks with the U.S.
  • The U.S. has indicated it won’t make a deal with Iran without the return of four Americans held by Iran.  Iran has shown no sign it will release the four hostages.
• Kazakhstan, Uzbekistan, and Kyrgyzstan suffered major power outages this week.  It is not clear what caused the outages, but given recent unrest in Kazakhstan, there are worries they may be tied to recent disturbances.
• After recent meetings, Iran’s hardliners are suddenly supportive of Moscow.

Alternative energy/policy news:

• The fossil fuel industry is facing an increasingly hostile investment and regulatory environment.  However, it is important to note that the industry is not without allies, and a pushback against the aforementioned trend is developing.  For example, the state treasurer of West Virginia is ceasing its use of a Blackrock (BLK, USD, 813.34) investment fund for banking transactions.  Blackrock has been vocal about reducing investment in fossil fuels, which triggered the action by West Virginia.  And, the state is not alone; 15 other states are joining the effort to oppose curtailing investment in the industry.
• Although the action by the states may slow the regulatory and investment measures to reduce fossil fuel consumption and production, generationally, the industry is likely fighting a losing battle.  The young in the developed world oppose the industry and will become more powerful over time.
• Nuclear power remains a controversial issue.  While Germany continues its phaseout of nuclear power, there is increasing investment elsewhere.
• At the same time, we are seeing roadblocks developing for solar power.  Rooftop or distributed solar power usually relies on subsidies and, in some cases, generous programs to purchase excess power from homeowners.  A coalition of utilities and labor unions is looking to curtail these incentives in California.  Without careful structuring of incentives to benefit utilities and their workers, these elements of the industry are natural enemies against distributed power.
  • Other issues are adversely affecting solar power, including tariffs (most panels come from China) and rising costs of installation.
• An unsung area that can reduce carbon emissions is improved consumption efficiency.  Although building emissions are not the largest source of carbon, it is an important area and one that has not shown appreciable improvement.  The administration is drafting new rules to incentivize improved efficiency in heating, lighting, and cooling commercial buildings.
• General Motors (GM, USD, 53.52) announced it will make a $7 billion investment in Michigan for battery production for EVs.
• Hydrogen is an old alternative to fossil fuels.  To some extent, it has been the “fuel of the future and always will be.”  In other words, it has been difficult to create and actually build out a hydrogen-based economy.  Hydrogen has some attractive features; fuel cells, which use the fuel, are highly efficient.  The gas can, in theory, be distributed through the existing fulling station network.  Unfortunately, at present, most hydrogen is produced from using fossil fuels, making this a less attractive option.  Notably, both Canada and China apparently are considering the development of hydrogen as an alternative fuel.
• Although China is a major source of key metals used in clean energy, it dominates the processing.

(Source: Visual Capitalist)

The chart below shows that demand for these metals will likely be robust, meaning that without strong investment, China will continue to dominate metals processing.  It should be noted that processing these metals can be environmentally “dirty.”  It may be difficult to process these metals in developed economies.

(Source:  FT)

• Lithium prices have been extraordinarily strong due to rising demand and tight supplies.

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

Since troughing in early December, oil prices have been steadily rising due to tightening supplies.  We are approaching the highs set in November.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 0.5 mb compared to a 2.0 mb draw forecast.  The SPR declined 1.3 mb, meaning the net draw was 0.7 mb.

In the details, U.S. crude oil production was unchanged at 11.7 mbpd.  Exports and imports both rose 0.7 mbpd.  Refining activity fell 0.3%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a pattern consistent with average and last year.

Based on our oil inventory/price model, fair value is $70.04; using the euro/price model, fair value is $54.12.  The combined model, a broader analysis of the oil price, generates a fair value of $62.32.  Current prices exceed our model projections, but price momentum is likely to push prices higher.

Market news:

• Oil prices have surged recently.  The combination of tight supplies, rising demand, and geopolitical tensions are all conspiring to move prices higher.  So far, the supply response has been modest, which means that price volatility remains elevated.  However, we are starting to see some rumblings of supply from the U.S. shale sector.  Other production areas remain stagnant, likely worried about stranded investment.
• Disinvestment has weighed on the energy sector, but recent comments from some major financial firms suggest the trend isn’t universal.  One issue that has been raised is that divestment could simply shift production from publicly held to privately held firms that may have lower environmental standards.  Essentially, the idea of reducing fossil fuel use by supply restrictions may not solve the problem and may cause higher prices and little environmental improvement.
• The recovery in energy demand in 2021 has led to higher emissions.

Geopolitical news:

• The Houthis, one of the principal actors in the civil war in Yemen, launched a drone attack on the UAE, killing three.  The target was the Abu Dhabi International Airport, nearly 800 miles from Yemen.  Although attacks on the KSA by the Houthis occur often, the last time the UAE was attacked was in 2018.  It seems the decision by the UAE to reduce its military support for groups aligned against the Houthis led to an unofficial ceasefire.  However, recently, UAE and the groups it supports have resumed attacks on the Houthis, apparently prompting the Houthis response.  The Houthis have been allied with Iran, but so far, the attacks by this group on the UAE have not affected attempts by Abu Dhabi and Tehran to normalize relations.
• Although we harbor strong doubts that the U.S. and Iran will be able to return to the 2015 nuclear deal, talks continue.  One major sticking point is that Iran wants guarantees the U.S. won’t withdraw from a new agreement.  This isn’t possible; there is little chance that the Senate would approve a treaty with Iran, which is the closest the U.S. can come to a guarantee.  Although we remain skeptical, there is some evidence within Iran that the hardliners are open to a deal.  The conservatives do not trust Washington, but lifting sanctions would boost the economy, which has been in the doldrums since the U.S. withdrew from the accord.
• Meanwhile, Iran is building stronger relations with China and Russia.  Iranian President Raisi recently visited Moscow to highlight growing ties.  It should be noted that Iran and Russia are not long-time allies.  Despite these moves to improve relations, Iran knows Russia is on friendly terms with Israel, Tehran’s sworn enemy, and the U.S.S.R. was a supporter of Saddam Hussein. Iran fought a bloody eight-year war with Iraq when the latter was governed by Hussein. Thus, Tehran understands that Iran’s foreign policy goals have not always coincided with Russia’s actions in the region.  However, Iran and Russia share an animosity toward the U.S., which gives them an interest in improving relations.  The two countries announced progress on a 20-year cooperation agreement.  Meanwhile, Beijing and Tehran have begun implementing a 25-year strategic partnership forged in March of last year.
• China hosted meetings of the GCC nations this week; as the U.S. attempts to reduce its activities in the region, China is signaling an increased interest.

• The KSA is considering the development of its indigenous uranium supplies.  Although such mining may be used for civilian purposes, it could also support nuclear weapons development.

Alternative energy/policy news:

• The key to expanding the EV market is batteries.  Not only do supplies need to increase, but the technology will likely need to improve.  Solid-state batteries hold the promise of quicker charging and a farther range.  QuantumScape (QS, USD, 18.48) announced a plan to build batteries for stationary applications, e.g., storage for wind and solar.
• Transportation is not the only area where reducing carbon emissions is important.  Cement and steel are also large emitters.  There has been some recent progress in producing “green steel.”
• Although there is some debate on the issue of climate change and the best way to address it, one area we watch closely is the behavior of insurers.  If insurance providers require various steps to be taken before providing coverage, or simply decide not to provide coverage at all, changes in economic activity will result.  It is possible the decisions made by insurance companies may lead to changes to address climate change.  Along with banks, decisions from the finance industry could have a bigger impact than regulation.

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

Since troughing in early December, oil prices have been steadily rising due to tightening supplies.  We are approaching the highs set in November.

(Source: Barchart.com)

Crude oil inventories fell 4.6 mb compared to a 1.7 mb draw forecast.  The SPR declined 0.3 mb, meaning the net draw was 4.9 mb.

In the details, U.S. crude oil production declined 0.1 mbpd at 11.7 mbpd.  Exports fell 0.6 mbpd, while imports rose 0.2 mbpd.  Refining activity unexpectedly fell 1.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week, we reset the chart for 2022, adding 2021 as a reference.  The key element to watch is to determine whether inventories follow the usual seasonal pattern, repeat last year’s path.

Based on our oil inventory/price model, fair value is $70.20; using the euro/price model, fair value is $53.68.  The combined model, a broader analysis of the oil price, generates a fair value of $62.18.  Current prices exceed our model projections, but price momentum is likely to push prices higher.

Although gasoline inventories have been rising rapidly, we note the rise is consistent with seasonal patterns.

We would expect gasoline stockpiles to rise another 12-15 mb by early February.

 Market news:

• The U.S. is now the world’s top LNG exporter, edging out Qatar and Australia for the first time.  In the late 1990s into the mid-2000s, the U.S. was aggressively building the infrastructure to import LNG.  Remarkably, 15 years later, the U.S. is a leading source of LNG to the world.
• Higher natural gas prices led to a resurgence in coal consumption this year, leading to a rise in greenhouse gas emissions.
• Banks are coming under increasing scrutiny over lending to fossil fuel companies.  As regulators restrict lending to the sector, financing will likely come either from internal cash flow or from the shadow banking system.  The bottom line is that the lack of available financing will tend to make the oil supply less responsive to higher prices.
• Market forces are powerful.  Using markets to price carbon could create an investment case for carbon removal.
• In the face of rapidly rising natural gas prices, a British energy supplier suggested homeowners should “cuddle their pets” to stay warm this winter.  It has subsequently apologized for the comment.  It reminds us of our youth and “Three Dog Night,” a band named after something our ancestors did to stay warm.

Geopolitical news:

• Kazakhstan’s president “invited” peacekeepers from various allied countries (mostly from Russia) as widespread unrest developed.  We will discuss the situation there in more detail in a future Bi-Weekly Geopolitical Report, but it is important to note that the country is a major oil and gas producer and provides 40% of the world’s uranium supplies.
• Natural gas prices in Europe appear to be manipulated by Moscow to gain leverage over the EU.  This situation will likely continue going forward.
• Showing brazen disregard for U.S. sanctions, China increased its purchases of oil from Iran and Venezuela.

Alternative energy/policy news:

• The transportation sector is working to boost fuel efficiency to control costs and reduce carbon emissions.  One experiment is that ships are deploying kites to allow wind energy to reduce fuel consumption.
• EVs are becoming more popular; one reason is that automakers are beginning to electrify pickup trucks.
  • A recent Deloitte report details that Japan and South Korea are leading the world in consumer attitudes in favor of EVs or other alternative vehicles.
• Germany has closed three of its six remaining nuclear power plants.
• One theme we have been watching is the oil to metals trend in electrifying the transportation sector.  BHP (BHP, USD, 66.58) is making a major investment in Tanzania to secure nickel supplies.

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