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

[N.B. Today’s report was delayed one day due to the Columbus/Indigenous Day holiday.]

Prices have moved above $80 per barrel.

(Source: Barchart.com)

Crude oil inventories unexpectedly fell 0.4 mb compared to a 2.0 mb build forecast.  The SPR declined 1.7 mb, meaning the net draw was 2.1 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.3 mbpd, remaining below the 11.5 mbpd pre-Ida level.  Exports rose 0.5 mbpd, while imports declined 0.2 mbpd.  Refining activity fell 2.0%.  We are in refinery maintenance season, which accounts for the usual seasonal build in crude oil inventories seen in the chart below.  This week’s draw is contraseasonal.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 68.8 mb.

Based on our oil inventory/price model, fair value is $65.70; using the euro/price model, fair value is $58.26.  The combined model, a broader analysis of the oil price, generates a fair value of $61.67.  We are seeing a notable divergence in the model between inventory and the dollar and a rising level of overvaluation.  Part of the overvaluation is likely due to fears of tighter inventories. If the builds continue, which is consistent with seasonal patterns, the model suggests some moderation of prices.  However, supply fears are so elevated this may not be the case.

 Market news:

• A key issue regarding why oil prices are high is that the world is rapidly moving to reduce investment in fossil fuels before renewables are ready to replace them.  This situation is leading to a supply shortage that higher prices will struggle to resolve, at least easily.  High prices will eventually curtail demand, but not quickly.  Energy demand, due to the lack of substitutes, traditionally has an inelastic demand curve, meaning it takes excessive price increases to reduce consumption.  High prices would normally spur oil drilling, but with financing constrained, we are not seeing the usual response from the fossil fuel industry.

The relationship between oil production and prices varies over time, but in recent history, a $60 per barrel oil price generated 13.0 mbpd of production.  Nearly $80 now is only fostering production marginally over 11.0 mbpd.  To some extent, higher prices will speed the transition to alternative energy, but the pain it involves will not be popular.

• In related news, Exxon (XOM, USD, 63.53) is considering whether it should continue with several oil and gas projects.  Earlier this year, the board added members of Engine No. 1, an environmental activist group.  It appears their presence may be affecting the company’s production, potentially reducing future oil and gas supplies.
• As fossil fuel production is being restricted, it’s affecting electricity production globally.  From California to China, generators are struggling to acquire fuel for electricity production.  If shortages persist, it will further crimp industrial activity.
• Although banks are pledging to cut funding for Arctic oil development, the promises apparently have some loopholes.  Still, the trend in place suggests that financing will remain difficult for fossil fuel companies.
• Rising U.S. LNG exports are lifting flows at the Henry Hub in Louisiana.
• The oil futures options markets are starting to see activity in the far out-of-the-money call options.

Geopolitical news:

• As the U.S. reduces its activities in the Middle East, the KSA and Iran are trying to improve relations.  The two nations are long-time adversaries, but the KSA has relied on the U.S. to contain Iran.  As the U.S. focuses on containing China, Riyadh appears to have concluded that it will need to live with Iran and thus needs to foster a new relationship.
• Although the U.S. continues to work toward Iran returning to the 2015 nuclear deal, there is no discernable progress on this issue.  However, we note that the JCPOA is popular with Iranians because it could relieve the current sanctions regime.  So, eventually, Tehran may decide to return to negotiations.
• In recent Iraqi elections, Muqtada al-Sadr’s bloc won a plurality and is the most powerful party in the parliament.  Iran has mixed views about al-Sadr.  They appreciate his anti-U.S. stance, but he is also pro-Iraqi and may oppose Tehran’s efforts to control Iraq.
• There had been tentative steps to improve relations with Venezuela, but the U.S. extradition of an ally of Venezuelan President Maduro has frozen talks.  Alex Saab, a Colombian businessman with ties to Caracaras, was arrested in the African state of Cape Verde in June 2020.  The country has agreed to extradite him to the U.S., where he will be arraigned on money laundering charges.
• Russia has been using the current energy crisis in Europe to press for EU concessions.  Long-term forecasts suggest Russia’s hold on the natural gas market will likely increase in the coming decades.

 Alternative energy/policy news:

• Part of the White House budget and infrastructure package was designed to shift the U.S. away from fossil fuels.  However, it appears that Congress is not going to agree with all these projects, meaning policy moving the U.S. toward greener energy will likely be slowed.
• The IEA is warning that alternative energy investment isn’t big enough to replace the loss of fossil fuels.
• Texas, a major oil and gas state, is also a hotbed for alternative energy output.

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

[N.B. Today’s report was delayed one day due to the Columbus/Indigenous Day holiday.]

Prices have moved above $80 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 6.1 mb compared to the 1.1 build forecast.  The SPR declined 0.8 mb, meaning the net draw was 5.3 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.4 mbpd, approaching the 11.5 mbpd pre-Ida level.  Exports rose 0.4 mbpd, while imports declined 1.0 mbpd.  Refining activity fell 2.9%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 68.4 mb.

Based on our oil inventory/price model, fair value is $65.55; using the euro/price model, fair value is $57.99.  The combined model, a broader analysis of the oil price, generates a fair value of $61.44.  We are seeing a notable divergence in the model between inventory and the dollar and a rising level of overvaluation.  Part of the overvaluation is likely due to fears of tighter inventories. If the builds continue, which is consistent with seasonal patterns, the model suggests some moderation of prices.  However, supply fears are so elevated this may not be the case.

In some respects, this week’s data doesn’t add up; the build with imports significantly down suggests that we may be seeing higher production than is being reported.  The plug number of “unaccounted for crude oil” is elevated, suggesting an undercount, and the most likely area is production, which is estimated.

The most recent official U.S. oil production data, which is through August, shows production at 11.1 mbpd.  We suspect production is probably closer to 11.6 mbpd.

 Market news:

• The IEA released its World Energy Outlook annual report this week.  The report makes it quite clear that the world is in an energy transition away from fossil fuels, but moving away from them will be rocky.  The report notes that if nations hold true to their climate pledges, fossil fuel demand will peak in 2025.  Such predictions create their own problems; after all, why would the industry make investments in future production if demand is expected to decline?
• Meanwhile, until a greener future materializes, rising demand and the lack of a robust supply response are leading to elevated prices.  Oil drillers are struggling to deal with higher costs, and financing is becoming more difficult to acquire.  As traditional sources of financing are lost, hedge funds are becoming a source of funding.  This funding is usually more costly and often requires equity participation.  At the same time, large banks haven’t completely abandoned the oil and gas industry, but the pressure is mounting to do so.
  • Although it doesn’t appear the Biden administration will use the SPR at this time to reduce oil prices, it is being considered as an option.  The White House invited U.S. oil companies for a visit to discuss how to bring oil prices down.  This approach does work at cross purposes for its climate policy goals.
  • The rise in energy prices is raising concern about its broader inflation effects.  The DOE is warning U.S. consumers that winter heating prices could rise 30%.
• Europe is facing a crisis in natural gas supplies.  The EU is trying to cushion the blow to consumers, but doing so reduces the price signaling effect, which is necessary to reduce demand.  As gas prices remain elevated, some dual-fired plants are switching to fuel oil, something we rarely see.
  • U.S. LNG exporters are taking steps to boost supply capacity to try to address the EU’s gas shortage.
• Even though coal prices have languished for years, elevated prices for oil and natural gas have made coal prices competitive.  In China, reduced mine output and import issues tied to China’s trade policy toward Australia have led to supply shortages, soaring energy prices, and some outages, adversely affecting factory production.  As China boosts imports of coal, oil, and natural gas, it is driving up prices worldwide, not just for energy but for a broad range of goods.

Geopolitical news:

• The energy crisis in the EU is giving Russia greater influence over Europe (and much of the rest of the world for that matter).  We have doubts Russia can aggressively expand natural gas output to single-handedly solve Europe’s energy problems, but President Putin is promising to “help.”  We suspect his goal is to force the EU into long-term supply contracts at lower prices than currently observed in the market but lock Europe into Russia’s supply network.
• The Biden administration wanted to return to the JCPOA, the Obama-era nuclear deal with Iran.  Despite diplomatic efforts, Iran remains wary.  In addition, there has been a change in government in Tehran to one that is much more hard-line compared to the last administration.  There are growing worries that Iran will end up losing the opportunity to make a deal with the U.S. and have a chance to ease sanctions.
  • Iran is trying to take advantage of Europe’s energy crisis to improve its diplomatic standing.
  • The CIA has closed its Iran Mission Center, dedicated to gathering intelligence on Iran.  Although this action might be taken as a positive move by the U.S. to relieve tensions, Tehran isn’t viewing it with favor, perhaps highlighting the level of distrust in the U.S.
• Tensions between Iran and Azerbaijan continue to escalate.  Earlier, we noted Azerbaijan had arrested Iranian truck drivers who were delivering goods to Armenia.  Iran has responded with military exercises on the Azerbaijan/Iranian frontier.
• Iraq held parliamentary votes this week; turnout was low and Shiite cleric Moqtada al-Sadr narrowly won the election.  The low turnout tends to undermine the mandate from the election.
• Off the coast of Yemen is a decaying oil tanker that is in waters controlled by Houthi rebels.  The tanker is not being maintained, and there are growing fears it will fail, triggering an oil spill that would be worse than the Exxon-Valdez.
  • Iran and Saudi Arabia are in talks to restore ties and end the war in Yemen.

 Alternative energy/policy news:

• As the world looks to develop cleaner fuels, hydrogen is an alternative.  Currently, most hydrogen comes from natural gas, but it is possible to pull hydrogen from water using clean electricity.
• Natural gas is generally less polluting than other fossil fuels, but drilling, transporting, and storing this gas opens up the possibility for leakages and emitting damaging methane.  We are beginning to see a greater focus on containing methane emissions.  Reducing these emissions is expected to be a major policy goal from the upcoming COP26 conference.
• The process of carbon offsets, which entail funding methods that absorb CO₂, is gaining momentum.
• Indigenous peoples’ activists are becoming another pressure group opposing oil and gas activities.
• Although nuclear power remains controversial, it will likely be necessary if the world wants to reduce carbon emissions.  We are seeing uranium prices at nine-year highs on expectations that nuclear power will need to expand in the future.  Thorium also remains an interesting alternative.
• Electric vehicles are gaining traction as a way to address carbon emissions.  However, there are growing worries that the electric grid isn’t reliable enough to be a secure source of transportation energy.
• China is expanding its investment in Argentina’s lithium resources.  Due to the risky investment climate, Argentina has lagged behind other producers, but China is apparently prepared to take the required risks.

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

Prices are approaching $80 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 2.3 mb compared to the 1.0 build forecast.  The SPR declined 0.9 mb, meaning the net draw was 1.4 mb.

In the details, U.S. crude oil production rose 0.2 mbpd to 11.3 mbpd, approaching the 11.5 mbpd pre-Ida level.  Exports fell 0.4 mbpd, while imports declined 0.9 mbpd.  Refining activity rose 0.3%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn consolidation and build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 72.3 mb.

Based on our oil inventory/price model, fair value is $67.48; using the euro/price model, fair value is $58.26.  The combined model, a broader analysis of the oil price, generates a fair value of $62.66.  We are seeing a notable divergence in the model between inventory and the dollar and a rising level of overvaluation.  Some of the overvaluation is likely due to fears of tighter inventories. If builds continue (and the seasonal pattern indicates a modest build that will start later in October), we will probably see some moderation of prices.

Ida

Thankfully, Hurricane Ida was not followed up by a subsequent storm as with Katrina in 2005.  Since the comparison is becoming less relevant, this will be the last week of reporting on this issue.

(Source:  DOE, CIM)

This chart compares refinery runs during the two periods following the hurricanes.  In 2005, Hurricane Rita soon followed Katrina.  Since that didn’t occur with Ida (at least so far), we have seen refinery activity return to normal this week.

 Market news:

• The global natural gas market continues to dominate the headlines as prices rise relentlessly.
  • As the global LNG market has expanded, the U.S. natural gas market has become increasingly sensitive to global prices.  U.S. natural gas is increasingly being exported to the world, reducing domestic supplies and lifting U.S. prices.  Under normal market circumstances, the rise in price would trigger increased investment and production.  However, in an ESG world, the normal market response is less effective, meaning that supply constraints are worsening.
  • A similar situation is developing in oil; U.S. shale producers are signaling that we probably won’t see an aggressive increase in production (current data supports this signal).  OPEC has also indicated that it won’t increase production, despite high prices.  A key element behind these decisions is the fear that climate policy will strand investment, leading to a reluctance to invest.  Since oil and gas are depleting assets, weaker investment will inevitably lead to less supply over time.
  • In a new development, Russian President Putin has indicated he would like to resolve the natural gas shortage; the quid pro quo will likely be the opening of Nord Stream 2.  Despite this news, it is unclear whether Russia actually intends to lift supplies.
  • An additional factor reported in a Dallas FRB survey is the lack of skilled labor in the Texas oil patch, constraining output.
  • As oil and gas prices have increased, even coal, the most shunned of the hydrocarbons, is seeing higher prices and shortages.  India, which relies heavily on coal, is facing severe shortages and may be forced to increase imports of higher-priced coal.
• A major oil spill off the coast of California, likely caused by an undersea pipeline rupture, will dominate the headlines in the coming days.

Geopolitical news:

• Mexico’s President Obrador is seeking to change the constitution and deepen the state’s hold on the hydrocarbon industry.  The plan would eliminate independent oversight of the state-owned firms and increase state ownership.  He also seeks to nationalize the lithium industry.  Given the weak performance of the state-owned companies, if he is successful, we would expect Mexican oil production to decline in the coming years.

 Alternative energy/policy news:

• As the U.K. energy crisis unfolds, PM Johnson is being pressed on his plans for decarbonization.  Part of Britain’s plans to address decarbonization is through subsidies and surcharges designed to encourage conservation and cleaner energy consumption.   Although politically unpopular, it will be practically impossible to decarbonize without raising prices on oil, gas, and coal.
  • Getting subsidies priced correctly is always a challenge.  Poland may have made their solar subsidies too generous.
• Among the alternative energy sources, tapping tides has not received significant attention, but in coastal regions, it could be an important source of clean energy.  Tides are powerful and regular, and tapping them could be beneficial.
• We have been reporting on new technologies in nuclear power.  We note a recent article in Mother Jones discussing nuclear pellet technology.  Although the reporting isn’t breaking new ground, the fact it is in left-wing media suggests a growing recognition that nuclear power will be part of decarbonization.
• Exxon (XOM, USD, 60.10) is continuing efforts to create biofuels from algae.
• Although reducing carbon emissions is important, the reality is that even if we were net carbon zero today, climate warming would likely continue for decades.  This fact has led to continued attempts to pull carbon from the atmosphere.  It is also likely, at some point, that geoengineering will be deployed to cool the planet.

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

Prices have rallied to above $75 per barrel.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 4.6 mb compared to the 2.5 mb draw forecast.  The SPR declined 0.9 mb, meaning the net draw was 3.8 mb.

In the details, U.S. crude oil production rose 0.5 mbpd to 11.1 mbpd, still below the 11.5 mbpd pre-Ida but also clearly recovering.  Exports rose 0.2 mbpd, while imports increased 0.1 mbpd.  Refining activity rose 0.6% as hurricane recovery continues.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn consolidation and build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 73.8 mb.  We suspect the disruptions from Hurricane Ida (see below for updates) have affected this data, but the impact is starting to fade.

Based on our oil inventory/price model, fair value is $68.13; using the euro/price model, fair value is $62.10.  The combined model, a broader analysis of the oil price, generates a fair value of $65.07.  Continued dollar strength is weighing on oil prices.  The decline in inventory, on the other hand, is a bullish factor.

Ida

Hurricane Ida followed a path similar to Hurricane Katrina.  For the next few weeks, we will track the impact of Ida on the oil and gas market, using Katrina as a baseline comparison.

(Source:  DOE, CIM)

This chart compares refinery runs during the two periods following the hurricanes.  This week, refinery operations recovered modestly.  In 2005, Katrina was soon followed by Hurricane Rita.  Barring a repeat, we would assume refineries will continue to rise to around 90% of capacity, and then stabilize.

 Market news:

• Both Europe and Asia are facing an energy crisis.
  • In the U.K., the supply chain for energy is showing signs of deep disruption.  Gasoline lines and service station closures due to lack of supply have caused severe problems.  Part of the issue is panic buying by drivers.  Complicating the situation is a lack of truck drivers, a consequence of Brexit.  In leaving the EU, European drivers felt unwelcomed and returned home, leading to a lack of shipping capacity.
  • In Europe, tight supplies for natural gas are causing a supply crunch for electricity, sending prices soaring.  Europe is producing less natural gas, partly because of environmental regulations.  Russia has curtailed shipments, likely to “encourage” Germany to rush the approval of Nord Stream 2.  Although LNG could help ease this supply shortage, Asia, so far, has been outbidding the EU.
  • The EU’s environmental rules have also played a role.  Carbon prices, part of the EU’s cap-and-trade system, are rising, leading to higher gas prices as well.  Paradoxically, the shortage of natural gas is leading to supply problems for industrial carbon dioxide.  Natural gas is a feedstock for fertilizer, and making that product creates CO₂ as a byproduct.  High natural gas prices have curtailed fertilizer manufacturing (something to watch for farmers in the coming months) and consequently CO_2.
• While the EU is struggling with natural gas and oil product supplies, China is forcing electric generators to curtail output to address severe pollution problems.  These regulations, coupled with rising natural gas and coal prices, are making utilities reduce the electricity supply, leading to falling industrial output.  These actions will exacerbate current global supply chain problems and will reduce China’s economic growth.
  • China has made regulatory reductions before.  There was a falloff in industrial output before the 2008 Summer Olympics.

Of course, the total decline in industrial production cannot be attributed to the games (a global recession was also part of that); the earlier ones were temporary.  The current reductions appear to be longer-lasting, perhaps leading to less global productive capacity.

• As winter approaches, nations are scrambling to secure natural gas supplies. China is buying LNG aggressively, sending prices higher.
• There are fears that the current supply problems in China will worsen this winter.
• S. regulators are pushing for stricter power plant standards to avoid a repeat of the Texas experience last winter.
• A key element to the recent rise in prices is the impact of environmental policy. Although the current policy doesn’t necessarily preclude oil and gas development, regulators have made it clear that the industry will struggle to acquire financing, and the risk of stranded oil and gas is high.  In addition, environmentalists have prevented the expansion of pipelines, leading to supply bottlenecks.  So, higher commodity prices are almost unavoidable.  In fact, to encourage the transition away from fossil fuels, high prices are likely required.
• The Biden administration is considering cuts to biofuel mandates, which tend to reduce oil prices and undercut grain prices.
• The lack of non-OPEC exploration activity will probably increase market power for OPEC.

Geopolitical news:

• As the U.S. withdrawals from the region, local powers are working to restructure relations.  Arab Gulf states are making informal steps to improve cooperation and resolve differences with Qatar.  Iran and the KSA are continuing to talk as well.
• The U.S. Treasury has applied sanctions to entities in the region that support Hezbollah.
• National Security Advisor Sullivan is scheduled to visit the Middle East next week.
• In light of the U.S. withdrawal from Afghanistan, Iran is increasing its pressure on groups in Iraq and elsewhere in the region supporting the U.S.

 Alternative energy/policy news:

• Given the energy crisis in the U.K., policymakers are considering increasing their commitment to nuclear power.
• Ford (F, USD, 14.36) announced a major effort to expand electric car and light truck production.  As we noted last week, Ford plans to recycle exhausted batteries, turning their cars into a closed loop.  This week, the company not only announced new vehicle production facilities but also announced a strong move into battery production.

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

Prices continue to hold above $70 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 3.5 mb compared to the 2.8 mb draw forecast.  The SPR declined 1.2 mb, meaning the net draw was 4.7 mb.

In the details, U.S. crude oil production rose 0.5 mbpd to 10.6 mbpd, still below the 11.5 mbpd pre-Ida but also clearly recovering.  Exports rose 0.2 mbpd, while imports increased 0.7 mbpd.  Refining activity rose 5.4% as hurricane recovery continues.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn consolidation and build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 78.1 mb.  We expect the disruptions from Hurricane Ida (see below for updates) will affect this data in the coming weeks.

Based on our oil inventory/price model, fair value is $69.58; using the euro/price model, fair value is $62.83.  The combined model, a broader analysis of the oil price, generates a fair value of $66.27.  Continued dollar strength is weighing on oil prices.  The decline in inventory, on the other hand, is a bullish factor.

Ida

Hurricane Ida followed a path similar to Hurricane Katrina.  For the next few weeks, we will track the impact of Ida on the oil and gas market, using Katrina as a baseline comparison.

(Source:  DOE, CIM)

This chart compares refinery runs during the two periods following the hurricanes.  This week, refinery operations recovered strongly.  In 2005, Katrina was soon followed by Hurricane Rita.  Barring a repeat, we would assume refineries will continue to come back online.

 Market news:

• The European natural gas crisis has intensified as supplies continue to tighten.  Inventories are at decade lows.

Three more U.K. natural gas suppliers to consumers have failed this week, stranding 1.5 million homeowners without natural gas service.  The firms apparently provided price caps without adequate price hedges, and as natural gas prices have soared, the firms were losing money on each BCF they provided.  The firms are asking for government help, perhaps even creating a “bad bank” for customers with contracts that can’t be fulfilled.   Meanwhile, other EU governments are considering emergency aid to households faced with soaring power bills.

• Europe is finding itself outbid for U.S. natural gas, as Asian buyers pay up to secure supplies.
• Russia has been focusing its supplies on Turkey and China, curtailing supplies to Europe.  Even though Russia is meeting its long-term supply contracts with Europe, its spot supplies have been going elsewhere.  We expect Moscow to use Europe’s natural gas supply crisis to push Nord Stream 2 to open.
• Adding to winter gas worries is a volcanic eruption on the Canary Island of La Palma.  Volcanic ejections can spew ash into the upper atmosphere, cooling temperatures.
• Energy prices have been rising as oil and gas drilling have slowed on the dismal future demand outlook.  Much of this dismal future is a function of environmental regulation.  Although curtailing fossil fuel use is necessary to reduce greenhouse gases, the accompanying price increase is unpopular and puts the parties in power at risk.
  • There is the possibility that shale oil drilling may be starting to pick up.

Geopolitical news:

• Behind-the-scenes discussions on Iran’s returning to the nuclear deal are underway, but a recent speech by President Raisi suggests Iran is more interested in securing vaccines.
• Although the Arab Gulf states remain dependent on the U.S. for security, China is making diplomatic and economic inroads.  Like much of the world, nations loath to choose between Beijing and Washington, but it will be increasingly difficult to remain neutral.
• The Libyan government appears to be failing, raising the potential for additional conflict.

 Alternative energy/policy news:

• As EV’s become more common, there are worries about batteries, specifically, what to do with them when a car’s useful life is spent.  Ford (F, USD, 13.24) is working on a plat to recycle batteries used in its cars, creating a “closed-loop” solution.
• A bill in Congress, supported by progressive Democrats, appears to require the Fed to act against financial institutions that lend to fossil fuel firms.  Although we doubt it will pass, the fact it was considered shows the hostile regulatory environment energy companies face.
• The default of sovereign debt is a constant problem in international lending.  A couple of centuries ago, lenders might use the military to force borrowers to pay or collect collateral.  Those tactics are no longer deployed, but the problem hasn’t gone away.  Belize is working on a novel plan to buy back its heavily discounted debt with funds provided by The Nature Conservancy.  It will use the restructuring to pay for marine conservation projects on its coral reefs.  If this works, one could see how other nations might try to do something similar.

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

Prices moved above $70 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 6.4 mb compared to the 3.6 mb draw forecast.  The SPR declined 0.5 mb, meaning the net draw was 6.9 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 10.1 mbpd, well below the 11.5 mbpd pre-Ida.  Exports rose 0.3 mbpd, while imports declined 0.3 mbpd.  Refining activity rose 0.2%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn consolidation and build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 75.8 mb.  We expect the disruptions from Hurricane Ida (see below for updates) will affect this data in the coming weeks.

Based on our oil inventory/price model, fair value is $68.46; using the euro/price model, fair value is $63.39.  The combined model, a broader analysis of the oil price, generates a fair value of $65.96.  Continued dollar strength is weighing on oil prices.  The decline in inventory, on the other hand, is a bullish factor.

Ida

Hurricane Ida followed a path similar to Hurricane Katrina.  For the next few weeks, we will track the impact of Ida on the oil and gas market, using Katrina as a baseline comparison.  Firms continue to struggle to resume production after the event.

(Source:  DOE, CIM)

This chart compares refinery runs during the two periods following the hurricanes.  Refineries require electricity to operate, and damage to the electrical grid slows the recovery from the storm.  With Katrina, runs stabilized over the following few weeks, only to fall further by the end of the month.  We see a similar pattern with Ida.  We doubt we will see a similar plunge this year.  In the year Katrina hit the Gulf, it was followed a few weeks later by Hurricane Rita.  Therefore, if another storm hits the area, this chart gives us an idea of what might transpire.

Natural gas update:  We are seeing clear warnings that natural gas prices could be elevated this winter.  Europe is already facing a squeeze on supply and record prices.  By winter, it could be a crisis.  Global storage levels are tight, and with the advent of LNG, it means the U.S. supply situation is tightening as well.  The U.S. is warning that this situation will increase Europe’s reliance on Russian gas, which will give Moscow leverage over the EU.

Supply has been falling for the past several months.  Even though consumption is also falling, it is declining more slowly, leading to a negative balance.  That is bullish for prices.  The supply problem seems to be tied to two issues.  Net imports are sharply negative (or, put another way, the U.S. is now a net exporter), and production has stalled.  On a yearly basis, production peaked in April 2020 and has fallen 3.6% since then.  The most likely reason is the lack of investment in new output.

The chart on the left shows supply (production + net imports) and consumption on a rolling 12-month basis.  The lower line shows the balance.  Although we don’t expect these imbalances to lead to the explosive rise in prices seen in the first decade of the century, $6.00 per MMBTU isn’t out of the question.

The imbalance has led to tightening inventory levels.  It appears increasingly likely we will enter the winter with less-than-normal stockpiles.

 Market news:

• As we reported last week, China executed a sale of oil from its strategic reserves.  So far, the sale hasn’t turned the bullish tide in oil prices.
• The U.S. continues to build out the infrastructure for oil exports.
• Spain is seeing a massive rise in electricity prices due to a combination of rising natural gas prices and higher emission rights.  The country has tacked on a windfall profits tax on utilities.
• OPEC+ is projecting a rapid rise in oil demand into Q4, primarily due to stronger Asian economic growth.  Global demand is forecast to rise as well because of the recovery from the pandemic.
• Meanwhile, the IEA is warning that storm-related outages will reduce supply.
• Disinvestment by colleges and universities out of fossil fuels continues.
  • Emerging market economies are asking for easier restrictions on fossil fuel investment to avoid crimping their development.

Geopolitical news:

• The IAEA and Iran have reached an agreement on nuclear monitoring, saving the talks to revive the 2015 nuclear deal.  There are hopes that talks will resume soon.  We have doubts that Iran and the U.S. can return to the former agreement.  Tehran has accumulated enough enriched uranium to build a device in a month, although there is no indication it has mastered the technology to construct a deliverable weapon.
  • Iranian guards are accused of physically harassing IAEA nuclear inspectors.
• Elections in Norway led to a center-left winner.  This political arrangement is less supportive of oil production than the center-right, but it looks like the Greens won’t be a major coalition partner if the party enters the government at all.  Thus, we expect Norwegian oil production to continue.
• The Nord Stream 2 pipeline is mostly complete.  Testing and permitting remain the only significant hurdles.  Senate Republicans are blocking White House nominations in protest to the administration, allowing the pipeline to progress unimpeded.
• Iranian and KSA talks are continuing.

 Alternative energy/policy news:

• One element of the budget moving through Congress is new rules for utilities regarding the use of renewable energy.  Utilities are trying to delay implementation to give themselves time to adjust.
• As governments consider carbon adjustment taxes on imports, the OECD is trying to create global guidelines to avoid these taxes used as trade impediments.
• Russia is trying to sell natural gas to China via pipelines.  Beijing has been rather cool to the proposal.  One factor is competition from LNG.  The other is that wind and solar power from Mongolia are an alternative to Russian gas.  It should be noted that despite this competition, Russia is reporting record sales of natural gas to China…which is gas not going to Europe.
• Chevron (CVX, USD, 97.77) plans to triple its investment in low carbon energy sources.  Carbon capture is part of this mix.
• Wind and solar power prices have declined to a point where they are stiff competition to natural gas and coal.  However, those renewable sources are intermittent; electricity prices in Europe spiked recently because the wind died down.
  • Batteries are one answer to this problem.  Although lithium and lead can be used in batteries, anything that can store energy can work as one.  Thus, pumped water storage can “store” excess electricity.  Energy Vault, a company that plans to use a pulley and cement block system to store energy, plans to go public via a SPAC.
  • Another possibility for storing energy is hot silica.
• Higher prices for carbon emissions permits are putting pressure on Poland’s coal and gas plants.
• Thorium reactors for electricity have been an alternative to uranium nuclear facilities but have never caught on.  Uranium plants yield material that can be used for nuclear weapons, making them attractive.  Thorium would not, at least not directly.  China is moving to a prototype thorium reactor, and if it can master the technology, it will likely move to expand its use.
• The move away from fossil fuels is about going from drilling to mining.  Nickel is one area of focus.

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

Prices continued to consolidate in the high $60s.

(Source: Barchart.com)

Crude oil inventories fell 1.5 mb compared to the 6.0 mb draw forecast.  Analysts (including us) were clearly expecting Ida to bring a large draw.  However, the drop in exports and the slide in refinery operations prevented a significant decline.  The SPR was unchanged this week.

In the details, U.S. crude oil production fell 1.5 mbpd to 10.0 mbpd.  Exports fell 0.7 mbpd, while imports declined 0.5 mbpd.  Refining activity fell 9.4%, led by a 16.7% slide in the Gulf region.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are at the end of the summer withdrawal season.  Note that stocks are significantly below the usual seasonal trough.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 69.7 mb.  We expect the disruptions from Hurricane Ida (see below for updates) will affect this data in the coming weeks.

Based on our oil inventory/price model, fair value is $66.42; using the euro/price model, fair value is $63.76.  The combined model, a broader analysis of the oil price, generates a fair value of $65.05.  Continued dollar strength is weighing on oil prices; the decline in inventory, on the other hand, is a bullish factor.

Ida

Hurricane Ida followed a path similar to Hurricane Katrina.  For the next few weeks, we will track the impact of Ida on the oil and gas market, using Katrina as a baseline comparison.  This week, we will look at refinery operations.

(Source:  DOE, CIM)

This chart compares refinery runs during the two periods.  Refineries require electricity to operate, and damage to the electrical grid will slow the recovery from the storm.  With Katrina, runs stabilized over the following few weeks, only to fall further by the month’s end.  We doubt we will see a similar plunge this year, as outside the Gulf region, most refinery activity was already depressed.

• An oil spill occurred after Ida. It remains unclear if it was caused by an operating pipeline, a well, or an abandoned pipeline. If it is the latter, the damage will probably be limited.  If an active pipeline or well is involved, and the slick widens, it could cause a further backlash against the oil industry.
• Ida has also reduced oil production in the Gulf of Mexico.

 Market news:

• Natural gas prices have been on a tear this year.

(Source: Barchart.com)

Although these increases pale in comparison to the first decade of the century, they are in a range of highs seen in the shale era.  With the expansion of LNG, natural gas has become a more global commodity.  We note supplies are tight in Europe, making the region vulnerable to a cold winter.  It will also support U.S. prices as producers struggle to meet global demand.

• China tapped its SPR for the first time in response to higher oil prices.  The news did send prices lower initially.  Although Beijing could justify the release because of Hurricane Ida, the National Food and Strategic Reserves Administration indicated the release was due to rising raw materials prices.  In general, the U.S. rarely uses the SPR to control prices.  It is usually tapped as a result of a weather-related supply event or for budgetary reasons.  It is possible that China may operate its SPR as a buffer stock, buying when prices are low and selling when they are high.  If they act in this manner, it will take some pressure off of OPEC+ to maintain prices.
• As the budget process begins, groups facing higher taxes, namely, the oil and gas industry, are pushing back.  Of particular interest is a fee on methane leakages.  Methane is a powerful greenhouse gas, and it often leaks into the atmosphere during oil and gas drilling.  There is proposed legislation for new fees on methane leaks.  The oil industry is pushing back against this proposal, as expected.  As fees on carbon become more common, the likelihood increases that oil, gas, and coal resources become stranded.

Geopolitical news:

• The new regime in Iran has picked its nuclear chief.  He is Mohammad Eslami.  Although an engineer, he is a civil, not a nuclear one, unlike his predecessors.  He does have experience in Iran’s defense industry, which is likely why he landed the position.
• On this front, it is looking increasingly like the 2015 nuclear deal with Iran will not be reconstituted.  Although Iran has expressed interest in resuming the talks, Teheran has also blocked IAEA access to Iran’s nuclear facilities.  This organization also claims that its surveillance equipment has been removed.
• The crisis in Lebanon is undermining Hezbollah’s control of the country.  This Shiite group has become the dominant power in Lebanon, but the continued economic downward spiral is making Hezbollah appear impotent.

 Alternative energy/policy news:

• Climate change appears to be causing increasingly volatile weather.  On the one hand, the costs of these events are increasing; on the other, improved forecasting and investments in resiliency have led to fewer fatalities.
• As biofuels become more popular, the food processing industry is finding itself competing with biofuel refiners for vegetable oils and animal fats.
• Although reducing greenhouse gas output is important to managing climate change, in reality, without reducing existing gases in the atmosphere, the ill effects are likely to continue.  In Iceland, a plant that uses thermal power is extracting CO₂ from the atmosphere and storing it underground.  This plant is the world’s largest and will begin reversing the levels of greenhouse gases in the environment.  Even though this is positive news, the level it will withdraw is less than 1% of the annual emissions of a typical coal-fired power plant.  So, this industry will clearly have to become much larger to have a serious impact.
• The Biden administration has a clean-energy plan that would require 44% of U.S. electricity to come from solar power.  The cost will be $562 billion by 2035.
• We are seeing increased investment in batteries that store energy at the commercial level.  Tying batteries to solar or wind generation removes the intermittency issue.  Metals become critically important for battery production.  Bill Gates is involved in a startup to use AI to find these metals.
• The electric vehicle market in China is growing rapidly, with numerous firms trying to compete.  Beijing has decided to implement some control in this industry to better marshal resources.
• Remember leaded gasoline?  The last nation on earth that used it, Algeria, has finally exhausted its supply, meaning that the entire world now uses unleaded gasoline.

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

After reaching $62 per barrel support, prices have snapped back and are consolidating around $68 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 7.2 mb compared to the 2.5 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.5 mbpd.  Exports rose 0.2 mbpd, while imports were unchanged.  Refining activity fell 1.1%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are at the end of the summer withdrawal season.  Note that stocks are significantly below the usual seasonal trough.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 72.3 mb.  We expect the disruptions from Hurricane Ida (see below for updates) will affect this data in the coming weeks.

Based on our oil inventory/price model, fair value is $65.91; using the euro/price model, fair value is $61.96.  The combined model, a broader analysis of the oil price, generates a fair value of $63.78.  Continued dollar strength is weighing on oil prices; the decline in inventory, on the other hand, is a bullish factor.

Ida

Hurricane Ida followed a path similar to Hurricane Katrina.  Power outages have been widespread, and the oil and gas industry is still trying to determine the level of damage.  For the next few weeks, we will be tracking the impact of Ida on the oil and gas market, using Katrina as a baseline comparison.

(Source:  DOE, CIM)

This chart indexes the level of inventory for the week after the two hurricanes struck.  Since they hit at the same time of year 16 years apart, we can easily track the impact.  Katrina led to a 5% decline in stockpiles, and inventory wasn’t replenished until late October.

 Market news:

• Widespread drought in the West has curtailed hydroelectric power.   As water levels decline, dam managers can struggle to keep the turbines spinning.
• As oil prices rise, the Biden administration is taking the tack that industry concentration is the reason for high oil prices.  The oil industry has always had some degree of concentration; after all, the government did break up Standard Oil.  But it is a hard case to make that industry concentration, rather than environmental policy, better explains the lack of supply response to high prices.
• Earlier this summer, OPEC+ agreed to production increases.  Kuwait has recently argued that the decline in demand caused by the Delta variant may require the suspension of that earlier agreement.  The cartel, which met today, agreed to its earlier policy of expanding production.  We note they ignored calls from the U.S. to lift output in a bid to reduce oil prices.

Geopolitical news:

• Although Afghanistan is not a major oil producer, the withdrawal of U.S. and NATO troops will destabilize the region and might affect other oil producers nearby.  At the same time, Iran, which is under sanction, now has a customer for its oil that isn’t sanction’s sensitive.
• Last weekend, at a regional summit held in Iraq, senior officials from the KSA and Iran attended the meeting.  They met directly for the first time in five years, at least officially.

 Alternative energy/policy news:

• The drought and hot weather in the West and Hurricane Ida have all raised worries about climate change, bringing a rising frequency of extreme weather events.  Current forecast models support this idea, but the effects may be longer term in nature.  At the same time, recent studies confirm a pattern we have noted in the past; bad economic periods tend to reduce environmental concerns.
• China has been moving to expand its electric vehicle industry with the goal of being a world leader in this area.
• The pipeline industry, which has faced pressure from environmentalists on new construction, is pressing to be part of carbon capture and storage systems, which should support additional construction.

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