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

After reaching $62 per barrel support, prices have snapped back.

(Source: Barchart.com)

Crude oil inventories fell 3.0 mb compared to the 2.0 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production was steady at 11.4 mbpd.  Exports fell 0.6 mbpd, while imports declined 0.2 mbpd.  Refining activity rose 0.2%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are significantly below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 67.7 mb.  Since early July, inventory levels have stabilized.  As the chart indicates, seasonal inventory stabilization usually occurs in September, and with stabilization, the seasonal deficit has narrowed compared to earlier in the summer.

Based on our oil inventory/price model, fair value is $63.65; using the euro/price model, fair value is $61.75.  The combined model, a broader analysis of the oil price, generates a fair value of $62.43.  Continued dollar strength is weighing on oil prices.

 Market news:

• As large oil companies and developers face pressure to divest oil and gas assets, they often sell them to smaller firms.  Environmental activists are increasingly opposing such sales.  Environmentalists really want to see the projects shut down, but as long as the projects have value, sales are more likely to occur and pass to firms with fewer resources to make the projects less damaging.
• Although the Biden administration is considered hostile to the oil and gas industry, the DOE has signaled it would support LNG exports.
• A federal judge has blocked Alaska oil permits on the North Slope, arguing that environmental impact studies were inadequate.
• The lack of pipeline capacity may eventually crimp natural gas production in Appalachia.
• There is a constant tension between farmers and refiners concerning biofuel blending.  The EPA has recently sided with refiners on blending mandates.
• A major fire on a PEMEX offshore oil platform led to five fatalities and has cut production by 420 kbpd.  It is not clear when production will resume.

Geopolitical news:

• The world’s attention has been focused on the crisis in Afghanistan, but the U.S. is also planning to withdraw combat forces from Iraq.  The Kurds could be at risk, as both Iran and Turkey want to prevent moves toward a Kurdish state.  Turkey has been taking aggressive actions against Kurdish groups they deem as terrorist organizations.
• As the Taliban gains control of Afghanistan, Iran is facing a series of potential problems.  The Taliban is a Sunni group, and Shiites in Afghanistan may be at risk; if they are, the logical place to flee would be Iran.  Iran has established refugee camps along its border with Afghanistan.  As the West freezes accounts and denies the Taliban government aid, it is likely the new government in Kabul will turn to opium, which raises the risk of trafficking and addiction in Iran.
• EU carbon taxes may be worse for Russia than sanctions, according to Igor Sechin, the head of Rosneft (OJSCY, USD, 6.23).

 Alternative energy/policy news:

• As we approach the end of fossil fuels, research is being conducted on all sorts of alternative energies.  Perhaps the “holy grail” of electricity production would be fusion reactors.  These reactors would not create the byproducts associated with nuclear fission or the runaway reactions.  It is still a challenging technology.  However, if the issues are resolved, it might resolve much of the climate problem.
• Although wind turbines are cropping up across the country, the firms involved continue to struggle to achieve consistent profits.
• A common criticism of solar power is that it needs subsidies to work.  However, Georgia (the state, not the country) is seeing a flourishing expansion of solar power without subsidies.
• The U.S. Treasury has issued new guidelines to multilateral development banks on fossil fuel projects.  The bottom line is that all coal projects and most oil projects won’t get funding.
• One factor that could push more aggressive development of clean energy is a growing realization that climate change isn’t just increasing global temperatures; it appears to be leading to a wider variety of weather events.  Recent temperature peaks in various parts of the world have increased awareness.
• The EU is considering investing in rare earth magnet production.

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

Oil prices remain under pressure as concerns over the Delta virus and seasonal factors press prices lower.

(Source: Barchart.com)

Crude oil inventories fell 3.2 mb compared to the 1.5 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.4 mbpd.  Exports rose 0.8 mbpd, while imports were unchanged.  Refining activity rose 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 69.0 mb.  Since early July, inventory levels have stabilized.  As the chart indicates, seasonal inventory stabilization usually occurs in September, so if this pattern continues, the seasonal deficit should narrow.

Based on our oil inventory/price model, fair value is $62.67; using the euro/price model, fair value is $62.09.  The combined model, a broader analysis of the oil price, generates a fair value of $62.09.  Continued dollar strength is weighing on oil prices.

Market news:

• Oil prices have come under pressure due to the impact of the Delta variant.  This variant is leading to limited lockdowns in parts of the world and raising fears of weakening oil demand.  Complicating matters are calls from the administration for OPEC+ to raise output.  The fear of weakening demand coupled with higher potential supply is bearish for crude oil.
• Although environmentalists would like to reduce coal usage, strong natural gas prices are fostering more coal-burning for electricity production.
• Although Alberta’s oil production hit a record, the future of tar sands looks bleak.

Geopolitical news:

• The new Iranian administration has named a hardliner to the position of foreign minister.  Hossein Amirabdollahian is said to be very close to the Quds Force of the Iranian Revolutionary Guard Corps.  His appointment further dims the likelihood of a resumption of the nuclear deal with Iran.
• Iran’s new president is weighing on whether to enter into talks with Saudi Arabia.
• A private group is said to be the source of a major hack of Iran’s railway system.

 Alternative energy/policy news:

• Although fracking and some onshore oil projects can be based on short-term outlooks for oil, deepwater projects take years to develop and need years of demand to justify.  We may be seeing the last Gulf of Mexico project, with nations projecting zero carbon emissions by 2050.
• Economists of all stripes generally agree that a key part of addressing climate change is establishing a proper price for carbon.  Once the cost of burning fossil fuels includes the cost of environmental harm, market incentives will encourage conservation and help pay for mitigation efforts.  Carbon capture is one technology that might allow for the continued use of hydrocarbons if the carbon can be stored and not allowed into the atmosphere.  However, without a realistic price, it’s hard to justify the cost of such projects.  The EU has a carbon market, and prices are reaching a point where investing in carbon capture projects is starting to look feasible.
• As we have noted, although electric vehicles remain the most likely replacement for cars and light trucks, large trucks and buses may use hydrogen instead.  Delivering hydrogen may be too difficult for retail use, but in concentrated depots, it might work well.  We are starting to see some cities experiment with hydrogen buses.
  • MIT is experimenting with a process that can generate hydrogen from scrap aluminum.
• Poland, a heavy coal user, is strongly considering moving to nuclear power.

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

After last week’s recovery, selling has resumed; this week’s data and fears of weaker demand due to COVID-19 are pressuring prices.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 3.6 mb compared to the 3.2 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production was steady at 11.2 mbpd.  Exports fell 0.6 mbpd while imports fell 0.1 mb.  Refining activity rose 0.2%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 69.7 mb.  Since early July, inventory levels have stabilized; as the chart indicates, seasonal inventory stabilization usually occurs in September, so if this pattern continues, the seasonal deficit should narrow.

Based on our oil inventory/price model, fair value is $61.46; using the euro/price model, fair value is $62.98.  The combined model, a broader analysis of the oil price, generates a fair value of $61.92.  The weaker EUR has started to affect the model forecast, putting all the models’ fair value calculations well below the current price.

Market news:

• Environmental policy generally finds support among voters until the inevitable increase in fossil fuel prices result. As the financial system provides less investment capital to the fossil fuel industry and the economy recovers, energy prices rise.  In fact, higher prices are likely a necessary component to encourage consumers to invest in energy conservation.  But higher energy prices are seldom popular, and as they rise, it makes implementing climate change policy challenging.
  • Spain is pushing back against EU climate policy as electricity prices surge and consumers complain.
  • The Biden administration is looking to increase fuel efficiency standards. Environmentalists are pushing for stricter standards, while the auto industry wants easier ones.

Geopolitical news:

• Over the weekend, an oil tanker, the MV Mercer Street, was attacked by drones, and two people were killed, a Briton and a Romanian.  Zodiac Maritime, an Israeli company, manages the vessel; it is owned by Taihei Kaiun (1968, JPY, 2723).  According to reports, the drones, which apparently carried explosive charges, crashed into the ship’s bridge, killing two crew members.  The U.S., U.K., and Israel have blamed Iran for the attack.  Tehran denies its involvement.  This attack has been part of a series of strikes between Iran and Israel.  We noted in June that Iran’s largest warship, the Kharg, caught fire and sank under suspicious circumstances.  Market reaction has been mostly nonexistent.  Oil prices are lower this morning on pandemic concerns.  However, an attack on oil shipping in the region around the Strait of Hormuz does raise the potential for a supply disruption.
• Following this event, suspected Iranian gunmen seized a tanker in the Persian Gulf.  Reports say the situation has been resolved, and the gunmen have left the ship, although details are still scarce.  Iran denies involvement, but there is some evidence that a group linked to Iran may have been involved.  Nations in the region are pushing for retaliation.
• These tensions coincide with President Raisi officially taking office today.  With the change in administration, there are growing doubts about a restoration of the 2015 nuclear deal.  The Biden administration has the goal of reinstituting the agreement, but Iran is less certain it wants to return to it.  Iran has been increasing its uranium processing and likely wants to maintain progress towards nuclear technology.  Another major issue is that the Iran nuclear deal was not a treaty.  Opposition in Congress meant that the measure could not pass through the legislature, so, and this occurred with the Trump administration, a new president could pull out of the agreement again.  Grand Ayatollah Khamenei wants guarantees that the U.S. won’t pull out again, but the structure of the agreement cannot provide that assurance.  It appears that Raisi’s plan is to focus on four areas—sanctions and other restrictions lifted, guarantees of irreversibility, normalization of trade, and the ability of Iran to verify sanctions are no longer in force.  We view these as non-starters; for instance, the U.S. is planning sanctions against Iran’s drones and guided missiles, meaning that some form of sanctions will always be in place.  Irreversibility can’t be offered either.  So, overall, we doubt the nuclear deal will return.
• There is one factor to watch.  Iran engaged in what was called “strategic patience” during the Trump years, limiting retaliation to avoid a stronger response from the U.S.  With Trump out of office, Iran appears to be escalating its activities in the region, apparently because it assumes a more measured response from Washington.  With the U.S. wanting to reduce its involvement in the Middle East to focus on China, Iran may see it as an opportunity not just to retaliate against earlier provocations but to expand its area of influence.
• Iran is facing a serious water problem caused by the lack of rainfall, mismanagement, and an attempt to become food independent.
• Iran is also facing electricity instability, with blackouts raising social tensions.
• As the world electrifies, the need for strategic metals is rising.  China has been making large investments in Africa.  It is now seeing pushback from African nations unhappy with Beijing’s behavior in the region.
• China has made major investments in the U.K. nuclear power industry.  The Johnson government is having second thoughts about that decision.  Investor reluctance to join a project with Chinese involvement has played a role, so have concerns about security given China’s involvement.
• Qatar is considering an investment in submarines.  It is negotiating with Italy to purchase the vessels.  If Qatar acquires submarines, it adds to concerns about an arms race in the region.

Alternative energy/policy news:

• The SEC is looking to force companies to make additional climate disclosures.  Firms are concerned that doing so will expose them to litigation and are, thus, trying to dilute the proposal.  Pressure to do so is coming from fossil fuel companies.
• One issue that new forms of energy discover is that often the process of developing cleaner forms of energy is, at least initially, also dirty.  The building of solar panels in China requires coal-fired electricity, for example.  The transition creates geopolitical issues as well.  China, for instance, processes two-thirds of the world’s lithium, a key metal in batteries.  The U.S. needs to build that capacity, but it won’t be clean.
• The U.S. applied tariffs on solar panels coming from China.  The tariffs did help lift domestic production but imports still represent about 85% of U.S. installations.  Domestic companies are lobbying for the tariffs, due to expire, to be extended.
• Battery companies are exploring other elements in battery production.  Last week, we reported that iron was being tested for utility batteries.  Sodium is being considered for EVs.  Recycling batteries is also becoming an issue.
• Hydrogen can travel through the existing pipeline network.

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

After last week’s selling, prices have recovered back above $70 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 4.1 mb compared to the 2.1 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production fell 0.2 mbpd at 11.2 mbpd.  Exports were unchanged while imports fell 0.6 mb.  Refining activity fell 0.3%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 79.0 mb.  At present, inventories have started to stabilize after falling quickly since March.

Based on our oil inventory/price model, fair value is $62.91; using the euro/price model, fair value is $72.29.  The combined model, a broader analysis of the oil price, generates a fair value of $62.51.  Oil prices are now in line with oil inventories but undervalued compared to the dollar.

Market news:

• As electricity demand rises along with natural gas prices, coal demand and prices have risen as well. Although coal has been under pressure for some time, the economic recovery is lifting electricity production, and high natural gas prices make coal an attractive alternative.
• China uses import quotas for crude oil, but these are often manipulated to permit firms to import more than their quotas allow. Beijing is cracking down on the practice, which may lead to a drop in imports.
• As U.S. production improves, oil service companies are seeing better performance. Meanwhile, shale drillers are merging, leading to industry consolidation.

 Geopolitical news:

• On August 5, Ebrahim Raisi will take over the Iranian presidency.  Although the U.S. is continuing to press for a return to the 2015 nuclear agreement, the odds of that occurring may be less under the new president.  Raisi will also inherit continued unrest in Khuzestan province.  Given Raisi’s history, we would expect a harsh crackdown on the protests.
• There is some evidence to suggest that the KSA had a role in the purported coup attempt in Jordan.  The idea is that Riyadh wanted Jordan to approve the Trump-era Israeli/Palestinian peace plan, and King Abdullah opposed it. In the wake of the tensions, both sides appear to be reestablishing relations.
• Hackers demand $50 million from Saudi Aramco (2222, SAR, 34.90) over data it took from the company.
• The U.S. will end combat missions in Iraq; a small contingent of troops will remain for training purposes.

 Alternative energy/policy news:

• Electrification has created a pressing need for improved battery technology.  Lithium-ion batteries are commonly used because they hold a high level of energy relative to their weight.  The lead-acid batteries used in cars that have internal combustion engines, for example, are too heavy for standalone auto use.  However, for some uses, such as backup power for electric utilities, lithium-ion batteries are too expensive to be an economic alternative.  A number of firms are unveiling new battery technology that uses iron and air to hold power.  Iron is significantly cheaper than the metals used in lithium-ion batteries; although the weight precludes their use in transportation, for stationary backup power, iron is perfectly suitable.  If this technology lowers costs, it will make the combination of wind/solar and batteries a viable alternative to coal and natural gas-fired turbines.
• Another emerging battery technology uses molten salt, although it is probably not evolving as quickly as the aforementioned iron-air batteries.
• China is working on a commercially viable thorium nuclear reactor.  Such a reactor would not generate the nuclear waste that current reactors produce.
• As the world warms, the need for air conditioning will rise.  The concern is that air conditioning requires electricity, and if the “juice” comes from fossil fuels, using air conditioning will compound the problem caused by greenhouse gases.  However, even if that hurdle is overcome by using renewables or nuclear, air conditioning refrigerants can also be potent greenhouse gases.  A new process would not only eliminate the current refrigerants but also be more efficient.

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

The OPEC+ agreement led to a deep selloff in oil prices, but the decline has attracted new buyers.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 2.1 mb compared to the 4.5 mb draw forecast.  The SPR was unchanged this week.

In the details, U.S. crude oil production was unchanged at 11.4 mbpd.  Exports declined 1.6 mbpd, while imports rose 0.9 mb.  Refining activity fell 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 550 mb.  Our seasonal deficit is 79.6 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $61.31; using the euro/price model, fair value is $63.07.  The combined model, a broader analysis of the oil price, generates a fair value of $61.89.  Even with this week’s pullback, oil prices are well above fair value for all the models.  The ability for oil to maintain current levels is dependent on sentiment towards OPEC and issues surrounding the pandemic.

Market news:

• OPEC+ made it official this week; starting next month, it will increase production quotas by 0.4 mbpd each month into next year. Although this news already was signaled, as we note in the opening chart, oil prices slumped on the news.  The fear is that the cartel is adding supplies to the market while it is being adversely affected by the Delta variant of COVID-19.  Based on our modeling work, the market has been overvalued, so a pullback isn’t a complete surprise, and using the production news created a narrative for longs to take profits.  Supplies will remain relatively tight, and we don’t expect prices to fall too much from here.
• Financial firms are increasing the financing for the oil and gas industry, but the firms are not using the loans for drilling. They are focusing on balance sheet repair.  This behavior isn’t surprising given the likely path of future demand.

Geopolitical news:

• Although the Biden administration wants to revive the 2015 nuclear deal with Iran, Tehran is making it just about politically impossible to bring this about.
  • In an audacious move, Iranian operatives plotted the abduction of Masih Alinejad, a journalist living in New York.  Alinejad, an Iranian, has been critical of the Iranian regime.  Four Iranians were charged with conspiracy in the incident.  Iran has a long history of luring dissidents back to Iran for arrest, but it is rare that they would try such a scheme in the U.S.
  • Iran has continued to violate the provisions of the nuclear deal, expanding its work in nuclear technology that could eventually allow it to build a weapon.  It is hard to see how that progress would be reversed if there was a return to the earlier arrangement.
  • If the plan to return to the 2015 nuclear deal fails, Iranian sanctions will likely remain in place.  Although some Iranian oil is getting to market, it is usually at a deeply discounted price.  So, the lack of an agreement is modestly bullish for crude oil prices.
• Iran is suffering through a bout of COVID-19 infections caused by the Delta variant.  The government has implemented a lockdown on Tehran as the Eid holiday approaches.
• Although much of Iran is ethnically Persian, the Azeris, who are Arab, also live in the country.  They tend to congregate in Khuzestan province.  Drought has struck this region, which is not only an oil-producing area but has an agricultural industry as well.  Divisions over water rights have triggered protests which have killed at least four people.
• Iran has been suffering through a series of blackouts.  Although the industry appears to have ample generating capacity, mispricing, the lack of maintenance, and the insistence on exports have led to outages, increasing dissatisfaction with the regime.
• Morocco has claimed Western Sahara as its own.  Those living in the latter region have been pressing for independence.  It is an ongoing situation that we discuss in a recent pair of WGRs.  The European Court of Justice is preparing a ruling on whether a rebel group in Western Sahara, the Polisario Front, is the legitimate representative of Western Sahara.  If it is, Morocco will be upset and may retaliate by cutting off natural gas pipelines to Europe.
• Relations between the KSA and Turkey deteriorated over the murder of Jamal Khashoggi, Turkey’s support of Qatar, and Turkey’s support of the Muslim Brotherhood.  Despite these differences, it appears the two nations are trying to improve relations. We suspect Turkey wants to align itself with the Arab states in opposing Iranian expansionism.
• The recent hack of the Colonial Pipeline was a major news event.  However, such activity has been going on for some time.  The U.S. admitted that Chinese hackers had penetrated several U.S. pipelines over a decade ago.

Alternative energy/policy news:

• Much to the chagrin of its trading partners, the EU is proceeding on a carbon border adjustment tax.  As we noted last week, the tax is part of a broader initiative to reduce greenhouse gases.  To some extent, this policy is an attempt by Europe to remain relevant in the world.  The EU no longer projects military power, and its economic growth has been modest for years.  But by expanding regulation, it is forcing nations who want to trade with the EU to adopt its rules.
  • The countries most affected by the new rules will be Russia, Turkey, and China.  However, the U.K. will be as well.  The U.S. is surprisingly far down the list.  Needless to say, those adversely affected are crying foul and may take their case to the WTO.
  • One area that could affect the U.S. is LNG exports.  EU rules are cracking down on methane leaks and areas that would force U.S. producers to take steps to reduce these leaks.
  • The U.S. is also looking at similar policies.
• The oil and gas industry continues to work on carbon capture to reduce its emissions of greenhouse gasses.  One area of interest is the use of CO₂ in enhanced oil recovery.  The gas is injected into producing wells to increase oil output.  Currently, CO₂ for this process is sourced from natural CO₂ wells; the goal of the industry is to capture the carbon from the drilling process or directly from the atmosphere.  In that way, a closed loop is created that makes oil and gas carbon neutral.
  • Chevron (CVX, USD, 99.98) is working on such a project in Australia, but so far, the results have been disappointing.
  • Exxon (XOM, USD, 58.16) and Royal Dutch Shell (RDS.A, USD, 38.60) have agreed to join a carbon capture and storage project in Scotland.
• Although batteries continue to be the leading technology for automobiles, trucks and planes may end up using hydrogen as their primary alternative fuel.
• Politicians often promote industrial jobs as a way to improve the lot of semiskilled labor.  However, this nostalgia tends to overlook the fact that these jobs were not always considered “good” jobs.  The pay was poor, and the work was brutal.  It was a series of policy decisions that made job conditions improve.  These included trade and immigration barriers that allowed for unions to flourish.  However, over time, industrial firms increased productivity, automated facilities in the developed world, and labor-intensive parts were moved offshore.  We note that there is much political discussion about good “green” jobs; the reality is that, at this point, such jobs are low-skilled and don’t pay well.  In addition, the jobs they are replacing in the energy sector tend to pay better.  It will take policy decisions to change this factor, and since green energy is mostly a technology industry, it will be a policy battle of notable proportion.
• Bill Gates is funding a major effort to build small modular nuclear power facilities.

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

Prices appear to be consolidating between $72 to $76 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 7.9 mb compared to the 4.4 mb draw expected.  The SPR was unchanged this week.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.4 mbpd.  Exports rose 1.4 mbpd, while imports rose 0.3 mb.  Refining activity fell 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 553 mb.  Our seasonal deficit is 81.7 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $61.99; using the euro/price model, fair value is $63.36.  The combined model, a broader analysis of the oil price, generates a fair value of $62.42.  Oil prices are well above fair value for all the models.  The ability for oil to maintain current levels is dependent on sentiment towards OPEC, although the continued decline in oil stockpiles is improving the valuation gap.

Market news:

• One reason capitalism has triumphed over communism is that, due to the profit motive and the ability to tolerate disruption, capitalist economies tend to use commodities with ever-increasing efficiency. In other words, capitalism tends to generate greater output with less input over time.  Communism, at least as it was practiced by the Soviets, tended toward high levels of commodity intensity.  In the 1970s, rising oil prices, coupled with tighter monetary policy to counteract inflation, led to two deep recessions, one in 1973-75 and another in the early 1980s.  In 1980, the U.S. needed 5,000 BTUs[1] of petroleum to make $1 of GDP; now that is down to around 1,700.[2]  Simply put, rising oil prices are not yet a threat to economic growth.
• Although we are seeing a slow rise in U.S. oil production, we are still well below previous peaks. A change in oil company behavior is an important element of this slower production growth.  In the past, companies would tend to maximize production rather than profits.  That is no longer the case.
• As oil prices rise, speculators are increasingly taking bullish positions on oil.
• Qatar is poised to expand its LNG production by 63% over the next decade.

Geopolitical news:

• OPEC+ and the UAE have reached an agreement.  The emirate wanted its baseline production, which would set its quota, to be increased by 0.6 mbpd.  After extended negotiations, the UAE agreed to a baseline increase of 3.9 mbpd.  Oil prices retreated on the news.  The cartel is expected to gradually increase output into next year, which may act to cap prices.  The IEA has warned OPEC that without production increases, oil prices might rise enough to adversely affect global growth.
• The G-20 endorsed carbon pricing as a way to address climate change.  The EU has detailed an expanded plan to reduce carbon output.  It is broad-based, including a carbon pricing scheme and a carbon border adjustment plan.  Basic material and ag mineral industries could be hard hit by the measures.  The plan affects households as well.  It is still unclear whether the plan will be adopted.
  • China is also launching its own emissions trading platform, which would be the world’s largest.
• U.S. negotiators are beginning to fear they will not be able to reach an agreement with Iran on reviving the Obama-era nuclear deal.
• Tehran is pleased to see the U.S. withdraw from Afghanistan, although it is also worried that increasing unrest could spill into Iran.  The Taliban is Sunni and has tended to oppose Shiites.  Iran’s new president, Ebrahim Raisi, recently met with India’s minister of external affairs to discuss the situation in Afghanistan.
• There is some evidence that Russia is pleased with Iran’s new president, as President Putin was unusually quick to contact Raisi after his recent win.  Overall, Russia/Iranian relations have improved over the past decade; meetings with the Rouhani government and Russian officials were frequent.  However, Moscow was probably a bit concerned that relations with the U.S. would improve, and Russia generally prefers American isolation in the Middle East.
• There are reports that Iran was recently hit with a series of cyberattacks.
• The KSA has continued to limit the number of pilgrims coming to Mecca due to COVID-19 concerns.

Alternative energy/policy news:

• The annual BP (BP, USD, 25.43) report on energy showed that wind and solar capacity rose at their fastest pace on record.  China’s capacity growth was the world’s largest.
• There is a growing battle between centralized and distributed electricity.  Large utilities want to build long transmission lines from the central part of the U.S., which is rich in wind power, to bring this electricity to urban areas.  Other activists want to acquire funding to buy rooftop solar panels to foster local power.  If the former wins out, utilities will still control the flow of electricity; if the latter wins, the power of utilities will be weakened.
• The China National Nuclear Corporation broke ground on the world’s first small nuclear reactor.  The Chinese hope this modular reactor will become a model for the more widespread development of nuclear power, which does not emit greenhouse gases.
• Thawing permafrost is threatening the Alaska pipeline.

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[1] Which is 0.4 gallons of crude oil, or four cups and 3 ounces.

[2] Roughly 13 ounces.

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

After rising above $76 per barrel on news of the OPEC+ impasse (see below) prices have corrected modestly.

(Source: Barchart.com)

Crude oil inventories fell 6.9 mb compared to the 4.0 mb draw expected.  The SPR fell 1.2 mb, meaning without the addition from the reserve, commercial inventories would have declined 8.0 mb.  We note the SPR is at its lowest level since October 2003.

In the details, U.S. crude oil production was unchanged at 11.1 mbpd.  Exports rose 0.1 mbpd, while imports fell 0.5 mb.  Refining activity rose 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are already below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 553 mb.  Our seasonal deficit is 77.1 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $59.48; using the euro/price model, fair value is $63.41.  The combined model, a broader analysis of the oil price, generates a fair value of $61.09.  Oil prices are well above fair value for all the models.  The ability of oil to maintain current levels is dependent on sentiment towards OPEC.

Rising gasoline prices can be a political problem for the White House.  However, the key isn’t just the rise in prices but the relationships to income.  Clearly, consumers prefer lower prices to higher prices, but the combination of high prices and low wage growth creates a much more serious problem.  One way we try to measure this relationship is to divide the current wage for non-supervisory workers into the national average gasoline prices.  This calculation measures how many gallons of gasoline an average worker can purchase from working one hour.

Currently, a worker can buy just over eight gallons at the average hourly wage.  The average since the mid-1960s is 8.6 gallons, so the current level is probably not enough to cause political turmoil.

Market news:

• Alaskan crude oil production is steadily declining, which will support higher prices over time.
• A Greenpeace activist was able to capture video comments from an Exxon (XOM, USD, 61.37) lobbyist that revealed some of the activities the company supported in Congress. The report put the company in a bad light and has triggered apologies.
• Propane prices are soaring. It is unusual for this time of year, as demand is seasonally weak in the summer.  If supplies remain tight, it could boost crop drying costs (farmers often use propane to dry their crops before storing them in silos) and may become a crisis by winter, when rural households use the fuel for home heating.  What’s behind the rise?  Propane is a byproduct of oil refining and natural gas processing.  When production rose with the shale revolution, the propane market became oversupplied, leading the industry to build export capacity.  Now, nearly 70% of U.S. production is exported.  To reduce exports, domestic prices must exceed foreign prices.
• As natural gas prices rise, coal demand is making a comeback.

Geopolitical news:

• The failed OPEC+ meeting dominated the news earlier this week.  The cartel failed to agree on a plan to increase oil production gradually.  The sticking point is that the UAE wanted a higher baseline of production; since the country has increased its productive capacity, this would mean a larger market share compared to the other members.  Opening up capacity discussions is fraught with risks.  Several nations have seen capacity fall, such as Venezuela and Libya, and their having higher quotas means that larger producers can fill the gap.  Interestingly enough, the news sent prices higher, at least initially.  In the past, a failure to make a new production agreement usually raised fears of higher output, leading to falling prices.  The UAE seems content to maintain the current agreement going into April 2022, which means the failure will lead to steady production levels.  So far, non-OPEC producers have shown little interest in increasing output. As we have detailed in earlier reports, the investing climate has turned hostile towards oil and gas, so OPEC+ is gaining market power.  At the same time, higher prices will spur conservation and lead to lower demand growth.
  • The increase in tensions between the UAE and the KSA is something new.  The two kingdoms have been traditional allies but the UAE’s demand for what is effectively a quota increase is threatening the KSA’s plan to keep oil prices elevated.
  • Interestingly enough, there is some evidence of a thaw between the KSA and Qatar, which may be due to the aforementioned issues with the UAE.
  • So far, high prices are not triggering a rapid increase in U.S. production.  Policy and ESG concerns are limiting investment to boost drilling.  However, another factor is that firms that hedged future production locked in a price lower than the current one, meaning that the signal of higher prices isn’t working, and it won’t until these hedges expire.
• As we noted last week, Russia has been restricting flows of natural gas to the EU, sending prices higher.  It appears the restrictions are affecting gas that transports across Ukraine; the Russians are apparently using the ploy to speed up the Nord Stream 2 project.
• Iran announced it is making uranium metals, bringing Tehran a step closer to materials required for an atomic weapon.
• Hossein Taeb, head of the Iranian Revolutionary Guard Corps intelligence wing, made his first visit to Iraq this week.  He is said to have met with various groups supported by Iran.

Alternative energy/policy news:

• The EU tends to favor biomass to energy as a way of meeting carbon goals.  Apparently, bureaucrats in Brussels are having second thoughts about the process and could implement restrictions on the practice.  If implemented, it will make achieving carbon goals more difficult.
• The EU is also working on a carbon border tax that would effectively raise the price of goods produced under conditions of weaker environmental rules.  However, it appears that the longer the measure is negotiated, the less onerous it becomes for importers.
• The direct carbon capture industry is attracting investment capital.

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

Oil prices are moving steadily higher although momentum is starting to slow.

(Source: Barchart.com)

Crude oil inventories fell 6.7 mb compared to the 4.0 mb draw expected.  The SPR fell 1.4 mb, meaning without the addition from the reserve, commercial inventories would have declined 8.1 mb.  We note the SPR is at its lowest level since October 2003.

In the details, U.S. crude oil production was unchanged at 11.1 mbpd.  Exports rose 0.1 mbpd, while imports fell 0.5 mb.  Refining activity rose 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are already below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 465 mb.  Our seasonal deficit is 75.1 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $57.17; using the euro/price model, fair value is $67.63.  The combined model, a broader analysis of the oil price, generates a fair value of $62.15.  Oil prices are still “rich” relative to inventory levels.  Recent dollar strength caused by uncertainty surrounding Fed policy has also reduced the dollar model’s fair value.

Market news:

• The Dallas FRB produces quarterly surveys of oil and gas activity in its district. The report suggests that production and investment are recovering.  At the same time, the survey indicates costs are rising as well.  So far, we have only seen a modest rise in production.  Some of this is due to concerns about future regulation.  The shale industry, in particular, is trying to shed its reputation as a capital consumer.  Thus, the previous pattern of rapid output increases does not appear to be occurring this time around…so far.
• The Supreme Court has backed refiners in their disputes over biofuel waivers. The renewable fuel standards mandated the required amounts of biofuels to be used, assuming steady growth in demand.  However, after the Great Financial Crisis, demand growth fell, and the only way to meet the standard was to move beyond the 10% “blend wall.”  The courts have pushed back against the mandated level of usage.
• This report examines the idea that we may be at peak oil consumption.

Geopolitical news:

• Libya has been in a civil war since 2014.  The situation became volatile in the wake of the ouster of Gaddafi in 2011.  Libya has a natural east/west division that has been exhibited during this ongoing conflict.  Outside nations are also involved.  Russia, Egypt, the KSA, and the UAE supported the Libyan National Army, led by Khalifa Haftar, which operated in the east.  Meanwhile, Turkey supported the Government of National Accord, which controlled the West.  In March, the two sides created a national unity government.  There are peace talks underway in Berlin to try to end the conflict.  Libya once produced almost 2.0 mbpd of crude oil.  Since the conflict, it typically generates 0.5 mbpd.  If the conflict is resolved, we could eventually see increased output.
• Iran has a new president, Ebrahim Raisi.  Nuclear deal talks continue, but rising tensions between the U.S. and Iran are complicating the discussions.
  • We also note new reports of sabotage of Iran’s nuclear industry.
• Russia has reduced natural gas supplied to Europe, driving prices higher.  It appears the decision to reduce supplies is politically motivated.

Alternative energy/policy news:

1. We have often discussed how climate activists have targeted pipelines ultimately to reduce the availability of fossil fuels.  Such actions are controversial; pipelines move oil and products with less environmental impact compared to trains and trucks.  The goal of activists is to reduce consumption, so if a pipeline disruption is resolved by trucks or trains, it makes conditions worse.  After the initial support from the Biden administration in halting the Keystone XL pipeline, the White House has become less active, disappointing environmentalists.  There is a political risk from rising gasoline prices, and we suspect the administration is trying to avoid voter dissatisfaction from higher energy prices while maintaining some level of creditability with environmentalists.

• Last week, we discussed ideas about placing sails on ocean-going vessels to reduce carbon consumption.  This report expands on that notion.
• A groundbreaking nuclear power plant, which uses molten salt instead of water, is being constructed in Wyoming.  It is replacing a coal plant.  Such plants have interesting features, including the ability to create intermittent power, unlike traditional nuclear reactors, which provide baseload power.  These reactors have the promise of being cheaper and safer and may provide a way to provide reliable carbon-free electricity.
• Renewable diesel, a plant-based product, has the potential to be a better replacement than biodiesel, which has suffered from poor performance in cold weather.  This new product is refined from the same feedstocks as biodiesel, but since it is refined much like crude oil, it has properties similar to fossil diesel.
• Direct carbon capture from the atmosphere remains the great hope of reducing CO₂.  This report is an update on progress.
• The Senate has passed a measure (S.1251) that would give farmers and foresters the ability to sell carbon credits for the CO₂ their activities capture.  The fact the bill passed overwhelmingly (92-8) shows that it is still good politics to be seen as farm friendly.  However, the actual execution of such policies is complicated.

The U.S. has moved to ban some solar products produced in Xinjiang.

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

Oil prices are moving steadily higher in an orderly fashion.

(Source: Barchart.com)

Crude oil inventories fell 7.6 mb compared to the 3.5 mb draw expected.  The SPR fell 1.7 mb, meaning without the addition from the reserve, commercial inventories would have declined 9.3 mb.  We note the SPR is at its lowest level since October 2003.

In the details, U.S. crude oil production fell 0.2 mbpd to 11.0 mbpd.  Exports fell 0.2 mbpd, while imports rose 0.2 mb.  Refining activity fell 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are beginning the summer withdrawal season.  Note that stocks are already below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 465 mb.  Our seasonal deficit is 72.2 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $55.05; using the euro/price model, fair value is $68.47.  The combined model, a broader analysis of the oil price, generates a fair value of $61.47.  Oil prices are still “rich” relative to inventory levels; recent dollar strength caused by uncertainty surrounding Fed policy has also reduced the dollar model’s fair value.

Although the economy is reopening, gasoline demand does not reflect any sort of “pent-up” demand.  Consumption is running in line with the five-year average.

Market news:

• It is well known that China dominates rare earths. As relations deteriorate, western nations are looking to rebuild rare earth mining and processing.  However, China didn’t achieve its current status because such activities are not possible elsewhere; China was willing to accept the environmental costs associated with the industry when the West was not.  Now, as the West tries to diversify its sources of these critical metals, it must decide where the burden of the environmental costs will fall.
• The SEC is pressing firms to make environmental risk disclosures. Businesses are pushing back.
• The natural gas market has been tightening, and prices have been rising as a consequence. As natural gas prices lift, coal demand has been increasing.
• A recent study by the San Francisco FRB suggests firms begin to factor in environmental changes even before regulations or laws change. Although regulations tend to change from administration to administration, firms must make investment decisions based on some sort of future equilibrium.  This report shows that they do.

Geopolitical news:

• The U.S. has started withdrawing military resources from the Middle East.  Specifically, America is removing anti-missile systems and air assets.  We expect that the U.S. wants to focus less on this region so it can concentrate on the threat from China.
• As expected, Ebrahim Raisi won the recent presidential elections in Iran.  We do expect Iran and the U.S. to agree to return to the 2015 Iran nuclear deal, but little other progress is likely.  Raisi has indicated he won’t curtail missile development or stop supporting Iran’s proxies in the region.  And, he has no interest in meeting with President Biden (and we can’t imagine Biden would want to meet with him either).
  • Meanwhile, the U.S. has closed websites tied to Iran that they accused of spreading disinformation.

Alternative energy/policy news:

• The shift from fossil fuels is really about the electrification of the economy.  This report is a good roundup of the challenges.
• Through aggressive subsidies, China has come to dominate the solar panel industry.  First Solar (FSLR, USD, 79.84) is investing in a new U.S. panel factory, banking on support from Washington to make the project viable.
• Russia’s state-run atomic energy firm, Rosatom, is embarking on green energy projects.
• Renewable energy is being purchased aggressively by tech companies.
• Carbon sequestering is one way that fossil fuels can reduce their impact on climate change.  The most common use of CO₂ is through enhanced oil recovery, where the gas is injected into wells to boost their pressure and improve productivity.  With that method, the gas remains in the ground.  Unfortunately, most of the CO₂ currently used for this process comes from underground instead of from refining and drilling.  To change this, the oil industry would need to build a pipeline infrastructure.
• This report offers a primer on hydrogen.
• As the shipping industry looks to reduce its carbon footprint, ships are investigating an old propulsion system, sails.

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