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

Here is an updated crude oil price chart.  Prices are consolidating after the late November rally.

Commercial crude oil inventories unexpectedly jumped 15.2 mb when a 1.0 mb draw was expected.  The SPR fell 0.1 mb; there is still 3.1 mb of storage in excess of the 635.0 mb that existed before the pandemic.

In the details, U.S. crude oil production was unchanged at 11.1 mbpd.  Exports fell 1.6 mbpd, while imports rose 1.1 mbpd.  Refining activity rose 1.7%.  The unusual build appears to be a combination of rising imports and falling exports.

The above chart shows the annual seasonal pattern for crude oil inventories.  This week’s data shows the large rise in crude oil stockpiles, which is clearly contraseasonal.  Inventories are past their second seasonal peak and usually decline into year’s end.

Based on our oil inventory/price model, fair value is $39.28; using the euro/price model, fair value is $69.41.  The combined model, a broader analysis of the oil price, generates a fair value of $52.68.  The wide divergence continues between the EUR and oil inventory models.  This week’s jump in oil inventories led to a large decline in the oil model forecast, while the weaker dollar boosted the EUR model forecast.  Overall, the dollar probably has a greater impact on oil prices and thus should keep the market elevated despite the increase in supply.

The above chart shows refinery utilization.  Although run rates rose, they remain nearly 15 percentage points below average, reflecting weak demand.

In case you missed it, check out this interactive chart of U.S. energy consumption.  Starting in 1800, it shows the shift from biomass to fossil fuels.  It’s a chart you will want to keep.  And, here is a primer on Cushing, OK, the delivery point for the NYMEX oil futures contract, a little town in Oklahoma that is a web of pipelines and a sea of storage facilities.

In Middle East news, two Iraqi oil wells in the Khabbaz field in Kirkuk were set ablaze by explosions carried out by Islamic State.  Although the attack had only a modest effect on prices, Islamic State has been intensifying its efforts in this area, reflecting the lack of security in Iraq.   Although Kuwait has an ample sovereign wealth fund, the emirate is facing a cash crunch as weak oil prices have reduced revenue and the economic slowdown has increased spending.  Moody’s downgraded Kuwait’s debt in September over these concerns.

We have been documenting the decline in product demand due to the pandemic.  Although recessions tend to be bearish for energy demand in general, this one has led to a sharp decline in mobility and has crimped gasoline demand.  We are starting to see a ripple effect through the refining industry.  Refiners have struggled with margins for years and the drop in demand has led to the closure of some refining operations.  These closures have been especially pronounced in the West, where many of the facilities are small and old and thus more costly to operate.  In Asia, there has been an increase in refining capacity and it is likely that, in the future, the West will be importing product from Asia.

On the alternative energy front:

• A potential battery breakthrough could have a significant impact on the electrification of vehicles.  Although all are familiar with lithium batteries, the actual amount of lithium in these batteries is small because the metal is unstable.  In practical terms, it has a tendency to catch fire if charged too quickly.  This is why airlines are uncomfortable with lithium batteries in cargo holds.  Specifically, lithium creates spikes called dendrites.  Over time, these dendrites form on the anodes of a battery and can cause it to short circuit.  A company called QuantumScape (QS, USD, 70.47) claims to have solved the problem by creating a solid state lithium battery.  If true, it would dramatically shorten recharging times (it can reach an 80% recharge in 15 minutes), with more density and longer-lasting.  If this battery works as advertised and is affordable, it would be a significant leap and likely improve adoption of EVs.
• Oil majors are facing increasing pressure to decarbonize.  Shell (RDS.A USD, 37.46) had several clean energy executives leave over a disagreement on the pace of change at the company.  The company says it wants to be at “net zero” by 2050.  Meanwhile, Exxon (XOM, USD, 43.35) is facing pressure to replace board members with ones more amenable to climate mitigation.  We also note the company has been slow to roll out its carbon capture program.
• Tom Vilsack has been chosen for Ag secretary.  He has had that role before; one thing we will be watching for is growing interest among farmers to participate in carbon sequester.  It may be possible for CO₂ to be captured by cover crops, which would bring additional revenue to farmers.  We will be watching to see if Vilsack becomes a proponent of this idea.
• Toyota (TM, USD, 140.70) is planning a new set of EVs.  It is also offering its second generation of fuel cell vehicles.

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

Here is an updated crude oil price chart.  Positive news on a vaccine for COVID-19 led to a strong rally this week, taking prices to the upper end of the current trading range.

Commercial crude oil inventories fell 0.7 mb when a 1.7 mb draw was expected.  The SPR was unchanged; there is still 3.2 mb of storage in excess of the 635.0 mb that existed before the pandemic.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.1 mbpd.  Exports rose 0.6 mbpd, while imports rose 0.2 mbpd.  Refining activity fell -0.5%.

The above chart shows the annual seasonal pattern for crude oil inventories.  This week’s data showed crude oil stockpiles were steady, which is somewhat contraseasonal.  Inventories are past their second seasonal peak and usually decline into year’s end.

Based on our oil inventory/price model, fair value is $44.18; using the euro/price model, fair value is $63.55.  The combined model, a broader analysis of the oil price, generates a fair value of $52.78.  The wide divergence continues between the EUR and oil inventory models.  However, current oil prices are below all three measures of fair value, suggesting that oil prices are likely undervalued.  The most important support is dollar weakness.

The above chart shows weekly gasoline inventories. Beginning in early November, inventories begin their seasonal increase that lasts into early February.  We are clearly seeing the usual seasonal pattern develop, which means that gasoline inventories should continue to rise for the next several weeks.

At the time of this writing, OPEC+ had not reached a decision; talks are continuing.  The UAE has expanded its production capacity and would like to boost output.  Iraq, which needs the revenue, would like to as well.  Libyan production is recovering, adding to global supplies.

But the biggest problem facing OPEC+, and to some extent, all oil producers, is the issue of peak demand.  If actions taken to manage climate change lead to less oil consumption, then oil reserve owners face the problem of stranded assets.  If demand and prices are set to decline on a secular basis, then there is an incentive to produce now as the value of future oil will likely be less.  It is important to remember that the reason for the collapse in oil prices in April was due, in part, to a market share war within OPEC+.  Although it is difficult to parse out all the factors that played a role in the Saudis backing away from their policy of lifting market share (and, consequently, pushing down oil prices), there is a strong case to be made that President Trump’s intervention played a role.  With Trump set to leave the White House next month and President-elect Biden’s policy of reducing carbon, the Saudis may be more inclined to return to their earlier policy.  So far, Riyadh is holding the line on production cuts.  But, if frictions rise high enough, Saudi Arabia may decide to restore discipline.  We do find it interesting that, just a few short months from negative prices, the cartel is getting antsy to boost output.  If OPEC+ fails to maintain production cuts, the U.S. energy industry, still struggling, will see further production declines.

In other oil and gas international news:

• Mohsen Fakhrizadeh, a leading Iranian nuclear scientist, was assassinated on Friday while traveling in a motorcade outside Tehran.  Israel is thought to be behind the attack, although its policy is to never admit or deny an operation unless its personnel are caught.  It appears the assassination was partially done by remote control.  This isn’t the first time Iranian nuclear scientists have been targeted; at least four others were assassinated between 2010 to 2012.  Iran will likely avoid escalating the situation to avoid undermining the potential for improved relations with the incoming Biden administration.  In addition, Tehran will want to avoid escalation in the waning days of the Trump administration, fearing a “parting shot” from Washington.  This gives Iran’s adversaries a window of opportunity to engage in attacks.  At the same time, this attack, along with others, will make it difficult for Iran to change its relations with the U.S. even with a new administration in place.  Iran generally doesn’t directly attack Israel, instead focusing on Israel’s overseas interests, but it will be difficult for Iran to not respond in some fashion.  The trouble is that responding after the inauguration would make it nearly impossible for the Biden administration to open negotiations.  The impact on markets, thus far, has been modest.  Iran isn’t trading much oil so we would not anticipate any disruptions in oil supply, although there is a possibility that U.S. interests in Iraq could be targeted.
• Houthi rebels attacked the Saudi oil export facility in Jeddah earlier in the week.  The missile struck a storage tank, but damage was otherwise limited.
• The administration is working to end the standoff between Qatar and Saudi Arabia. Three years ago, Riyadh established a blockade on Qatar (there were pictures of dairy cows being flown into Qatar as part of the response).  According to reports, Jared Kushner is going to the region to hold talks on ending the blockade.
• Venezuela has convicted six oil executives and sentenced them to prison. They were charged with corruption.
• Europe has been restricting natural gas imports from areas where it believes methane leakages are not properly monitored and contained. Although U.S. firms have faced import restrictions from the EU, there is hope that the incoming Biden administration will be able to convince the Europeans that U.S. LNG is safe.
• Bitcoin prices have been surging recently; the “mining” of bitcoin requires massive computing power and, thus, electricity. Russians are being accused of using Abkhazia’s cheap electricity to establish server farms to mine bitcoin.  In 2008, the region was invaded by Russia and is no longer under the control of Georgia.  The region has claimed independence, but only a handful of nations recognize its independence.  Bitcoin mining is leading to local power outages.

Hydrogen is getting a lot of press lately.  Japan and Australia are working on a project where the latter supplies the former with the gas from coal.  South Korea and China are also working on projects.  There are reports that salt mines are being prepared to inventory to product.  Even pundits are getting involved.

A massive solar project is being planned in Texas, the largest in the U.S.  Of course, with solar and wind, battery storage remains an issue.  Batteries are seeing new investment as well.  And, there is new research in recycling oil EV batteries, which may further increase storage capacity.  The commitment to EV by car companies appears to be increasing; General Motors (GM, USD,  44.68) has decided to exit the lawsuit it had joined against California over emissions standards.

Although propane fundamentals do not suggest a supply problem, a rise in outdoor dining has led to restaurants firing up portable heaters, which is leading to localized shortages.

Finally, the CFTC did not blame anyone for the oil price declining into negative territory in April.  We suspect that passive investment played a major role in the decline, but government regulators were unable to make a determination.  It is possible this decision could be revisited under the new administration.

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