Weekly Energy Update (August 18, 2022)

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

Crude oil prices remain under pressure on fears of a deal with Iran and weakening economic growth.

(Source: Barchart.com)

Crude oil inventories fell 7.1 mb compared to a 0.3 mb build forecast.  The SPR declined 3.4 mb, meaning the net draw was 10.2 mb.

In the details, U.S. crude oil production was steady at 12.2 mbpd.  Exports rose 2.9 mb, while imports were unchanged.  Refining activity dipped 0.8% to 93.5% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Clearly, this year is deviating from the normal path of commercial inventory levels although this week’s outsized decline is consistent with seasonal behavior.  We will approach the usual seasonal trough for inventories in mid-September.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in 2004.  Using total stocks since 2015, fair value is $104.45.

With so many crosscurrents in the oil markets, we are beginning to see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $64 per barrel, so we are seeing about $24 of risk premium in the market.

Market news:

 Geopolitical news:

 Alternative energy/policy news:

  • With the Inflation Reduction Act now signed into law, a backlash against economists for pushing for a carbon tax is developing. To some extent, this makes sense as using other tools can be more politically popular.  However, from an efficiency standpoint, a carbon tax would still be a superior policy, but obviously, if you can’t get it passed, holding on to that policy to the exclusion of all others makes little sense.  What the bill is really all about is industrial policy.  Government shaping the economy is nothing new but is generally considered legitimate only in cases of clear market failure.  Since a carbon tax was never implemented, it really hasn’t been proven that a market failure exists.
  • There is great excitement in the environmental community over the new measures but one potential concern is the lack of workers to build out the plan.
  • Germany is extending the life of its three remaining nuclear power plants.
  • Any commodity activity disturbs something. Whether its drilling, ranching, farming, or mining, something or someone gets disturbed.  As demand for lithium rises, opposition to mining or brining has emerged.  Although such opposition may be overcome, higher costs are likely to result.
  • As we noted last week, the price of EVs continues to climb. Ford’s (F, $16.18) announcement of substantial price increases on its F-150 “Lightning” EV pickup is the most recent example of this issue.
  • There is growing evidence that the Arctic is warming faster than other parts of the world. The impact is difficult to estimate, but we would expect greater weather variability from this situation.
  • Much of the Midwest, parts of the Southwest, Florida, and the Atlantic coast could become subject to extreme heat events in the coming decades. But the real worry is heat in areas unprepared. The linked map shows the areas of installed air conditioning.
  • Hot weather just isn’t an inconvenience. The drought and warm weather is affecting industrial activity in Germany.  In China, power shortages, caused by hot weather, are causing car and battery plants to suspend operations.  Tech firms have also temporarily shut down.
  • Delays of utility-scale solar projects are steadily rising. These delays may be tied to trade restrictions which have recently been eased.
  • California looks ready to extend the life of the Diablo Canyon nuclear power plant that was scheduled for decommissioning.
  • Increasingly, we are seeing an “all of the above” strategy in energy investment. Investing in renewables doesn’t necessarily preclude investing in fossil fuels.
  • Although wood burning is not necessarily environmentally friendly, it appears Germans are considering it in the face of rising fossil fuel prices. Wood pellets are also seeing rising demand in Europe and Asia.
  • This recent report from the Peterson Institute details China’s dominance in rare earths processing.

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