Weekly Energy Update (December 8, 2022)

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

Crude oil prices continue to come under pressure on worries over economic growth.

(Source: Barchart.com)

Crude oil inventories fell 5.2 mb compared to a 3.9 mb draw forecast.  The SPR declined 2.1 mb, meaning the net draw was 7.3 mb.

In the details, U.S. crude oil production rose 0.1 mbpd to 12.2 mbpd.  Exports fell 1.5 mbpd, while imports were unchanged.  Refining activity rose 0.3% to 95.5% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  As the chart shows, we are past the seasonal trough in inventories and heading toward the secondary peak which occurs in early Q4.  SPR sales have distorted the usual seasonal pattern in this data.  This week’s draw takes inventories further below the seasonal average, though perhaps the most important takeaway is that the usual seasonal pattern in inventory is breaking down.

Shortly after the war started, we stopped reporting on our basic oil model that uses commercial inventory and the EUR for independent variables.  We have updated that model, which puts fair value at $73.60 per barrel.  We are currently trading near fair value for the first time since the war began.

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 2001.  Using total stocks since 2015, fair value is $106.07.

The CapAt long last, the EU has finally agreed on a price cap plan for Russian oil, pending Poland’s approval tomorrow.  The cap price is $60 per barrel, and since the current Urals price is around that level, it’s possible that not much will change.  The price was below what the Eastern Europeans were pushing for—Poland wanted a $30 price.  The U.S., however, was afraid that a price that low, which would effectively ban Russian oil exports, would trigger a major price rally and harm the world (and U.S.) economy.  The current price won’t really stop Russian exports if Russia wants to sell the oil.  Russia’s initial reaction is to refuse to sell oil to nations using the price cap.  We also note that, effective last Monday, the EU and U.K. will stop seaborne oil imports from Russia, which will have a more material impact on the oil markets.  The most likely market reaction is volatility.  The initial reaction to the cap and the OPEC+ decision was a sharp rise in oil prices, but that reaction faded earlier this week.

Market News:

  • The White House is seeking to halt SPR sales in the coming years. Congress has tended to use the SPR as a sort of budget “piggy bank” to allow for funding of various projects.  Thus, various sales have already been authorized for future years.  However, with the SPR being drained by the sales completed due to the war in Ukraine, the administration now wants to halt those future sales.  So far, we are not seeing any programs put in place to refill the reserve, but this action does suggest growing concern about the sales.
  • Recent data suggests that U.S. drilling activity remains lackluster. Due to regulatory and investment constraints, the U.S. oil and gas industry thus far has not reacted strongly to high oil prices.  We expect that to continue.
  • The fertilizer market has been a major concern since the Russian invasion of Ukraine. Both nations are major producers of fertilizers and feedstock for the product.  The UN says that it is near a deal that would allow Russia to export ammonia via a Ukrainian pipeline.  Ammonia is a key element for the economy and resuming this supply is important.  We note that fertilizer prices have been falling recently as markets adjusted to high prices, and the UN news will likely support further price declines.
  • One of our firm’s positions is that the unwinding of U.S. hegemony will lead to supply disruptions and trigger hoarding. Confirming this assertion is an announcement that Japan is building a strategic reserve for natural gas.  Japan gets nearly all of its natural gas from LNG and has faced higher prices as European demand for LNG has soared due to the war.
  • High prices and weak economic activity have reduced EU natural gas demand.
  • If China continues to ease COVID restrictions, oil prices should benefit.
  • Saudi Arabia announced it has discovered two new natural gas fields.
  • A 2019 study by the NBER showed that lower heating costs prevent winter deaths. The study suggested that the shale gas revolution likely saved 11k lives in the U.S.  If the study is correct, high heating prices may lead to higher mortality rates in Europe this winter.
  • Ethanol blending has hit new records.
  • Mild temps are bearish for natural gas prices. Meanwhile, U.S. LNG projects are being funded rapidly, although there are concerns that the industry won’t be able to find enough gas to match these projects.
  • Glencore (GLNCY, $13.31) is planning to accelerate coal mine closures. The closures have little to do with profitability but are instead being done to meet emissions targets.  The IEA is forecasting that renewables will overtake coal by 2025.
  • Russia and China have completed a pipeline to Shanghai.
  • New England authorities are warning that if the weather is unusually cold, rolling blackouts might occur. Some of the problem is tied to the Jones Act.

 Geopolitical News:

 Alternative Energy/Policy News:

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