Weekly Energy Update (January 21, 2022)

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

Since troughing in early December, oil prices have been steadily rising due to tightening supplies.  We are approaching the highs set in November.

(Source: Barchart.com)

Crude oil inventories unexpectedly rose 0.5 mb compared to a 2.0 mb draw forecast.  The SPR declined 1.3 mb, meaning the net draw was 0.7 mb.

In the details, U.S. crude oil production was unchanged at 11.7 mbpd.  Exports and imports both rose 0.7 mbpd.  Refining activity fell 0.3%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  This week’s report shows a pattern consistent with average and last year.

Based on our oil inventory/price model, fair value is $70.04; using the euro/price model, fair value is $54.12.  The combined model, a broader analysis of the oil price, generates a fair value of $62.32.  Current prices exceed our model projections, but price momentum is likely to push prices higher.

Market news:

  • Oil prices have surged recently.  The combination of tight supplies, rising demand, and geopolitical tensions are all conspiring to move prices higher.  So far, the supply response has been modest, which means that price volatility remains elevated.  However, we are starting to see some rumblings of supply from the U.S. shale sector.  Other production areas remain stagnant, likely worried about stranded investment.
  • Disinvestment has weighed on the energy sector, but recent comments from some major financial firms suggest the trend isn’t universal.  One issue that has been raised is that divestment could simply shift production from publicly held to privately held firms that may have lower environmental standards.  Essentially, the idea of reducing fossil fuel use by supply restrictions may not solve the problem and may cause higher prices and little environmental improvement.
  • The recovery in energy demand in 2021 has led to higher emissions.

Geopolitical news:

Alternative energy/policy news:

  • The key to expanding the EV market is batteries.  Not only do supplies need to increase, but the technology will likely need to improve.  Solid-state batteries hold the promise of quicker charging and a farther range.  QuantumScape (QS, USD, 18.48) announced a plan to build batteries for stationary applications, e.g., storage for wind and solar.
  • Transportation is not the only area where reducing carbon emissions is important.  Cement and steel are also large emitters.  There has been some recent progress in producing “green steel.”
  • Although there is some debate on the issue of climate change and the best way to address it, one area we watch closely is the behavior of insurers.  If insurance providers require various steps to be taken before providing coverage, or simply decide not to provide coverage at all, changes in economic activity will result.  It is possible the decisions made by insurance companies may lead to changes to address climate change.  Along with banks, decisions from the finance industry could have a bigger impact than regulation.

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