Weekly Energy Update (July 14, 2022)

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

Since early June, oil prices have fallen significantly, breaking the psychologically important point of $100 per barrel.  Technical support exists at $95 per barrel, so we will be watching to see if it holds.

(Source: Barchart.com)

Crude oil inventories rose 3.3 mb compared to a 1.5 mb draw forecast.  The SPR declined 6.9 mb, meaning the net draw was 3.6 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 12.0 mbpd.  Exports rose 0.4 mb, while imports fell 0.6 mbpd.  Refining activity rose 0.4% to 94.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  It is clear that this year is deviating from the normal path of commercial inventory levels.  Although it is rarely mentioned, the fact that we are not seeing the usual seasonal decline is a bearish factor for oil prices.

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 seen in 2004.  Using total stocks since 2015, fair value is $101.09.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $65 per barrel, so we are seeing about $35 of risk premium in the market.

Gasoline demand:

In general, gasoline demand is price inelastic, which is “econ talk” for demand being insensitive to price.  Since substitutes for gasoline are mostly non-existent, consumers trying to adapt to higher prices are left with other methods, such as carpooling, combining trips, or using public transportation.  Unfortunately, data on public transportation is only available through Q1.  However, the data does suggest that ridership is well below pre-pandemic levels.  In the long run, demand can fall if car owners shift to more fuel-efficient vehicles; the work-from-home movement may also lead to lower structural demand.

At the same time, gasoline demand is very elastic to economic growth; as growth slows, demand declines.  We are seeing clear evidence of weakening demand.

Seasonally, this is where we usually see peak demand.  The fact that demand is falling and that it is usually price insensitive likely argues that the economy is weakening.

 Market news:

 Geopolitical news:

It’s a big week in geopolitics and energy.

 Alternative energy/policy news:

  • The intelligence apparatus often tries to change policies in target nations. Authoritarian nations, given their control of the media, tend to have a “leg up” in the battle for opinion.  A good example of this recently is that China has been using social media to encourage environmental groups to oppose rare earths mining in the U.S. and Canada.  Although rare earths mining and processing is often environmentally “dirty,” it is also true that rare earths are critical in alternative energy production.  China dominates both mining and processing because it has been willing to absorb the environmental costs.[1]  However, as the West has realized its vulnerability in this area, there has been renewed interest in mining and processing rare earths outside of China.  Clearly, Beijing is trying to discourage such efforts.
  • Although nuclear power remains controversial, there are elements in the environmental community that realize it may be necessary to expand nuclear power to reduce carbon emissions. One especially attractive technology is molten salt reactors.  Not only are the facilities smaller, but they should also be safer.
  • One of the issues that concerns policymakers is that Russia and China are now at the forefront of nuclear reactor designs. The IEA estimates that nuclear power will need to double by 2050 to have any chance of reaching net zero emissions.
  • Thermal technology could also be used to store production from wind and solar power. Currently, utilities must carry traditional redundant capacity to wind and solar capacity due to the natural interruptions of these sources.  Having storage would remove that need and improve the economics of renewables.  Germany is currently building a similar facility to hold hot water.  Finland is experimenting with using geothermal techniques and sand to store power as well.
  • It is likely that carbon capture from the atmosphere will be required to have any chance of reaching climate goals. An Australian design suggests that solar power could be the key to creating the energy for carbon capture.
  • It is also likely that as global temperatures rise, nations and some large firms may try geoengineering to improve conditions. These technologies could have unexpected effects, and so the scientific community has been reluctant to aggressively pursue them.  But, as temperatures rise, so will the drive to make such investments.  However, given that we will likely see such techniques deployed, the US. government is starting to fund research in a bid to control their implementation.
  • Jet fuel made from bacteria may be more energy-dense that that from fossil fuels.

  View PDF

[1] Lacking an effective tort bar is useful for such efforts.