Weekly Energy Update (July 21, 2022)

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

It appears that oil prices are settling into a broad trading range between $125 and $95 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 0.5 mb compared to a 1.0 mb draw forecast.  The SPR declined 5.0 mb, meaning the net draw was 5.5 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.9 mbpd.  Exports rose 0.7 mb, while imports fell 0.2 mbpd.  Refining activity declined 1.2% to 93.7% 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 last seen in 2004.  Using total stocks since 2015, fair value is $102.12.

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 $65 per barrel, so we are seeing about $35 of risk premium in the market.

Gasoline Demand

Gasoline demand has turned lower.  Although high prices may have been the culprit, gasoline demand was price insensitive for most of market history.  However, with the advent of work from home and increasing retirements, gasoline prices may have become more sensitive.

(Source:  EIA)

This easing of demand does appear to be lowering gasoline prices.


In observing the long-term history of gasoline demand, we note that by stripping out the monthly variation with a Hodrick-Prescott filter, it appears that underlying demand is weakening.

Gasoline demand rose strongly from the end of WWII into the mid-1970s, but the Iran-Iraq War’s price spike and its gasoline shortages led to a drop in demand that lasted about a decade.  Demand rose again in the early 1990s into the Great Financial Crisis, but since then demand has been mostly sideways.  This would suggest a secular change in gasoline demand is in place, which signals persistently weak demand.  Thus, the current slowdown may be part of a larger trend.

In observing the above demand chart, it does beg the question, “Why would anyone build additional refinery capacity if demand isn’t set to grow?”

 Market news:

Geopolitical news:

  • President Biden made it to the Middle East last week. The trip was a mixed bag of sorts.  On its face, the president was trying to normalize relations with a key ally, the KSA.    The U.S. has been concerned about Chinese and Russian encroachment in the region and is always worried about Iranian actions. The U.S. is working to support an Israeli/Gulf Nation coalition to contain Iran.  We note that Russian President Putin has been in the region this week, visiting Turkey and Iran. However, President Putin’s trip was prompted by high oil prices.  On that front, we doubt much will happen.  The consensus is growing that the Arab oil producers are near capacity.  Biden was warmly greeted in Israel and there was some movement to improve relations between Israel and the Arab Gulf states.  But the odds of getting appreciably more oil isn’t likely, despite comments suggesting otherwise.
  • The question of Russian oil continues to vex the West. Cutting off oil flows would reduce Russia’s income, but it is clear that Moscow is still finding buyers, many of whom are in Europe.  Russia has also rebalanced oil flows, sending more to China and India.  Simply put, there is little evidence to suggest sanctions have reduced Russia’s oil revenue.  The classic economic response to such a problem is to implement a tariff, which  would raise the price of Russian crude, making it less attractive to buyers.  Either Russia would be forced to stop selling crude to the tariff-implementing nations or would need to cut its price to world levels by the amount of the tariff, reducing Russia’s revenues.  Treasury Secretary Yellen offered up the tariff idea, but it went nowhere.  She then proposed a price cap. If a large enough group could come together, they could set a price that would reduce Russia’s revenue.  In theory, the price could be near marginal costs, which would make it reasonable to Russia to continue producing.  At first glance, this proposal seems wanting; after all, if a buyer could simply set the price, there is little need for markets.  However, there is a case to be made that if enough buyers participate, they could dictate a price.  Obviously, Russia could simply decide to stop selling oil, but that would be risky.  If wells are shut in, it’s not likely they will be restarted, and this action could lead to a permanent loss of global capacity.  In addition, Yellen is proposing a price that would not generate losses for Russia, so she claims they should accept it.
    • Interestingly enough, China, a key Russian ally, has not rejected the proposal outright.
    • So, what could go wrong? Such arrangements have been tried throughout history.  The U.S. had a scheme where oil had different prices depending on when it was produced; it simply led to regulation evasion.[2]  It’s not hard to see how Russia could game this arrangement.  Let’s say the price is $50 per barrel. Russia will sell you the oil at the price if you agree to sell something else to them below market prices, e.g., semiconductors.
    • Meanwhile, we are seeing energy flows adjust to sanctions. China is shifting oil imports to Russia, reducing flows from Saudi Arabia. Given the price difference, this makes sense.  Saudi extra light crude is trading at a nearly $40 per barrel premium to the Urals benchmark; prewar, this difference ran about $5 per barrel.  We have seen, in the past, that the Saudis would try to defend their market share in key markets. For example, in the late 1990s, the price war between Venezuela and Saudi Arabia was over the U.S. market.  We doubt such a conflict will emerge here for two reasons. First, the KSA is careful not to sour relations with Russia. Second, we don’t think the kingdom has the excess capacity to take such action.  In addition, it’s not just crude oil, as China is buying all types of energy from Russia.
    • One of the reasons the U.S. is so keen to set up this price-cap system is to try and thwart an EU proposal to deny Russian oil tankers’ insurance. Although China, Russia, India, or some other buyer could ensure the vessel, EU and British insurance firms provide 85% to 90% of all policies.  Some owners won’t sail without insurance from these sources and the Suez Canal Authority won’t accept any insurance other than EU or British policies.  The U.S. fears that if the EU plan goes through, Russian oil will become impossible to source and prices could soar.  The price cap is designed to postpone the insurance ban.
  • Libya Prime Minister Abdul Hamid Dbeibeh, wants to fire the head of the nation’s National Oil Company, Mustafa Sanalla. Libya has been rocked by civil war ever since a coalition of EU nations and the U.S. ousted Moammar Gaddafi.  The nation is currently divided, with both sides fighting over control of oil revenues.  This fight has led to insecure oil flows which occasionally reduces global supplies.

 Alternative energy/policy news:

  View PDF

[1] This is part of a deal to end the blockade on Ukraine grain, but it is still uncertain if the blockade will actually be lifted.  The details are daunting as the waters around Odessa are heavily mined and it isn’t clear if Russia will allow NATO minesweepers to clear a shipping channel.  It’s also not obvious that Ukraine will trust the Russians to clear the mines either.

[2] Marc Rich was to be indicted for this and other embargo evasions with Iran.  He fled to Switzerland.