Weekly Energy Update (July 15, 2021)

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

Prices appear to be consolidating between $72 to $76 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 7.9 mb compared to the 4.4 mb draw expected.  The SPR was unchanged this week.

In the details, U.S. crude oil production rose 0.1 mbpd to 11.4 mbpd.  Exports rose 1.4 mbpd, while imports rose 0.3 mb.  Refining activity fell 0.4%.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are well into the summer withdrawal season.  Note that stocks are well below the usual seasonal trough seen in early September.  A normal seasonal decline would result in inventories around 553 mb.  Our seasonal deficit is 81.7 mb.  At present, inventories are falling faster than normal.

Based on our oil inventory/price model, fair value is $61.99; using the euro/price model, fair value is $63.36.  The combined model, a broader analysis of the oil price, generates a fair value of $62.42.  Oil prices are well above fair value for all the models.  The ability for oil to maintain current levels is dependent on sentiment towards OPEC, although the continued decline in oil stockpiles is improving the valuation gap.

Market news:

  • One reason capitalism has triumphed over communism is that, due to the profit motive and the ability to tolerate disruption, capitalist economies tend to use commodities with ever-increasing efficiency. In other words, capitalism tends to generate greater output with less input over time.  Communism, at least as it was practiced by the Soviets, tended toward high levels of commodity intensity.  In the 1970s, rising oil prices, coupled with tighter monetary policy to counteract inflation, led to two deep recessions, one in 1973-75 and another in the early 1980s.  In 1980, the U.S. needed 5,000 BTUs[1] of petroleum to make $1 of GDP; now that is down to around 1,700.[2]  Simply put, rising oil prices are not yet a threat to economic growth.
  • Although we are seeing a slow rise in U.S. oil production, we are still well below previous peaks. A change in oil company behavior is an important element of this slower production growth.  In the past, companies would tend to maximize production rather than profits.  That is no longer the case.
  • As oil prices rise, speculators are increasingly taking bullish positions on oil.
  • Qatar is poised to expand its LNG production by 63% over the next decade.

Geopolitical news:

Alternative energy/policy news:

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[1] Which is 0.4 gallons of crude oil, or four cups and 3 ounces.

[2] Roughly 13 ounces.