Weekly Energy Update (June 30, 2022)

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

(N.B.=> due to Independence Day, the next report will be issued on July 14.)

The DOE has resolved its systems issues and released weekly data for 6/17/22 and 6/24/22.  We update the data below.

After a sharp correction on recession worries, crude oil prices are recovering.

(Source: Barchart.com)

Crude oil inventories fell 2.8 mb compared to a 1.0 mb draw forecast.  The SPR declined 7.0 mb, meaning the net draw was 9.8 mb.

In the details, U.S. crude oil production rose from 0.1 mbpd to 12.1 mbpd.  Exports and imports both fell 0.2 mbpd.  Refining activity rose 1.0% to 95.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  This week’s report hints we are starting the usual seasonal decline in inventory that should last into early September.  We are not seeing declines similar to last year but something more like the average path.

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 $100.86.

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 $50 of risk premium in the market.

 Market news:

  • Last week, Energy Secretary Granholm met with energy executives. Although the runup to the meeting suggested a “woodshed” moment, in reality, the government really can’t do much to get more product supply to market.  Refineries are running around 95% of capacity, and short of nationalizing the industry and running at a loss, there isn’t much that can be done to ease prices.  It seems the meeting was cordial.  Perhaps the administration realizes (finally!) that lambasting the industry isn’t conducive to cooperation.
    • In a sense, the administration wants the oil and gas industry to expand furiously in the short run, only to strand the assets in the long run. That isn’t likely to work.
    • The White House has proposed a gas tax holiday for the summer. Not surprisingly, Congress seems unlikely to act.  Cutting the tax only to reinstate it in September, about nine weeks before the midterms, won’t be attractive to any incumbent facing election.
    • It’s not just high crude oil prices that have boosted gasoline prices; high corn prices have also boosted ethanol costs..
    • When an oil well is drilled, it is unusual to completely drain all the available hydrocarbons. Most of the oil is tapped through natural pressure.  As pressures fall, oil companies have various techniques to further pull oil out of the ground.  Water and carbon dioxide injections are commonly used to “enhance” production.  Even shale oil is, in a sense, derived from a technique to further wring oil out of existing fields.  Now, oil companies are “re-fracking” existing frack wells to pull out more oil.  This process has lower costs, in part, because all the well infrastructure is in place.
  • The Dallas FRB has released its Q2 survey of oil and gas firms in its district. The key takeaway—94% of firms report they are suffering from supply chain issues, and nearly 70% don’t see them getting resolved in less than a year.  The biggest shortages are in equipment and personnel.
  • The DOE estimates the global excess capacity for crude oil is below four mbpd. French President Macron says that the leaders of the UAE and KSA have told him their ability to expand production is severely limited.  Javier Blas of Bloomberg examines the notion that Saudi Aramco (2222, SAR, 39.20) can actually sustain production at 12.0 mbpd.  The level hasn’t been tested in a while, and, quietly, some officials suggest this number may represent a temporary peak, but it’s not a sustainable level.
  • The European Parliament is considering a plan that would obligate EU nations to fill their natural gas storage to a level of 80% by winter. As supply turmoil continues, various EU nations are calling on European consumers to reduce consumption now to allow for a supply replenishment.
  • Although the public usually believes “oil is oil,” in reality, there are differences. In general, oil is either heavy or light, sour or sweet.  The first group refers to viscosity; some oil flows easily (shale oil, for example) while others are thick (Canadian tar sands, Venezuelan Orinoco).  The second group refers to sulfur contents.  Refineries tend to specialize in these differences.  A refinery constructed to refine sweet/light won’t easily be able to process sour/heavy.  Over the past 20 years, U.S. refineries increasingly invested in the ability to process heavy/sour crude oil on the idea that as production dwindled, the most plentiful oil would be of that grade.  Shale oil upended that forecast, which is why the U.S. mainly exports shale oil and imports heavy/sour crude.  The SPR has both types, but in the most recent release, the government has primarily been selling the heavier/sour grades, which U.S. refineries can process most efficiently.  It is estimated that at the end of October, when this phase of the SPR release ends, the U.S. will only have 179 mb of the heavier/sour crude oilThis will make the SPR a much less effective price buffer going forward.

 Geopolitical news:

  • The G-7 is meeting this week to discuss the Ukraine situation and the energy crisis. As we note below, the climate change agenda has clearly taken a back seat to trying to avoid an energy crisis.  The G-7 has made this switch abundantly clear.  The group admits fostering new investment in oil, gas, and coal may be necessary.
  • Although the EU continues to try to revive the Iran nuclear deal, we still contend the odds of success are nil. Still, our take isn’t curbing the desire of the EU to make a deal.  To some extent, the Biden administration seemed to want this, too, although we have doubted the president really wants to use political capital for this mission.  We note Special Envoy Robert Malley is traveling to Qatar to engage in backchannel discussions with Tehran. The main sticking points remain.  Iran wants guarantees that a future administration will not renege on this arrangement (which is not possible as an administration cannot easily bind a future one), and Iran wants the Islamic Revolutionary Guard Corps removed from the U.S. designation as a Foreign Terrorist organization (which would be politically costly for the Biden administration).
  • Meanwhile, there are increasing worries that Israel, backed by its new partners in the Abraham Accords, may attack Iran’s nuclear facilities. Israel successfully destroyed nuclear facilities in Iraq and Syria, but the hardened facilities in Iran were thought to be strong enough to prevent Israel from successfully doing the same.  However, that was before Israel was allied with the Persian Gulf states.  Earlier assessments assumed Israeli warplanes would fly from Israel across semi-hostile territory to strike Iran.  The length of the trip would limit the number of sorties and reduce the chances of success, but if Israel’s warplanes could use bases in the Persian Gulf states, it is likely there would be multiple days, if not weeks, of air operations.  Of course, if the Persian Gulf states cooperated with Israel, it would open them up to Iranian retaliation.  So far, energy markets are mostly ignoring this risk.  Given the political risks that President Biden is taking by traveling to the region, we suspect that the war situation may be the reason for the visit.
  • South America is facing turmoil caused by the energy situation:

 Alternative energy/policy news:

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[1] Strictly speaking, the BIRC isn’t a formal organization, so it isn’t obvious how one “applies.”