Weekly Energy Update (October 28, 2021)

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

Prices have moved above $85 per barrel this week but retreated on this week’s inventory data.

(Source: Barchart.com)

Crude oil inventories rose 4.3 mb compared to a 1.8 mb build forecast.  The SPR declined 1.1 mb, meaning the net draw was 3.2 mb.

In the details, U.S. crude oil production was steady at 11.3 mbpd, remaining below the 11.5 mbpd pre-Ida level.  Exports fell 0.3 mbpd, while imports rose 0.4 mbpd.  Refining activity rose 0.4%.  We are in refinery maintenance season, which accounts for the usual seasonal build in crude oil inventories seen in the chart below.  This build season usually ends in mid-November.

(Sources: DOE, CIM)

This chart shows the seasonal pattern for crude oil inventories.  We are in the autumn build season.  Note that stocks are significantly below the usual seasonal trough.  Our seasonal deficit is 66.8 mb.

Based on our oil inventory/price model, fair value is $64.34; using the euro/price model, fair value is $58.50.  The combined model, a broader analysis of the oil price, generates a fair value of $61.04.  We are seeing a notable divergence in the model between inventory and the dollar and a rising level of overvaluation.  Part of the overvaluation is likely due to fears of tighter inventories. If the builds continue, which is consistent with seasonal patterns, the model suggests some moderation of prices.  However, supply fears are so elevated this may not be the case.

 Market news:

  • Last week, we noted that despite high oil and gas prices, production hasn’t responded as much as one would expect compared to earlier episodes of higher prices.  As with many trends, there are multiple reasons behind the sluggish response.  One element is that firms are no longer optimizing for production but for profitability.  It means that instead of using all the cash available and borrowing, firms are husbanding liquidity and rewarding shareholders.  In the past, U.S. shale producers, in particular, did not focus on shareholder return.  In order to attract capital, the industry decided it needed to improve its reputation.  As the value of producing property rises, some investors are selling out, suggesting they don’t see a bright long-term future.  Another element of this trend is that margins are getting squeezed due to higher production costs.  Thus, to maintain margins, firms simply appear more willing to allow higher prices to fulfill that goal.
  • Coal is admittedly one of the dirtiest fuels.  Not only does it emit large amounts of greenhouse gases, but it also fouls the air with sulfur, particulates, and nitrous oxide, the key catalysts for acid rain.  Over the past decade, coal has seen its market share drop, replaced by renewables and natural gas.  But with natural gas prices soaring this year, coal is making a global comeback.  China, facing a severe energy crunch, has eased restrictions on its use and is boosting imports from Indonesia.
  • In Europe, nations are doling out subsidies to help pay for higher energy costs.  Sadly, this practice won’t increase energy supplies and delays the necessary demand destruction to reduce the use of fossil fuels.
  • The World Bank is warning that inflation risks are elevated due to the spike in energy prices.
  • Propane, a fuel with a wide variety of uses, is seeing supplies tighten.  The U.S. has been increasing its exports of the fuel, which is derived mostly from natural gas.  For urban and suburban home heating, natural gas and electricity are common fuels.  These are regulated by public service authorities that limit price changes.  Propane is commonly used in rural homes, and prices are set in the spot market.  In addition, the fuel is used in crop drying, which can exacerbate local shortages.  Tight supplies will tend to lift propane prices this winter.  The chart below shows that current stockpiles are below the five-year range, signaling low inventories.

Geopolitical news:

 Alternative energy/policy news:

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