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

Oil prices are breaking out, raising the potential for a move toward $95 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories fell 2.2 mb compared to forecasts of a 2.0 mb build.  The SPR fell 0.3 mb, which puts the net draw at 2.4 mb (difference due to rounding).

In the details, U.S. crude oil production was steady at 12.9 mbpd.  Exports fell 1.1 mbpd, while imports rose 0.7 mbpd.  Refining activity fell 1.6% to 89.5% of capacity. We are clearly heading into the autumn refinery maintenance period which should reduce demand.

(Sources:  DOE, CIM)

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s decline is contra seasonal and thus is bullish for crude oil prices.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $74.92.  Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

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 late 1984.  Using total stocks since 2015, fair value is $95.49.

Market News:

• The IEA issued an updated report detailing what would be necessary to reach carbon reduction goals by 2030. Generally speaking, it is still possible to reach these goals, but the path is narrowing.  The IEA claims that fossil fuel demand will need to decline 25% by 2030; we suspect that isn’t likely.
  • Oil execs claim that without more support for shale drilling, oil is headed to $150 per barrel. We don’t think that is probable in the near future because OPEC+ has significant excess capacity.  However, over time, it could occur.  The idea that demand must fall by 25% will likely temper investment activity in oil and gas.
  • One of the key factors in shale production is water. There are concerns that Texas is consuming so much water that it may eventually curtail output.
  • U.S. oil production is steadily rising and is offsetting some of the production cuts from OPEC+.
• As oil prices continue to rise, the G-7 cap on Russian oil prices has become irrelevant. The restrictions on Western insurance remain in place but are increasingly being ignored as Russia is managing to acquire insurance from other sources.
  • Russia has banned product sales in a bid to ensure ample domestic supplies. Russian domestic prices have declined in the wake of the restrictions.
• Although there is still talk about phasing out fossil fuels in the West, China’s climate envoy has made it clear that Beijing isn’t ready to give up on these fuels anytime soon. This comment makes the idea of “peak oil demand” appear a bit premature.
• It was a warm summer, and September has also been warm. The combination of undersea volcanic activity, the emerging El Niño, and the peak of the solar cycle have all combined to lift summer temperatures.  We will now be watching to see if we have a mild winter as a continuation of these trends.
• Russia banned the export of distillate products earlier this month, but as prices have increased, it has lifted its ban on bunker fuel, the high-sulfur fuel usually burned by ships.
• Despite high prices, U.S. E&P company capex remains constrained.

Geopolitical News:

• In the wake of the Iran/U.S. prisoner swap, there is hope that the two parties will use this event to improve relations. Although we have our doubts that this will work, there are parties trying to foster negotiations.
  • Qatar is offering to facilitate talks between the U.S. and Iran about moving forward on a new nuclear deal.
  • On the other hand, Iran’s foreign minister, who was in New York for the UN General Assembly meetings, was unable to visit Washington for talks.
  • Robert Malley, who we discussed in an earlier Weekly Energy Update, appears to be part of a deep influence campaign by Iran.
  • President Raisi of Iran is calling for the U.S. to leave the Middle East.
  • Iran claims to have thwarted a massive bombing campaign. Tehran blames Israel.
• In a bid to conserve foreign currency reserves, Iraq will restrict all internal transactions to the IQD. Usually when a central bank puts such restrictions in place, the action reduces trade.
• Over the past few weeks, we have discussed Saudi/Israeli normalization. The barriers to a deal remain high, but talks appear to be continuing.  As a potential deal looms, Iran is trying to figure out how to respond.  A KSA/U.S./Israel deal would create a formidable obstacle to Iran’s goal of dominating the region.
  • As negotiations continue, we note that the new Saudi envoy to the Palestinians has visited the West Bank. Also, Israel’s tourism minister has visited the KSA, which makes the minister the highest ranking official to actually visit Saudi Arabia.
• One of the key elements of the geopolitics of oil is that Europe lacks enough oil and natural gas to be energy independent. Thus, it needs imports to meet its energy needs.  The U.S. wants Europe to be dependent on America.  Europe, obviously, wants diversity of sources.  Washington has historically tolerated Europe getting supplies from the Middle East and Africa but has consistently opposed Europe getting oil and gas from Russia.  As the war in Ukraine has disrupted Russian supplies, the EU is finding itself increasingly dependent on the U.S., especially for natural gas.
  • Mexico is planning to join the ranks of LNG export nations.
• Chevron (CVX, $170.23) announced it will resume drilling activity in Venezuela. The country has been under sanction for some time, but in the wake of the war in Ukraine, Washington has gradually lifted sanctions in a bid to keep oil prices under control.
  • At the same time, Citgo, the large U.S. refiner that is a subsidiary of the Venezuelan state oil company PDVSA, will be auctioned off to pay Venezuelan debt. So far, the Maduro government hasn’t taken measures to stop the sale.

Alternative Energy/Policy News:

• European officials warn that the region must diversify its solar panel supply chains away from its dependence on China. The U.S. industrial policy is attempting to support a domestic solar panel industry.
  • The EU is getting increasingly aggressive in protecting its auto industry, threatening not only China but also U.S. EV producers with trade restrictions.
• China is also dominant in rare earths mining and processing. Vietnam is vying to compete with China in this market.
  • Vietnam is also making headway in the EV market and hopes to become a source for the EU now that Europe is considering restricting Chinese EVs.
• Ford (F, $12.55) halted work on a battery plant in Michigan. The plant, which uses Chinese licensed technology, has been controversial.  The UAW, which is currently striking, has claimed that this halt was designed to influence the union’s wage efforts.  However, the company claims it isn’t sure it can “competitively” operate the plant.
  • Chinese firms are investing in Moroccan phosphate, which they use in batteries.
  • Looking for a good primer on EV batteries? This report from The Economist lays out the different battery technologies and where new developments are going.
• Geothermal energy remains an attractive alternative energy. So far, it has mostly been restricted to regions with volcanic activity but there are hopes that it can be deployed more broadly.  In addition, there is research under way to make current geothermal power more efficient.
• There is also research in progress that could transform CO² into synthetic natural gas.
• The U.S. is aiming to build a nuclear fusion facility within the next decade.
• Microsoft (MSFT, $310.65) is funding small modular reactors to provide energy to the company. This energy is designed to, in part, provide electricity for its AI efforts.

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

Oil prices have continued their rise, with Brent trending toward $95 per barrel.  Recent extensions of the production cuts by the Kingdom of Saudi Arabia (KSA) have boosted prices.

(Source: Barchart.com)

Commercial crude oil inventories fell 2.1 mb compared to forecasts of a 1.7 mb draw.  The SPR rose 0.6 mb, which puts the net build at 1.5 mb.

In the details, U.S. crude oil production was steady at 12.9 mbpd.  Exports rose 2.0 mbpd, while imports fell 1.1 mbpd.  Refining activity fell 1.8% to 91.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s decline is mostly consistent with expected seasonal patterns.  However, we should start to see inventories rise in the coming weeks, but if they fail to do so, it could give another lift to oil prices.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $74.10.  Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

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 late 1984.  Using total stocks since 2015, fair value is $95.20.

Market News:

• Last week, we reported on the IEA’s position that peak oil demand is near. We note that this week, skeptics to this idea have responded.
• Société Générale (SCGLY, $5.16) announced it is scaling back its lending to the fossil fuel industry. Reducing available capital to the energy industry is bullish for crude oil prices.
• Although we remain concerned about European natural gas prices this winter, current inventory capacity is essentially full, meaning that LNG cargos destined for Europe have no place to go. Thus, in the near term, prices could come under pressure.
• It appears that China is rapidly building crude oil inventories. Although we don’t know the prices at which the oil was acquired, we are surprised China has been aggressively buying oil in a highly priced environment.  We do note that the largest exporter of oil to China is Russia; Moscow has likely given Beijing favorable prices and is allowing China to purchase oil in CNY.
• Ireland has rejected plans to build an LNG terminal, citing its goal of reducing greenhouse gases. It remains to be seen if Ireland can meet its energy needs through other means.
• Although overall U.S. production has been rising, the DOE says that output from leading shale oil areas has fallen for three consecutive months.
• California is putting restrictions on diesel semis starting next year, which is leading trucking companies to aggressively acquire rigs before the deadline.

Geopolitical News:

• The five Americans held in Iran have left Tehran. Despite this diplomatic effort, tensions with Iran remain elevated.  Iran has expelled around one-third of IAEA inspectors in what is being called an “unprecedented” action.  The move will likely slow, or even prevent, further improvement in relations.  We note that European nations have decided to maintain sanctions, suggesting the prisoner swap was a one-off.  At the same time, there are hopes that this confidence-building measure could lead to improved relations.
• The Saudi oil minister claims that the recent cuts in production were required to “stabilize” the oil market and were not about raising prices. If so, the oil price chart shown earlier would suggest this effort was an abject failure.
• As tensions rise between Armenia and Azerbaijan in the Nagorno-Karabakh region, there are worries that the Baku oil flows could be interrupted. Fortunately, it looks like a ceasefire has been negotiated.
• There are unconfirmed reports that the KSA has ended talks with Israel on normalizing relations. Israel says negotiations continue.
• Meanwhile, the U.S. is trying to facilitate talks between the KSA, the UAE, and the Houthis on a ceasefire in the Yemen Civil War. Although the KSA and UAE both endorse suppressing the Houthis, they support different groups in Yemen.  Thus, the negotiations will be difficult.  A ceasefire in Yemen could help stabilize the region.
• In the U.S., as the Democratic Party supports the expansion of green energy, the GOP appears to be increasing its support for the fossil fuel industry…and looking for campaign donations.
• We have noted that the Russian oil and gas embargo has led to a restructuring of global energy flows. This report details recent trends.

Alternative Energy/Policy News:

• Wind energy has recently come under strain as rising costs are leading to projects being postponed or cancelled. Governors on the Atlantic Seaboard are asking for federal help to keep the projects afloat.
• Last week, we noted that the EU is starting to push back against Chinese EVs in a bid to protect their own auto industry. It looks like this pushback is gaining momentum.  As the EU starts to close its market, China is eying Japan as a target for its EVs.
• The state of California is suing major oil companies for damages caused by climate change, alleging the firms covered up evidence that fossil fuel consumption would have adverse climate effects. We have no position on the merits of the case, but would suggest that its existence alone could have a dampening effect on future oil production.
• Although the long-term outlook for lithium is bullish, in the near term, supply exceeds demand. Thus, we may be in for a period of falling lithium prices.
  • Oil companies are looking to extract lithium from fracking wastewater.
  • Researchers at Princeton have developed a new lithium extraction process that promises to enhance the productivity of the metal.
• One important hurdle for EVs is range anxiety. Energy Secretary Granholm’s recent EV demonstration trip was a mess; securing recharging venues was hard and they were not in the most convenient spots.  However, it should be noted that we are in the early days of the EV era.  Next generation batteries could go a long way toward addressing current problems.  Toyota (TM, $187.86) claims its next generation battery will have a range of 497 miles, which rivals gasoline engines.  The company says that it will offer solid state batteries by the end of the decade with ranges around 920 miles and 10 minute recharges.
  • U.S. EVs have reached two million on the road.
• To acquire key minerals for the energy transition, Norway wants to mine the seabed. We suspect this will be controversial.

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

Oil prices have continued their rise, with WTI trending towards $90 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories rose 4.0 mb, compared to forecasts of a 2.0 mb draw.  The SPR rose 0.3 mb which puts the net build at 4.2 mb (the discrepancy is due to rounding).

In the details, U.S. crude oil production rose 0.1 mbpd to 12.9 mbpd.  Exports declined 1.8 mbpd, while imports rose 0.8 mbpd.  Refining activity rose 0.6% to 93.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s rise is mostly consistent with expected seasonal increases in crude oil stockpiles.  However, the sharp drop in exports is a bit of a puzzle and if reversed next week, inventories could remain tight.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $73.30.  Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

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 late 1985.  Using total stocks since 2015, fair value is $94.95.

Market News:

• The executive director of the IEA issued an editorial in the Financial Times where he forecast peak oil and natural gas demand would occur by the end of the decade. The increase in EVs and renewables is expected to supplant fossil fuels.  Obviously, we won’t know for sure if he is correct for a few years, but this position does affect behavior.  Oil and gas firms have already shifted their focus from growth to providing return to shareholders and owners.  After all, how does one justify expanding production that may simply be stranded?  On the other hand, if he is wrong, and demand continues to grow, the behavior of firms increases the likelihood of much higher oil prices.
• Russian refineries are planning seasonal maintenance that will allow for more oil exports but will also curtail product exports. It will be interesting to see if Russia maintains its promise to restrict oil supplies in light of this seasonal situation.
• Although the Kingdom of Saudi Arabia’s (KSA) production restrictions have supported oil prices recently, it will almost certainly weaken the economy. That’s in part due to increasing Iranian exports and rising Guyana production that will reduce the KSA’s market share.  We don’t expect a change in Saudi production this year, but we wouldn’t be surprised to see an attempt to regain market share next year.
• U.S. shale producers are trying to impress investors with their improved efficiency. In the past, it was all about production, but now there is a focus on profitability.  One measure of efficiency is the length of drilling laterals; in other words, getting more oil from each wellhead.
• As the odds of an Australian LNG strike loom, Chevron (CVX, $165.59) is likely to deploy a legal strategy to avert a work stoppage. Workers have already went on strike to signal their resolve.  There is an element of Australian law that suggests that if two sides in a labor dispute are hopelessly deadlocked, one side can petition for arbitration and work continues.  It is apparently untested, and we would be surprised if the courts give Chevron an out.
  • EU natural gas prices jumped on strike news.

Geopolitical News:

• As we have noted recently, the U.S. and Iran are taking steps to improve relations. For example, frozen Iranian financial accounts held in South Korea have been allowed to be sent to Tehran in exchange for prisoners.  The prisoner swap has been officially approved this week.  However, that isn’t keeping U.S. officials from seizing Iranian oil that violates American sanctions.  We note that the owner of a ship holding Iranian oil has admitted he broke sanctions in court.
  • If Saudi/Iranian relations continue to improve, is there a chance that the KSA will soften its stance on Hezbollah? And will that affect the potential for an Israeli/KSA normalization?
  • There is a political cost to this deal. Iran is generally unpopular and doing anything that smacks of appeasement raises concerns.
  • Despite reports that Iran is slowing down its nuclear enrichment activities, the IAEA continues to report that Iran has expanded its stock of near-weapons grade uranium.
• One sign that the markets believe there will be a thaw with Venezuela is that it’s long moribund bond market is rallying.
• There are Iranian Kurdish groups opposed to the government in Iran that have taken refuge in Iraq. A recent agreement between Tehran and Baghdad calls for Iraqi officials to disarm these groups.  It is unclear if Iraq will actually follow through on this promise, as it might trigger an armed response from Iraqi Kurds.  Although the Kurds are themselves divided, being attacked by an outside force might just unify the Kurds in the face of a common enemy.
• Although Russian oil sales to Europe have been curtailed, they are not eliminated. Small EU nations tend to be buyers still.  The Czech Republic is increasing its purchases of Russian oil, for example.

Alternative Energy/Policy News:

• MIT has announced a new carbon capture technology using an electro-chemical process that uses less energy. Current methods tend to require high levels of energy and if this energy comes from fossil fuels, the gains are mostly cosmetic.
  • Amazon (AMZN, $141.58) is making a major investment in direct carbon capture. We are seeing a trend in large companies backing this technology.
• Geothermal energy is poised for aggressive development. This form of energy is clean and mostly non-controversial.  The problem has always been that there are limited areas where such energy can be economically exploited.  However, new methods of extracting this power are being developed which, if successful, will lower costs and make the power more widely available.
• The U.S. and the KSA are in talks to secure and develop EV metals in Africa. This unusual partnership is being fostered by fears that China will extend its dominance over these metals.
  • Malaysia is set to ban the exports of rare earths, demanding that firms build processing facilities in country for the finished product.
• Not only are cars going electric, but large trucks are too, although progress has been much slower due to the weight of batteries. Elon Musk is looking at building out a massive recharging network for such vehicles but wants public sector support.
• China’s dominance in photovoltaic (PV) is leading to lower prices for solar panels, essentially undercutting producers in the U.S. and Europe. EU producers are warning that they will be facing bankruptcy without state support, either from tariffs or subsidies.
  • In the U.S., support for the PV industry as part of the Inflation Reduction Act hasn’t yet translated into manufacturing, but it is expected to expand solar power in the U.S.
• The annual U.K. wind auction failed to gather any winning bids this week. Rising costs for building facilities is said to be the culprit.
• The EU is just a couple of weeks away from implementing its carbon border taxes. Companies in Europe are scrambling to adjust to higher priced imports.
• As China exports low cost EVs to Europe, the EU announced it will investigate the role of Chinese government subsidies in this surge.  Such studies are usually a precursor to dumping tariffs.

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