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

Falling U.S. inflation is raising hopes that the Fed’s tightening cycle is coming to an end.  That has lifted oil prices, triggering a breakout above the recent trading range.

(Source: Barchart.com)

Commercial crude oil inventories rose 5.9 mb, well above the 0.1 mb draw forecast.  The SPR fell 0.4 mb, putting the total build at 5.5 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 12.3 mbpd.  Exports fell 1.8 mbpd, while imports fell 1.4 mbpd.  Refining activity rose 2.6% to 93.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined.  This week’s build is contraseasonal; current inventories are in line with seasonal levels.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $59.77.  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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002.  Using total stocks since 2015, fair value is $94.27.

Market News:

• China has made a concerted effort to improve energy security. Increasing its imports from Russia and making aggressive diplomatic and investment actions in the Middle East are all part of this goal.  It should be noted that domestic production is also increasing.
  • China has increased residential natural gas prices in a bid to reduce demand.
• Hot weather continues. In the U.S., 6 million Americans are in areas of extreme heat.  Phoenix is threatening to break its previous record of 18 days with 110+ F temperatures. Miami has also seen temperatures near that level and has suffered through 30 consecutive days of  heat indexes over 100 F.

 Geopolitical News:

• As sanctions erode on Iran, Tehran is boosting exports, thwarting the Kingdom of Saudi Arabia’s efforts to lift prices.
  • Iraq is becoming increasingly important in Tehran’s sanction busting.
• Venezuela has seen sanctions gradually erode as the world adjusts to the war in Ukraine. The country is using expanding oil exports to pay down debt.
• Russia tends to view Central Asia as its near abroad. We have noted that recently China has been challenging Russia for this region.  Reports suggest that the Prigozhin mutiny has led the “stans” to further distance themselves from Moscow.
• Rob Malley is a long-time diplomat that specializes in Iran. He was the Iranian envoy (the U.S. doesn’t have formal relations with Iran) for the Biden administration and was involved in the JCPOA talks.  He has been relieved of his duties as the FBI investigates his handling of classified materials.  However, there is growing speculation he may be a spy for Iran.
• Last week, we noted that the U.S. Navy had thwarted efforts by Iran to seize vessels. Apparently, this action wasn’t enough to keep Iran from trying again as the IRGC has now seized a tanker in the Persian Gulf.  Meanwhile, Indonesia has seized an Iranian tanker thought to be engaged in an illegal oil transfer.
• Iran is said to be increasing cyberattacks against Western targets.
• There is increasing evidence that Iran is trying to attack Israel directly via Hezbollah.

 Alternative Energy/Policy News:

• Although car dealers are tending to hold less inventories these days, reports suggest that EV inventories are becoming rather bloated. Current inventories are at about a 92-day supply, twice the industry average. Sales have picked up, but supply is outpacing demand with probably the biggest issue being price.  Also interesting is that hybrid inventories are only 44 days.
• Chinese automakers are targeting the U.S. Chinese EVs are a threat to the U.S. market due to their lower costs.
• Mercedes-Benz (MBGYY, $19.86) is the latest automaker to adopt the Tesla standard for charging connectors. The company joins five other firms, including General Motors (GM, $39.77) and Ford (F, $15.10), in adopting this standard.
• The IEA has released its first report on minerals critical to the energy transition. There is an expanded race to secure key metals involving governments, commodity firms, and automakers.
• The energy transition can’t occur without mining and smelting. Although such activities are generally acceptable in the abstract, they become problematic when they occur close to home.
• The IEA has published an update on the progress made toward zero emissions.
• The seabed is a controversial region for gathering these critical minerals. Island nations and China are keen to develop this source, while European nations are trying to restrict the effort.  Meetings on this issue are underway in Jamaica.
• Climate problems are becoming a challenge for insurers. The U.S. system of state regulation may not be suited to respond.
• Biofuel makers are starting to consider bamboo as a source. The plant grows rapidly and could become a reliable source for ethanol.  We note that on the West Coast biofuels are displacing distillate fuels.

  View PDF

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

Oil prices may be establishing a new trading range between $67 and $75 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories fell 3.8 mb when compared to the forecast build of 0.5 mb.  The SPR fell 1.7 mb, putting the total draw at 5.6 mb.

In the details, U.S. crude oil production fell 0.2 mbpd to 12.2 mbpd.  Exports rose 1.3 mbpd, while imports declined 0.2 mbpd.  Refining activity declined 0.6% to 93.1% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined.  This week’s draw is consistent with seasonal norms.  The seasonal pattern would suggest that stocks should fall in the coming weeks, but this pattern has become less reliable due to export flows.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $58.21.  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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002.  Using total stocks since 2015, fair value is $93.15.

Market News:

• The Netherlands is closing Europe’s biggest natural gas fields due to local concerns about earthquakes. Often oil and gas extraction can lead to earthquakes; Oklahoma has experienced similar issues.  This decision, though, will put the EU at risk of supply shortages.
• The war in Ukraine has led to a massive restructuring of the global energy market. LNG has become an important fuel, and there has been a clear expansion of its use.  This expansion has led to a rapid increase in the infrastructure for the fuel, including gasification plants in the Middle East, Australia, Canada, and the U.S.
  • China has embarked on long-term contracts with suppliers, which establish the funding for investment. The EU, likely because of expectations of renewable growth, is less open to long-term contracts.  If natural gas usage continues, Europe could find itself isolated.
  • Russia’s oil refineries hit new highs in utilization, which may mean that Russia intends to meet its OPEC+ obligations by replacing oil exports with product exports. Russian oil exports have been affected by the war.
  • Russia’s oil flows to India have been at deep discounts, helping to improve India’s economy.
  • Russian natural gas is still flowing through Ukraine, but the current agreement ends next year, and Kyiv expects Russian gas flows to stop.
• There are some unusual actions being taken by the Kingdom of Saudi Arabia (KSA) regarding oil flows. For example, consistent with its decision to reduce oil flows, Saudi oil exports fell to a five-month low in April.  However, there are numerous reports that the KSA is storing 20 mb of oil on 10 tankers in the Red Sea.  We also note a spike in supertanker rates, which may be tied to the KSA’s decision to float oil storage.
  • The Permian Basin is now producing more oil than the KSA’s giant Ghawar field.
  • So far, the KSA’s bid to boost prices has failed to work.
• The summer solstice came this week, marking the onset of astrological summer (meteorological summer began on June 1). We are seeing a strong heatwave in the South, especially in Texas.  Hot weather boosts electricity demand and usually is bullish for natural gas prices.  We note Texas degree days are running well above normal.

(Source: Reuters)

• • Texas isn’t alone in its drought; Iran is facing a crisis as well.

• Mexico has joined several firms in a deep-water oil and gas project.
• Guyana is delaying offshore oil-block auctions in a bid to increase the number of participants in its oil exploration.
• Ship channel dredging will allow larger oil tankers to directly load oil and products from the Texas coast.
• The DOE suffered a data breach tied to Russian hackers.
  • DOE Secretary Granholm failed to disclose stock holdings; it is unclear if this fact will lead to her ouster.

 Geopolitical News:

• The U.S. is still buying uranium from Russia for American power plants. Although nuclear power is an attractive alternative energy, the lack of a non-Russian supplier is a risk.
• One of Russia’s long-term geopolitical goals is a warm water port. Although the warming of the Arctic may give Moscow the sea access it wants, it has eyed the Middle East as a possible path to the ocean.  As Iranian and Russian relations improve, Russia is looking to build access to the Indian Ocean through Iran.  A risk to this path is that the Arab states in the Persian Gulf have tended to side with the U.S.  However, as relations fray between Washington and these Arab states, the risks in using Iran for sea access decline.  Thus, the recent thaw between Riyadh and Tehran is a benefit to Moscow.
• We are seeing a concerted effort by China to secure energy sources. China appears to be deploying an “all of the above” strategy, including both alternatives and fossil fuels.  What is important here is that China is most interested in energy security, with less regard for the source.
• Central Asia isn’t just the focus of China and Russia. Germany is also looking to secure energy from the region and held talks with Kazakhstan
• As we noted last week, we were mostly wrong about an Iran nuclear deal. What we got right was that the JCPOA was dead.  What we didn’t expect was that the U.S. would opt for a limited deal in what looks like a bid to reduce regional tensions.  We doubt this will increase global oil supplies much since Iranian sanctions are far from tight, but easing tensions will likely make more oil available to the West.  We suspect the White House is fully focusing on November 2024, and although there will be a political cost to a thaw, the chances of lower oil prices are probably seen as a greater benefit.
  • It isn’t clear what will actually be agreed to in the deal. The U.S. appears willing to accept Iranian uranium enrichment to around 60%, which is less than weapons-grade but still shows that the country can reach the 98% required for bombs.  Particles enriched to nearly 84% have already been reported.
  • Iran will receive some funds that are currently frozen, and the U.S. will get prisoners freed.
• The KSA has invited Iran’s president to Riyadh for an official visit.
• China has agreed to build a nuclear power plant in Pakistan.
• Here is a cool map of China’s energy infrastructure.

 Alternative Energy/Policy News:

• One of the emerging themes for the next few years will be the choice Western nations face on EVs. If the goal is extensive adoption, the most effective way of achieving this is to allow Chinese imports.  China’s EV industry has improved rapidly and is now producing world-class cars at reasonable prices.  On the other hand, if the goal for Western nations is re-industrialization, Chinese cars should be restricted.  So far, we have generally expected Europe to be much more open to Chinese EVs compared to the U.S.  However, there is evidence that the EU is rethinking that position.
  • Tesla (TSLA, $268.75) is rapidly becoming the connection standard for the EV industry as more EV makers adopt its standard. Doing so gives car owners access to Tesla’s charging stations.
• In fact, meeting climate goals is often in direct conflict with meeting geopolitical goals. There are serious doubts as to whether the West can move toward carbon neutrality without China.
• Solid state EV batteries have the potential to revolutionize the industry. Toyota (TM, $157.40) has a test vehicle it claims has a range of 932 miles with a 10-minute charge.  If high range/short charging becomes the norm, ICE vehicles will be much less attractive.
• The U.S. is leading a critical minerals partnership in a bid to create a strong supply chain for metals needed for the energy transition. Presently, China holds a commanding position in these metals, but the U.S. and its allies want to build a supply network that prevents China’s dominance.
  • It should be remembered that part of the reason for China’s dominance is that it was willing to accept the environmental costs of mining and processing these metals.
  • The U.S. is facing calls from nations with key minerals but without free trade agreements with the U.S. to join this partnership. So far, Washington has restricted the subsidies, but if the U.S. doesn’t expand the list, China might become an alternative funder.
  • Minnesota may become an important source of nickel, but the permitting process could be daunting.
• Chinese regulators approved a thorium reactor. Thorium reactors have some major advantages over uranium reactors.  They didn’t get used in the early days of nuclear power because nations wanted the dual option of being able to make nuclear weapons, and  thorium can’t be weaponized.  In addition, this reactor will use molten salt, which is another significant benefit.
• Hydrogen is a fuel that offers promise in providing clean power but tends to fail at gaining traction due to costs. The U.K. is looking to use the fuel for home heating but is struggling with the details.  In the EU, there is a program to expand the pipeline network to move hydrogen.
• The U.K. has opened its first deep geothermal project in 37 years.
• Although there is great hope for fusion power, the reality is that we are a long way from commercial fusion power.
• The Biden administration announced an increase in biofuel use, but surprisingly, the ethanol mandate was less than expected. Even with other biofuels, the mandates were less than expected.  Biofuels replace fossil fuels to some extent, but also still require fossil fuels in production.  In general, biofuels are more about reducing U.S. dependence on foreign oil and are an aid to farmers.  Corn ethanol, for example, reduces greenhouse gas emissions by 19% compared to gasoline.  The best benefit comes from biomass and cellulosic ethanol.  But because neither comes from a cash crop, support for these fuels is lacking.

  View PDF

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

Oil prices may be establishing a new trading range between $67 and $75 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories rose 7.9 mb when compared to the forecast draw of 1.5 mb.  The SPR fell 1.9 mb, putting the total build at 6.0 mb.

In the details, U.S. crude oil production was steady at 12.4 mbpd.  Exports rose 0.8 mbpd, while imports were flat.  Refining activity declined 2.1% to 93.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined.  This week’s outsized build puts inventories back at seasonal norms.  The seasonal pattern would suggest that stocks should fall in the coming weeks, but the seasonal pattern has become less reliable due to export flows.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $57.11.  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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002.  Using total stocks since 2015, fair value is $92.53.

Market News:

• The IEA released its forecast for oil demand over the next five years. The group estimates that expanding EV usage will dampen gasoline demand and thus lead to a peak in global oil demand after an almost continuous rise for 80 years.

• As the above chart shows, oil demand is forecast to fall dramatically mostly due to negative growth for road transportation.  We have serious doubts that this will actually occur, but oil producers, especially those beholden to shareholders, have to be aware of this forecast since it suggests that investment in new production is at risk of being stranded.  Therefore, shareholders are likely to demand a shareholder return instead of investment into new production, and it appears this trend is already beginning to happen.  This forecast is likely to add to bullish pressure for prices, especially if demand exceeds expectations.
• Oil prices continue to mark time in the wake of the OPEC+ announcement. Our take is that the U.S. wants prices around $60 per barrel and the Saudis have a target of at least $80 per barrel.  Because of this, we are sitting in a netherworld between these two price points.  Worries about Chinese demand are acting as a bearish factor on prices and offsetting the supply cuts coming from OPEC+.
  • We note that it’s hot in China, but so far, coal and LNG demand have been remarkably modest. This situation would suggest weak industrial activity.
  • OPEC+ production fell last month, with some sources suggesting a 67 mbpd cut while others report a lesser one. In any case, we are seeing a decline in supplies.
  • There are reports that the Saudis were targeting bearish oil speculators. Given the market’s reaction, that idea makes some sense.  We note that each OPEC+ announcement seems to be having less of a bullish impact.
• U.S. crude oil exports have been increasing, but we are starting to get close to capacity at some export facilities.
• Natural gas production in the Permian Basin has hit a new record high.
• There is always tension between commodity project development and environmental concerns. Oil drilling in the Amazon Delta is pitting oil drillers against environmentalists.
• Much to our surprise, it looks like the U.S. will add 3.0 mb to the SPR. Of course, this injection pales in comparison to the sales over the past year.  We note the Biden administration wants to purchase another 12.0 mb over this coming year.
• Venezuela has suffered falling oil production for years. However, we are starting to see a slow recovery in this area.  As Russian sanctions change global oil flows, the U.S. has begun easing sanctions on Caracas.

 Geopolitical News:

• Although Putin and Xi seem to have a close personal relationship, the geopolitics of China and Russia are often contentious. One reason is that both nations have interests in the same regions, with one area of potential conflict being Central Asia.  Russia views this region as part of its “near abroad” as some of these states were part of the Soviet Union.  China wants the natural resources of these nations and is making investments in a bid to improve ties.  As nuclear power demand rises, China is trying to encourage the Central Asian nations to supply it with uranium.  The region is rich with this material.  This development is raising tensions between China and Russia.
• There are reports that U.S. and Iranian negotiators have made progress in restarting the nuclear deal. We remain highly skeptical of such reports.  Although corralling Iran’s nuclear program would be potentially positive, the political costs of helping Iran would be high.  Also, we doubt that the incumbent administration could promise any agreement would be binding for future administrations barring an actual treaty agreement, which seems unlikely.
  • The U.S. has denied having these reported talks, though that doesn’t necessarily mean they didn’t happen. Israel reported that the U.S. and Iran held talks on what might be a narrowing set of goals.  At the same time, the lead Iranian negotiator has been invited to Norway for talks.  Overall, we think the Europeans really want access to Iranian oil and may be trying to foster talks.  As we noted above, we think the political hurdles are too high for success.
  • Furthermore, the U.S. has begun to offload the Iranian oil it seized due to sanctions. If there were serious efforts being made to restart nuclear negotiations, we doubt this would be happening.
  • It has been reported that Iran is sending drone parts for assembly in Russia; again, if Iran were really trying to restart talks, the U.S. wouldn’t be issuing this intelligence.
• The recent dam rupture in Ukraine has been in the news but the damage done to the Tolyatti-Odesa ammonia pipeline is also important. Ammonia is one of the key building blocks in fertilizer production.  This pipeline is the world’s largest but has not operated since the Russian invasion.  The attack on this pipeline may make Moscow less likely to extend the grain deal.  Natural gas is important to ammonia production, and the loss of this pipeline could have a minor bearish impact on European natural gas.
• In the wake of SoS Blinken’s trip to the Kingdom of Saudi Arabia (KSA), Riyadh made it clear that it wants support for a civilian nuclear program. The Saudi foreign minister warned that the U.S. faces competition from other nations.  The KSA is pressing for a civilian nuclear program in return for recognizing Israel.
  • There are reports that the U.S. and the KSA both threatened each other after the kingdom cut oil production. It appears that recent visits were designed to repair relations.
• We continue to monitor the steady flow of leaks concerning the Nord Stream Pipeline sabotage. Reports now suggest the CIA warned Ukraine not to attack the pipeline.  It remains unclear who did attack the pipeline as both the U.S. and Ukraine had an incentive to destroy the structure because it more closely tied Germany to Russia.  These leaks do suggest the U.S. is trying to distance itself from the attack and pin the event on Ukraine.
  • In related news, Dutch intelligence also reportedly warned the U.S. that Ukraine was planning an attack on the pipeline.
• Azerbaijan is making diplomatic engagements with regional powers likely in an effort to reduce the risks to oil flows.
• As relations between the KSA and China improve, Chinese businesses are “streaming” to the kingdom in search of investment opportunities.
• China is rapidly expanding its refining capacity and, according to the IEA, is poised to become the holder of excess refining capacity. Since there is little direct consumption of crude oil, this excess capacity will tend to narrow profit margins for refiners.
• Russia has resumed oil exports to North Korea. Given that North Korea has limited capacity to pay for such oil, we suspect that Moscow is swapping oil for military equipment.
• The EU is looking to ban all Russian pipeline gas imports by the end of the year. This move would most harm Hungary.

 Alternative Energy/Policy News:

• EV growth is projected to rise steadily in coming years, but there are serious doubts about the availability of battery metals. The dependence on China for batteries remains a major issue as well.
  • It’s arguable that short-sighted U.S. policies for the battery industry helped create China’s dominance.
  • Battery metals are critical to the EV transition; the lack of mining talent could boost costs in the future.
  • There is a significant price war going on in China’s EV market. A major producer has cut prices, suggesting the price war is spreading.
  • BYD (BYDDY, $66.39), the Chinese auto company, is poised to become the world’s largest EV producer. It specializes in low-cost vehicles and makes one for the world market that costs just over $11k.  We note BYD is also building the infrastructure to manufacture sodium-ion batteries, which are much cheaper than lithium-ion batteries.
• As more investment funds flow into alternatives, we continue to monitor new technological developments. Work being done on plasma drills could expand geothermal power which is nearly emissions-free.
• Although nuclear power is often heralded as a solution to climate change and carbon emissions, in reality, the U.S. has allowed its uranium industry to unwind, preferring to acquire the metal from other places. When the world was considered safe for trade and investment, this policy may have made sense; it doesn’t now.
• In our 2023 Geopolitical Outlook, we discussed the race for space. Part of the allure of space is the possibility of beaming electricity from orbiting solar panels that would be exposed around the clock.  Although seemingly farfetched, a team at CalTech is testing such a program.  Obviously, if this works it becomes a game changer for energy.
• Back on Earth, the expansion of wind and solar energy is being hamstrung by the lack of grid expansion. This is why there was an interest in Congress to address permitting in the debt ceiling negotiations.  Smoke is a problem, too.
• Summers are becoming increasingly unpleasant for both coasts but especially for the West Coast. There have been several news items suggesting a rapid warming trend; however, this trend may be due more to non-recurring factors and may not actually signal permanent changes.

  View PDF

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

Oil prices continue to trade in the lower part of the trading range despite the Saudis’ announcement of a unilateral production cut.

(Source: Barchart.com)

Commercial crude oil inventories fell 0.5 mb when compared to the forecast build of 1.5 mb.  The SPR fell 1.9 mb, putting the total draw at 2.3 mb.

In the details, U.S. crude oil production rose 0.2 mbpd to 12.4 mbpd.  Exports fell 2.4 mbpd, while imports declined 0.8 mbpd.  Refining activity jumped 2.7% to 95.8% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined.  As the average line shows, we are nearing the seasonal draw period, although that pattern has become less reliable with the U.S. exporting crude oil.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $59.61.  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.  With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002.  Using total stocks since 2015, fair value is $93.27.

Market News:

• The outcome of the OPEC+ meeting was that the Kingdom of Saudi Arabia (KSA) announced a large production cut independent of the rest of the cartel. The KSA will lower its output to 9.0 mbpd, and oil prices initially rose on the announcement.  Below the surface, there are growing tensions within the cartel.  OPEC traditionally sets output quotas based on production capacity.  However, transparency on capacity is lacking, meaning that members have an incentive to overstate their capacity, which would then lead to a higher quota.  In recent years, the cartel has struggled to meet its production quotas; in fact, their new term is “target,” which is telling.  Saudi Arabia was pressing African members to reduce their stated capacity which would mean lower quotas, but naturally they resisted.
  • What’s the motive for the KSA to go it alone? We presume there are three reasons behind the decision.  First, the IMF estimates that the kingdom needs an oil price of $80 to meet its fiscal requirements.  Now, obviously, the IMF is calculating a total revenue number, so lowering production does reduce that calculation unless the price exceeds the lost revenue from the production cut.  We suspect the crown prince has a price in mind and the oil minister had to hit it, although it might be the case that the leadership has not thought through the full ramifications.  Second, we suspect MBS continues to harbor animosity toward the Biden administration.  It’s rather evident that there is a disparity between Washington and Riyadh on oil pricing.  The U.S. wants a price below $70 per barrel, while the KSA wants a price north of $80.  Higher gasoline prices are politically unpopular and this action has the potential to cause just that.  SoS Blinken is in the KSA, so the decision to cut production will surely make talks contentious.  We do note Blinken’s trip is centered on the KSA normalizing relations with Israel.  Saudi Arabia has indicated that in exchange for recognizing Israel, Riyadh wants Israel to transfer its civilian nuclear technology.  Third, the KSA may view the voluntary cut as a way to gain further control over the oil market.  If the kingdom is holding onto the bulk of the excess reserves, it will take over the role of swing producer.  It’s notable that the Saudis gave up this role in 1985, triggering a near collapse in prices.  It may be that the new generation of leadership is simply unaware of this history.  The role only works if no other nations expand capacity.  It’s interesting that the Saudis didn’t ask Russia or the UAE for cuts, which further isolates the KSA in the cartel.
  • Either the Saudis really need higher oil prices, or they are assuming that other suppliers won’t fill the gap created by the KSA cut.
  • The cartel did agree to consider lower production targets for 2024.
• China is starting a deep well project in Xinjiang which is projected to drill down 36k feet; ostensibly, this is a science project, but there is also talk about trying to engage in deep earth oil exploration. Recent comments from President Xi about oil independence are driving these sorts of projects.
• Various dredging projects off the coast of Texas are allowing larger tankers to load up Texas oil for export.
• The U.S. rig count has dropped, raising fears about future U.S. oil production. We also note that operating conditions appear to be deteriorating.  At the same time, Exxon (XOM, $105.73) claims that refracking existing U.S. wells could double output.
• Saudi Arabia is looking to invest in Iraq’s natural gas industry.
• Environmentalists are targeting LNG exports by forcing insurance companies to stop providing coverage.

 Geopolitical News:

• We have written on the de-dollarization in oil markets. We are now hearing about the downsides since Russia is apparently sitting on billions of INR and is struggling to do something with them.  India has capital controls that restrict Russia’s access to India’s capital markets, and it isn’t obvious whether the forex markets can absorb Russia’s sale of its holdings.
• There are reports that Ukraine planned the attack on the Nord Stream pipelines and the U.S. was aware of the plans. This news adds to the likelihood that Ukraine was responsible for the attack.  If so, this would likely strain relations with Germany.
• European nations and the U.S. are restarting talks on how to deal with Iran’s nuclear program. Recent reports about Iran’s enrichment program and the hardening of its research sites are leading to an attempt to return to diplomacy.
  • The U.S. and U.K. navies responded to a merchant vessel in the Strait of Hormuz that was being harassed by IRGC speedboats. Iran, meanwhile, announced a new regional maritime alliance that would exclude the U.S.  We struggle to see why nations like the UAE or Saudi Arabia would join with Iran on such a pact (given that Iran is the instigator of maritime problems in the Gulf), but the announcement is a development that we will be tracking going forward.
  • Iran appears to be backing away from the purchase of Su-35s from Russia.
  • The UAE is engaging with Iran while at the same time trying to obtain security guarantees from the U.S. The UAE may be trying to determine how far the U.S. will go in providing security to the region, and if the guarantees are seen as lacking, the emirate may decide it needs to have better relations with Tehran.
  • Iran has unveiled a missile it claims to be hypersonic. Such missiles can generally evade existing defense systems; thus, the announcement is raising concerns, especially for Israel.  In response, the U.S. has added even more sanctions on Iranian and Chinese entities involved in Iran’s missile program.
• Venezuelan President Maduro is visiting the KSA this week to discuss various investment ideas. Venezuela was under sanction, but the Biden administration has eased restrictions to reduce oil prices.  The visit, occurring just before SoS Blinken arrives in the KSA, is an interesting juxtaposition.

 Alternative Energy/Policy News:

• We have been noting the rise in resource nationalism. Mexico is becoming more aggressive in restricting foreign company access to its mining resources, which could boost prices on key metals.
• Texas is an energy powerhouse. Not only does the state produce the most crude oil but it  is also a leading producer in wind, solar, and nuclear power.  State lawmakers were considering bills to curb wind and solar projects, but those bills appear to have mostly died.  In many respects, Texas is a prime example of the “all of the above” solution to energy issues.
• Climate change concerns are causing some parts of the U.S. to become uninsurable.
• As we have noted over the past few weeks, China dominates the solar energy industry. It has been the low-cost producer of panels and other components.  However, the U.S. is now subsidizing this industry and there are signs that firms that have previously struggled to survive against China are now seeing a way forward.
• China’s BYD (BYDDY, $64.40) has moved up in the rankings of suppliers of EV batteries. It is now second only to Contemporary Amperex Technology Co. (300750.SZ, CNY, 207.30) after overtaking LG Electronics (066570.KS, KRW, 125,700).  The fact that two Chinese companies dominate the EV battery market highlights the difficulty that the auto industry will have in isolating China.  As we have noted in recent reports, China’s EV industry has rapidly become world class, putting the West in a difficult spot.  If the goal is rapid adoption of EVs for energy transition purposes, it makes more sense to import Chinese EVs; however, such a policy will likely devastate the auto sector in the West and undermine the re-industrialization process.  On the other hand, restricting imports will drive up costs and slow the energy transition.  We note that China’s export data for May was disappointing, but one bright spot has been EV exports.

(Source: Capital Economics)

• Hydrogen remains a potential replacement for hydrocarbons. However, the production of hydrogen can come from both “dirty” and “clean” production methods, which has led to a color coding of hydrogen.  The Biden administration is trying to create a regulatory path for fostering the development of the fuel that will go along with a subsidy program to boost production.  The subsidy program still requires decisions about what will be covered.  The industry wants loose standards, while environmentalists are pressing for only the “greenest” of sources.  Although we don’t know the outcome yet, this administration tends to try to split the middle on these issues, which will tend to please no specific group.

  View PDF