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

Crude oil decisively broke its recent $72-$82 per barrel trading range.  Fears of recession,  exacerbated by widespread banking problems, weighed heavily on oil prices.

(Source: Barchart.com)

Crude oil inventories rose 1.6 mb on forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.2 mbpd.  Exports rose 1.7 mbpd, while imports fell 0.1 mbpd.  Refining activity rose 2.2% to 88.2% 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 have slowed.  Levels remain above seasonal norms, but with refinery activity starting to ramp up for summer, we should see some declines in the coming weeks.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $52.32.  Although we think there is enough geopolitical risk in the world to prevent a decline to this level, it does suggest the oil market is dealing with rather weak fundamentals.

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 2001.  Using total stocks since 2015, fair value is $92.96.

Market News:

• The Biden administration announced that it approved the Willow oil project on Alaska’s North Slope, which is expected to produce 180 kbpd. ConocoPhillips (COP, $101.99) has had three drilling pads approved; the company had asked for five.  The administration is facing political tensions over the approval.  On the one hand, high oil/gasoline prices are never politically popular, but on the other, the Democratic Party coalition has a large environmental wing that has consistently opposed North Slope projects.  The White House is trying to “thread the needle” by arguing that the project is smaller than initially projected, but that will be of little comfort to environmentalists.  In addition, the administration is expected to limit offshore oil drilling in the Arctic Ocean.
• The IEA report confirmed a large jump in global inventories, which mirrors the increase seen in the U.S. (see chart above). Rising production offset a less robust lift in consumption.  Although Russian oil exports did decline, production remains higher than expected.
• The CERA conference, which was held last week in Houston, featured oil industry execs suggesting that oil and gas production will rise, while climate change advocates continue to point out that temperature goals won’t be met if the oil execs turn out to be right. To some extent, this is a timing issue.  Shifting to a new energy source takes time and often requires an exogenous catalyst; for example, the shift to oil from coal was bolstered by WWI and the naval transition away from coal.  So far, we have yet to see that catalyst.
• As we noted last week, there is increasing evidence that the shale boom may have peaked. If so, attempts by the U.S. to withdraw from the Middle East may be premature.
• Lower oil prices are supporting global growth.
• Overall, winters appear to be getting warmer, and that trend will tend to depress natural gas demand. We note that European steel mills are reopening due to lower energy prices and higher steel prices.  In addition, a plethora of LNG projects could reduce natural gas prices in the future.  More nations are building regassification facilities, but there is risk of overinvestment on both the supply and demand side.
  • China may take advantage of lower LNG prices, but Japan is buying less.
• The EU plans to end the sales of internal combustion engines by 2035, but Germany and others are pushing back. France, which supports the measure, is working to undercut Germany on this issue.
• Oil tanker rates are rising substantially, and market reports suggest that China’s reopening is the key factor.
• OPEC+ has seen mostly steady demand this year as falling Western demand is offset by China’s reopening.
• The House GOP is putting together a major energy bill designed to boost fossil fuel production. It is unlikely to pass the Senate, but even if it does, the president will likely veto it.  However, it does create a “marker” for the future.  The House is also trying to reverse the Biden administration’s decision to suspend tariffs on imported solar panels.

 Geopolitical News:

• In a blockbuster development, the Kingdom of Saudi Arabia (KSA) and Iran have agreed to resume diplomatic relations in a deal brokered by China. Beijing has gained international stature with the deal, something the U.S. would not have been able to accomplish due to the severing of relations with Iran in 1979.  Here are our key takeaways:
  • This is a major win for China. Foreign powers have tried to play the role of “fair broker” in the Middle East, but eventually, all who tried have ended up choosing sides.  China isn’t at that stage yet, although we doubt it will be able to maintain neutrality indefinitely.  Nevertheless, if China can use its clout to stabilize the region, it will boost China’s influence at the expense of the U.S.
  • An important reason for China’s success is that both sides are fatigued by the status quo. Iran has been isolated by U.S. sanctions and internal unrest.  Its economy has been hit by protests and a sharp depreciation in the IRR.  The KSA would like to end the conflict in Yemen.  Improving relations could allow Iran to more easily circumvent sanctions, and Tehran may be able to stabilize the conflict in Yemen by reducing support for the Houthis.  Once both sides regain their footing, it may be hard to maintain this thaw.
  • One motivation behind the KSA’s agreement to the deal (seemingly something it was considering even before China got involved) was to use the thaw as leverage against the U.S. The Saudis have already indicated what the cost of continued U.S. support will be: Riyadh wants a civilian nuclear power program, official security assurances, and less scrutiny of arms purchases.
    • U.S. relations with the KSA have been shaky for some time. The Saudis were furious with Washington after the attack on Ras Tanura in 2019.  The U.S. seemed to signal that it would retaliate, but then did nothing, thus undermining the security guarantee.  President Biden calling MBS a “pariah” hasn’t helped either.  The Saudis appear to be moving in the direction of being less aligned with the U.S.
  • Other Persian Gulf states will likely be willing to deal with Iran if the KSA is on board.
  • At the same time, we doubt Iran will reduce its support for proxy forces in the region. It won’t abandon Hezbollah, for example.  At some point, diplomatic progress will likely cease.
  • Also, if there is an event in the region, the KSA will likely find that China isn’t much help. On the other hand, we note that China, Russia, and Iran are holding naval drills in the Gulf of Oman, suggesting China is at least trying to show that it can project power in the region.
  • For Israel, this announcement is a problem. Israel always wants to keep the possibility open of using military force against Iran, which would entail overflying KSA airspace.  That might not be possible now.  There are elements in Israel upset with the Biden administration for not being “harder” on Tehran.
  • Overall, we don’t expect this agreement to affect OPEC+ discussions or policy. Most members are near capacity anyway and the world will need more, not less, oil from the cartel.
• In other Iran news, the government announced it has pardoned 22k protestors.
• One of the features of war is miscalculation. Since war is difficult, nations entering a conflict often underestimate the costs and overestimate the strengths of their positions.  With the war in Ukraine, Russia assumed European nations were so dependent on Russian oil and gas that they would capitulate and not support Ukraine.  The West assumed that the combination of sanctions and the lack of Western oil technology would lead Russian energy production to collapse, forcing Russia to end the conflict with Ukraine.  So far, neither has occurred.  And so, it looks more like we are in a war of attrition.  Russia does face a long-term issue with oil production due to the lack of Western technology, but that degradation will likely take some time to become clear.  Moreover, Europe has discovered new sources of oil and gas, but at higher prices, and if the shale boom has peaked, then Europe may have only found a short-term solution to its supply problem.
• During the Obama administration, the policy aims of the U.S. and Israel regarding Iran diverged. The U.S. was trying to reduce tensions with Tehran, which Israel vehemently opposed.  However, as Iran continues to enrich uranium, policy differences have begun to narrow significantly.
  • The U.S. Treasury implemented additional sanctions on Iran due to human rights abuses.
• Russian President Putin rejects the narrative that Ukraine sabotaged the Nord Stream pipelines.

 Alternative Energy/Policy News:

• Tesla (TSLA, $181.65) is vowing to eliminate rare earths in its autos. The report caused rare earth companies’ equity values to drop.  As we have noted before, China dominates rare earth processing and mining.  The West is trying to create additional supply but faces daunting permitting constraints.
• China is limiting access to cobalt as prices fall to a 32-month low.
• President Biden and European Commission President von der Leyen met in Washington in an attempt to structure a very narrow “free trade deal” that would allow European companies to extract Inflation Reduction Act subsidies without moving operations to the U.S.
• The collapse of Silicon Valley Bank has raised concerns about climate tech funding.
• As we noted last week, Volkswagen (VWAPY, $13.00) is aggressively investing in EV production.
• China has actually built enough solar capacity that electricity prices have turned negative in some areas.
• One topic that was widely discussed at CERA was moving to hydrogen.

  View PDF

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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 1.7 mb compared to a 1.9 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production declined 0.1 mbpd to 12.2 mbpd.  Exports fell 2.3 mbpd, while imports rose 0.1 mbpd.  Refining activity rose 0.2% to 86.0% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We have been accumulating oil inventory at a rapid pace, even without SPR sales.  This week, while there was a modest drop in inventory, we remain well above normal seasonal levels.

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 2001.  Using total stocks since 2015, fair value is $93.31.

The Unaccounted Problem

The DOE’s weekly report is a combination of survey data and estimates.  Although traders focus on the weekly reports, the government views the monthly reports as the most accurate.  Unfortunately, the monthly reports are issued with a two-month lag. For practical purposes then, the weekly data, though imperfect, is what moves markets.

Line 13 of the petroleum supply section of the petroleum balance sheet is a plug number called “adjustment.”  It was previously called “unaccounted for crude oil” as it balances the known sources of crude oil (production, net imports, stock change) with the level of crude oil consumed by the domestic refining industry.  Lately, this number has been rising.

When the reading is above zero, it indicates that more crude oil was refined that week than was identified in the surveys or estimates.  What we know is that there is more crude oil (and/or associated products) available, but what is being missed is quite important.  The DOE argues that blending components used by refiners are possibly being included in the count of crude oil.  However, it is also possible that (a) production is higher than estimated since production in the lower 48 is an estimate, (b) imports are higher, (c) exports are lower, or (d) there is more oil being moved from inventory.  Obviously, how this unaccounted crude oil is accounted for matters a great deal.  Our guess is that it’s likely a combination of blending stocks being counted as crude oil and, perhaps, lower exports.  In any case, the monthly numbers should provide some clarity…in May.

Market News:

• The Columbia University Center on Global Energy Policy released a report on investing in a market that is transitioning away from fossil fuels. The report notes that not only are investments in oil and gas production falling, but the investments still occurring are increasingly being made by state-owned oil companies, most of which are in the Middle East.  The private sector isn’t investing for several reasons, one of which is a history of low returns in the industry as investors are demanding better returns.  If these trends continue, it suggests that oil prices will tend to be elevated even as demand weakens.  The CEO of Saudi Aramco (2222, SAR, 34.95) warns that persistent underinvestment will keep oil supplies tight.
• U.S. LNG is filling the gap caused by the end of Russian natural gas sales to Europe. The EU is moving to consolidate purchases in a bid to lower prices.
• It’s CERA week in Houston. One of the key topics is the lack of spare capacity in oil production.  Another important item emerged from the shale patch which warned that the best days may be behind the industry, meaning that OPEC+ can reassert control over oil prices.
• This map shows European fuels of choice for electricity production.
• The DOE is preparing to refill the SPR…next year.

 Geopolitical News:

• We have been monitoring the ongoing speculation surrounding the sabotage of the Nord Stream pipelines. A recent New York Times article suggests that a Ukrainian group, not directly affiliated with the government, was likely responsible.  Although Seymour Hersh caused a stir recently when he suggested that it was a U.S.-led attack, most analysts felt that Ukraine had the strongest incentive to carry out this attack.  If the Ukrainians turn out to be responsible, it would adversely affect the country’s relations with Germany.  A proxy group would give Ukraine plausible deniability, which would help with this issue.  As expected, the Ukrainian government has denied responsibility.
  • Russia has decided to mothball the remaining parts of the Nord Stream 1 & 2 in light of last year’s sabotage.
• This week’s BWGR discusses the potential emergence of a “petroyuan” structure to create an alternative to the dollar/Treasury reserve system. Reports indicate that Russian oil exports are being paid in a variety of currencies.  Since Russia has been excluded from the dollar system, it makes sense that Moscow would accept various currencies for payment.  On an interesting note, even the use of other currencies hasn’t been completely successful in avoiding U.S. sanctions.  Some sort of digital payment mechanism will likely be required in order to avoid the U.S. banking system completely.
• There has been a spate of apparent poisonings in Iran, which seem to be targeting girls’ schools. It is not clear whether these attacks are related to the hijab protests or are coming from elements in the Taliban who oppose educating women.
  • Iran is promising to cooperate with the IAEA after the recent findings of enriched uranium particles at near-weapons-grade levels. The fact that Tehran is trying to at least portray it is working with the IAEA suggests that it is not ready to declare itself a nuclear power.
  • Iran announced that the “questions” of enrichment have been answered, although the IAEA hasn’t confirmed this assertion.
  • On the other hand, Iran has agreed to reinstall monitoring cameras at its nuclear facilities.
  • Interestingly enough, the U.S. has not responded strongly to the news of enrichment, while Europe, on the other hand, has been calling for censure.
• The U.S. fears that Iran is using Iraq to acquire dollars and evade sanctions. In response, the Treasury Department is tightening transfers.  Unfortunately, this decision is adversely affecting Iraq’s economy.
• Russian tax revenue from oil and gas sales fell 48% in February. Lower prices and reduced volume led to the drop.
  • Uzbekistan is reluctantly turning to Russia for natural gas.
  • Russia is exporting oil to the UAE, and it is likely that this oil is being “laundered” for sale to areas that are observing sanctions on Russia.
• As Russia and Iran draw closer, the Gulf Nations and Israel are pressing Moscow not to sell arms to Tehran. Russia, like China, has been trying to woo all parties in the Middle East, but it is finding that deep divisions exist.  Although both China and Russia have interests in developing closer relations with Iran, building a coalition will, almost by necessity, exclude the Gulf States and Israel.  As Europe and the U.S. have learned over the years, managing differences in the region is difficult.  At the same time, the U.S. is expressing greater concern over the growing Iranian/Russian ties.
• The Kingdom of Saudi Arabia has sent $5 billion to Turkey to bolster Ankara’s foreign reserves.

 Alternative Energy/Policy News:

• The IEA released its CO₂ emissions report for 2022. Although emissions reached a new record high, the pace of emissions growth is actually declining.
  • Carbon capture projects are continuing to develop, but the pipelines that carry CO₂ to storage are unregulated at this point.
• Agroforestry is the practice of planting trees around farm fields. The idea is that the trees will help prevent soil erosion and can provide shelter for livestock.  Government funding for increasing agroforestry is being considered.
• The anti-ESG movement has begun to target insurance companies that may be denying coverage due to climate change concerns. The industry is pushing back, but it may be impossible for the government to force firms to cover areas adversely affected by climate issues.
• In the early days of the auto industry, firms often attempted to vertically integrate operations. As the industry matured, it decentralized, which led to multiple firms supplying all sorts of inputs.  Due to insecurity of supply, EV makers are attempting to follow the early founders of car manufacturers by vertically integrating.
• Volkswagen (VWAGY, $18.99) will build a battery plant in North America to take advantage of the subsidies offered by the Inflation Reduction Act. This news will likely trouble EU policymakers, who have been critical of the “buy American” elements of the act.
• One of the problems with the transition to clean energy is that China dominates the production of the needed components. As the world devolves into blocs, the U.S.-led bloc may, in the short run, either continue to use fossil fuels or import clean energy components from China.
• China is reportedly building “breeder” nuclear reactors. Although such reactors can be used to generate power, they also create plutonium which can be used for nuclear weapons.
• Geothermal power is attracting attention from industry and government.
• Environmentalist groups have been trying to curb oil and gas production by restricting pipeline expansion. Data from the DOE suggests that they were remarkably successful.  Meanwhile, oil companies are preparing the groundwork needed to acquire subsidies for investments in carbon capture.

  View PDF

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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 1.2 mb compared to a 1.8 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd.  Exports rose 1.0 mbpd, while imports fell 0.1 mbpd.  Refining activity fell 0.1% to 85.8% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We have been accumulating oil inventory at a rapid pace, even without SPR sales.  The primary culprit is low refining activity, which should pick up later this year.  The rapid rise in stockpiles is a bearish factor for oil, and current stockpiles have already exceeded the five-year average peak normally seen in early summer.

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 2001.  Using total stocks since 2015, fair value is $94.18.

Natural Gas Update:

Natural gas prices have been under pressure this winter, mostly due to mild temperatures.

This chart shows the deviation of population-weighted heating degree days[1] for the U.S. compared to the average from 1981 through 2010.  A negative reading suggests warmer-than-normal temperatures, meaning fewer heating degree days.  Although this January was not the mildest on record, heating degree days were clearly below normal.

In looking at the trend of supply and consumption, currently the market is oversupplied (indicated by the balance variable being greater than zero).  Interestingly enough, consumption remains robust but so does supply growth.

Because of the warm winter, current inventories are above normal.

The previous chart shows seasonally adjusted working natural gas storage.  As the deviation line shows, stockpiles are above normal.  We have one more month of storage withdrawals.  In April, the inventory injection season begins.

Market News:

• As Russian oil flows to Europe decline, we are seeing the U.S. gain market share. Throughout history, the U.S. has, at times, been a major supplier of oil to Europe.  Often, these flows have occurred due to wars or other such events.  History seems to be repeating itself.
  • Reports suggest that Venezuelan crude is also going to Europe.
  • Meanwhile, China has been an aggressive buyer of U.S. crude oil as well.
  • Last month, the Europeans ended the purchase of Russian oil products, and it appears that these products are now flowing to North Africa. It is not out of the question to assume that some of these products may “leak” to Europe.
  • Russia has halted oil flows to Poland.
• Platts (SPGI, $341.51) announced it will include WTI in its Brent basket for calculating prices. This decision may narrow the Brent/WTI spread.
• OPEC February production rose 150 kbpd. Two-thirds of this rise came from Nigeria.
• The IEA has released its annual natural gas report. One key finding is that Europe is rapidly building out LNG receiving capacity.
• Despite the recent decline in EU natural gas prices, chemical firms continue to exit Germany due to high costs.
• Saudi Aramco (2222, SAR, 31.55) is considering an investment in a foreign LNG plant as demand surges.
• After three consecutive La Niña events, the World Meteorological Organization says the odds of an El Niño in 2023 are elevated. The following maps show the possible global impact on temperatures and precipitation.

(Source: NOAA)

The below map shows likely winter temperature effects from El Niño.

(Source: weather.gov)

• Although strong pricing of oil should support increased drilling activity, shale producers have been raising output slowly. Rising production costs and less attractive fields are capping production growth.
• After more than 70 years, BP (BP, $39.87) announced that it will cease publishing its Statistical Review of World Energy. The report will now be compiled by the Energy Institute.

 Geopolitical News:

• After a couple months of operating the price cap on Russian oil sales, the data suggests that the cap hasn’t led to lower prices but has succeeded in fragmenting the global oil market. That doesn’t mean the cap will never work, but as of now, the cap hasn’t affected prices.  In the wake of this research, there are calls for tighter sanctions.  The problem with this approach is that consumers must accept the tradeoff of higher prices.
  • Indian buyers report that complying with G-7 sanctions has become complicated and burdensome and may lead to less Russian oil imports.
  • Sanctions are degrading Russia’s refining industry. Some sanctions ban purchases of Russia’s refined products, but problems go beyond just the loss of market access.  Personnel losses due to the war or emigration are also having an adverse impact.
• Two weeks ago, we discussed the report from Seymour Hersh that accused the U.S. of attacking the Nord Stream pipelines. We note that even before the sabotage, natural gas flows had been interrupted on several occasions.  It appears that German firms are beginning to take legal action against Russian firms for failing to meet their contractual obligations.
  • In the wake of the Nord Stream attacks, we are hearing of increased Russian activity in the North Sea. This region is not only an active oil and gas region, but it is also laced with fiber optic cables that could be severed.  The fear is that Russia may begin its own sabotage operations in the area.
• Iran appears to be preparing for a broader rupture with the West over uranium enrichment. Meanwhile, the Iranian rial (IRR) is depreciating rapidly; it is reportedly trading at IRR 575,000/USD 1.  An iPhone now costs over one billion IRR.
  • General Hossein Salami, the commander of Iran’s Islamic Revolutionary Guard Corps, claims that Iran is “at war” with Europe. It’s not clear what triggered this statement, but one likely reason was the EU’s reluctance to break with the U.S. over the JCPOA.
  • Iran is claiming it has a hypersonic missile, and the country is working to expand its footprint in space by collaborating with Russia. Russia is also helping improve Iran’s missile program.
  • Brazil allowed two Iranian naval vessels to make a port of call despite U.S. objections. The “global south” is increasingly opposing U.S. and European policy goals.

  Alternative Energy/Policy News:

• China has been able to expand its mining and processing of rare earths and other minerals by accepting lower environmental standards. However, Beijing has been steadily implementing stricter environmental standards in recent years.  It appears this rolling crackdown may reduce lithium by as much as 10% of global supplies.  We do note that production appears to have resumed, but the fact that it can be closed quickly will likely lead EV producers to hold more inventory.
  • China is looking to invest in Bolivia’s troubled lithium industry.
• Chinese auto battery makers are reducing costs to their domestic EV industry, which could give them an advantage in the global EV market. Among other EV producers, there is a clear attempt to vertically integrate to secure supply chains.
  • Lithium prices are falling due to declining battery prices in China.
  • Auto unions are beginning to realize that the shift to EVs will mean fewer jobs.
• China is reportedly boosting its wind energy capacity.
• One, albeit controversial, way to address climate change is with geoengineering. Geoengineering encompasses a wide range of interventions designed to cool the planet.  One idea is to mimic volcanic eruptions which spew particulates into the upper atmosphere.  After major eruptions, temperatures tend to fall for several months.  We note that a startup firm claims it is using weather balloons to disperse particles into the stratosphere in a bid to cool temperatures.  The practice is controversial because it is cheap enough for private actors to perform but various tactics could have unanticipated side effects.  Scientists have been calling for more research on geoengineering as a way to slow implementation until we can get a better idea of what various practices will actually do.
• Lurking in the background of clean fuels is hydrogen. The gas burns cleanly in a fuel cell with high efficiency.  The problem is getting the hydrogen.  In general, it comes from two sources:  electrolysis and by splitting natural gas.  The former breaks down water into oxygen and hydrogen, usually at a great cost, and the latter isn’t much cleaner than just burning natural gas.  However, there may be a direct source as there are pockets of hydrogen available in free form.  These sources have mostly been ignored by the industry, but there is now growing interest in free hydrogen which may prove to be a cheap, clean, and abundant source of energy.
• Direct carbon capture could conceivably reverse climate change. The problem is that current methods are either too small to matter or consume too much energy.  Researchers are working to tap thermal energy to address the problem.
• Japan is starting commercial production of “semi-solid” batteries. Although they have less capacity, they are considered safer and less polluting.
• Japan is also returning to nuclear power, reversing policies enacted after the Fukushima disaster.
• China’s purchases of Russian uranium are raising fears of a new arm’s race. In addition, as nations expand their nuclear weapons capacity, it could drive up the price of uranium used for power production.
• Biochar comes from heating biomass in the absence of oxygen.  The resulting charcoal-like lumps can be applied to soil and will absorb carbon.

[1] Heating degree days (HDD) are a measure of how cold the temperature was on a given day or during a period of days compared to 65^oF. For example, a day with a mean temperature of 40°F has 25 HDD. Two such cold days in a row have a total of 50 HDD for the two-day period.

  View PDF

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

Crude oil remains in a trading range between $72-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 7.6 mb compared to a 2.0 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.3 mbpd.  Exports rose 1.5 mbpd, while imports rose 0.1 mbpd.  Refining activity fell 0.6% to 85.9% of capacity.

 (Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  We are accumulating oil inventory at a rapid pace, even without SPR sales.  The primary culprit is low refining activity, which should pick up later this year.  The rapid rise in stockpiles, though, is a bearish factor for oil, and current stockpiles have already exceeded the five-year average peak normally seen in early summer.

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 2001.  Using total stocks since 2015, fair value is $94.35.

Market News:

• Environmentalists have been using the courts to prevent oil companies from building pipelines, effectively bottling up supplies. Canadian oil and gas from Alberta have been especially vulnerable to transportation issues.  The most logical direction of travel would be south into the U.S., but pipeline capacity issues around the Keystone pipeline limit exports.  Attempts to expand the pipeline have been thwarted by regulators.  In response, oil interests in Alberta are looking to use rail to expand sales into the U.S.  While there is some interest, the recent tragedy in Ohio may present some opposition to this expansion.
  • Pipelines to Corpus Christi are reaching capacity, which could cap U.S. oil exports.
  • Oil companies are increasingly caught between the pressure to increase output and environmentalists attempting to reduce oil and gas supplies. Overall, this situation will increase costs and will likely reduce supply.
• Natural gas prices have had an epic decline over the past several months. High prices in the wake of the war in Ukraine have led to reduced demand and have moderately increased supply.  However, a mild winter reduced seasonal demand and the need to reduce storage has caused a sharp drop in prices.[1]  The EU’s natural gas consumption fell 19.3% in the period from August 2022 to January 2023 as compared to the same period last year.  Price signals matter, and we note there are reports of reduced gas drilling in the U.S.
  • The IEA warns that the current low prices for natural gas do not necessarily mean that supply problems won’t emerge in Europe later this year. EU inventories will be elevated going into the spring when inventory injections begin.  Nevertheless, high stock levels at the end of winter won’t necessarily guarantee ample supplies for next winter.
  • Heat pump sales in Europe are rising rapidly. Although heat pumps are not necessarily ideal for very cold temps, they do reduce heating demands under normal circumstances.
• Analysts are becoming increasingly worried that the world’s remaining oil reserves will be of lower quality, requiring higher levels of investment to produce usable oil. If so, this means that costs will rise which will likely lead to higher prices.
• Although Saudi Arabia continues to post optimistic demand forecasts for oil, the lack of investment suggests that the country doesn’t believe its own estimates.
• One behavior that we often see when supply concerns rise is hoarding. Nations with a key commodity or product will restrict exports to keep prices low in the home country.  This is something of a dubious policy since export controls often lead to underinvestment and lower supplies over time.  It can also increase smuggling in an attempt to arbitrage the usually higher prices abroad.  However, just because a practice doesn’t always yield optimal results doesn’t prevent it from happening.  We note that Australia is considering export caps on natural gas, and if this occurs, it could trigger panic buying by consumers who would lose access to this product and drive the prices even higher.
• A subcontractor to the CFTC that provides the commitment of traders’ data was hacked; the report has been delayed.

 Geopolitical News:

• Although the war in Ukraine and subsequent sanctions have not ended Russia’s oil and gas sales, it has caused serious disruptions to trade flows. Natural gas flows from Russia to Europe have been curtailed.  Russian oil shipments are increasingly flowing to Asia, and especially China.  Increased Russian oil sales to Asia are affecting Middle East oil sales to the region, putting the two oil regions into competition for market share.  Despite increased flows from Russia, China continues to show interest in Middle Eastern We commented last week that the Iranian president traveled to Beijing to solidify relations, and China is also attempting to acquire Iraqi oil.  However, China remains a significant buyer of Russian crude oil as well.  We also note that China usually buys Russian oil at deep discounts.
  • Kazakhstan is starting to export crude oil to Germany through the Druzhba pipeline which is owned by Russia. Technically, this oil isn’t under sanction, but it may be difficult to prevent Russian oil from being sold to Europe under the guise of Kazak oil.
  • Essentially, we are moving away from a global oil and gas market to one with regional divisions. Commodity markets adapt, but the way markets are dividing is less efficient.
• The recent uproar over the Chinese spy balloon has raised questions about how well the CPC actually controls its companies and bureaucracy. In this vein, we note that Chinese officials are talking to refiners, both state-owned and private sector firms, about their oil purchases from Russia.  It is unclear exactly what the government is trying to discover, but it is likely that Beijing doesn’t want to get surprised by news of Russian purchases.
• China is easing its import ban on Australian coal. The ban was initially implemented when Australia supported an international investigation into the origins of COVID-19.  The ban is being lifted now that COVID has fallen from the news and China needs coal.
• Dutch intelligence is warning that Russia is targeting energy and internet infrastructure. Reports suggest the Russians are likely to use espionage to disrupt energy and data flows.
• The IAEA has indicated that Iran has enriched uranium to 84%, just under the 90% required for nuclear weapons. This level would suggest Iran is at the nuclear threshold, but, so far, there have not been any reactions to this news.  Israel has indicated in the past that it views a nuclear-armed Iran as an existential threat, so this news could trigger a strong response from Israel.  We note Iran has disputed the IAEA’s report as we suspect that the country does not want this news to become public.
• An Iranian drone has struck an Israeli-owned tanker in the Arabian Sea.

 Alternative Energy/Policy News:

• One of the elements of the Reagan/Thatcher revolution was the discreditation of industrial policy. The idea that government could “pick winners and losers” seemed doomed to fail.  The collapse of communism, which epitomized planned economies, further undermined industrial policy.  However, as geopolitics is increasingly affecting economics, industrial policy is returning.  The Inflation Reduction Act’s provisions to support the buildout of green energy is a clear example of industrial policy.
• Tesla (TSLA, $198.39) has cut prices to such an extent that the Model 3 is now the cheapest new car in America.
• The IEA is pressing governments to tighten rules on methane emissions. Methane is a greenhouse gas, and although it doesn’t last long in the atmosphere, it is much more potent than carbon dioxide.  Tightening these rules will add costs to oil and gas exploration and development, which will likely lead to lower production.
• Rare earths are critical in the transition away from fossil fuels. EVs and wind turbines use these minerals, and they are also part of certain tech products such as smart phones.  China is not only the world’s leading miner of rare earths, but it also dominates ore processing.  The U.S. has reopened a rare earths mine in Mountain Pass, CA, but has exported the ore to China for processing in the past.  Japan has built a processing plant and the U.S. has decided to move away from China and export the ore to Japan, further evidence that the U.S. is delinking from China.
• Battery technology really doesn’t work well for semitrailers. The need for power is great, and the battery weight becomes prohibitive.  There are some efforts to use hybrid technology (going downhill with a semitrailer can generate significant power), but it’s hard to replace diesel.  However, fuel cells and hydrogen may be a better alternative over the long term.
• On the subject of batteries, for stationary needs, such as utilities, gravity storage may become a solution.
• The U.S. is expanding its charging network, and U.S. regulations are requiring the installations to be U.S. made, riling trading partners.
• Mexico is planning to nationalize its lithium reserves. Bolivia is wooing China to help it develop its lithium industry.  Bolivia has the world’s largest lithium reserves but doesn’t register as a producer due to years of government mismanagement.  Although China has the wherewithal to build Bolivia’s industry, the infringement on sovereignty will be a problem.
  • Chinese lithium prices are down 30% due to falling demand for EVs.
• China is continuing to expand its solar capacity.
• China’s leading EV producer BYD (BYDDY, $57.03) is now exporting and selling cars in Germany.
• For those keeping score, the map below shows the nations (and states) that have target dates to phase out the sale of internal combustion engines. Automakers remain divided on how fast EVs will replace gasoline-powered cars.

[1] Most natural gas storage is housed in depleted wells.  To maintain well integrity, gas must be injected and withdrawn at a steady pace.  During mild winters, current production and required storage withdrawals tend to cause significant price weakness.

  View PDF