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.

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[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.

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

Crude oil prices appear to have based but so far have failed to break above resistance at around $80-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose a whopping 16.3 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 0.2 mbpd, while imports declined 0.8 mbpd.  Refining activity fell 1.4% to 86.5% 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 (see below).  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.

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, 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 $95.37.

The Nord Stream Issue:  Seymour Hersh, a long-time investigative reporter, released a blockbuster allegation a few days ago, suggesting that the U.S., along with Norway, attacked the Nord Stream pipelines.  According to his report, U.S. Navy divers from the Diving and Salvage Center based in Panama placed explosives on the pipeline and were responsible for the damage.  If these allegations are true, it would create a crisis.  Arguably, this action is a casus belli and could put the U.S. and NATO into a direct conflict with Russia.  Although, before we take the report at face value, caution should be exercised.

Hersh is an 85-year-old investigative reporter who won a Pulitzer Prize in 1970 for uncovering the Mỹ Lai massacre.  However, over the years, a good bit of his reporting has been increasingly discredited.  He wrote a large piece for the London Review of Books that suggested the Obama administration’s account of the assassination of Osama bin Laden was essentially a lie.  He faced strong criticism for that report, which relied heavily on unnamed sources.  Later, he seemed to side with the Assad regime over chemical weapons, but the allegations he made were not entirely refuted either.  Our take is that Hersh, at least at one time, was an important journalist.  Over the years, though, his reporting seems to have become increasingly erratic.

As we noted, Hersh isn’t a crackpot, but likely due to his experiences in dealing with the U.S. military and intelligence agencies, he seems to have taken a position more recently that the benefit of the doubt should go to foreign interests.  Thus, there is a potential bias to his reporting.  At the same time, even though there is a notable lack of sourcing in the report, there are solid geopolitical reasons for the U.S. to want to end Nord Stream.

The age of oil has been difficult for Europe, mainly because the continent doesn’t have much oil of its own.  Although Europe is blessed with ample coal resources, the superiority of oil as an energy source meant that without secure sources of oil, European dominance of the world was in trouble.  There is a bit of production available in Romania, and of course, after oil prices spiked in the 1970s, oil was extracted from the North Sea, but Europe was never going to achieve oil and gas independence.  The European powers attempted to expand their colonial reach into the Middle East and Asia to acquire oil, but those areas proved difficult to secure.  The Dutch lost the oil in Southeast Asia to Japan during WWII.  After WWII, when the U.S. fostered independence for European colonies, Europe lost controlled access to oil in North Africa and the Middle East.  Until the early 1970s, Europe was mostly dependent on the U.S. for oil.  Not wanting to be fully dependent on Washington for energy, Europe, and especially Germany, turned to Russia.  Naturally, this reliance on Russia wasn’t popular with the U.S.  Consistently, American administrations criticized Europe for its increasing reliance on Russia oil and gas.  The Nord Stream projects were especially galling because they directly linked Russia to Germany.

Thus, the destruction of the pipelines is arguably in American interests.  That’s why this narrative will likely be hard to quash, even if the Hersh reporting is false.  It is natural to assume that if a party benefits from an event it might have had a role in causing it.  However, that is about as far as this goes.  It is quite possible that Hersh received this information from someone that would also benefit from increased tensions between the U.S. and Russia.  And since no sources are named, it may be impossible to really prove anything.

We will continue to monitor developments and reporting around this issue.  We doubt that we will see anything definitive on this in the near term, so the most likely outcome is that it won’t cause an escalation directly involving the U.S. and NATO against Russia.  But we could see “tit-for-tat” actions, such as sabotage of LNG facilities, cutting of fiber optic cables, etc.

Market News:

• The big news this week, although maybe it shouldn’t be, is that the U.S. will sell an additional 26 mb out of the SPR. This sale was previously mandated by Congress.  Over the past couple of decades, Congress has, on occasion, used the SPR as sort of a “slush fund” to address budget issues that couldn’t be met with taxes or by borrowing.  This is a rather small sale given the scale of recent withdrawals, but the market didn’t take the news well by selling on fears of further sales from the reserve.  In fact, the administration considered canceling the sale, but doing so would have required an act of Congress, probably difficult to do in the current environment.  We don’t think this sale matters all that much, but our Twitter feed lit up with all sorts of commentary about how irresponsible the SPR sales were, and “look, they are at it again.”   We don’t disagree about the risks from earlier sales, but this one isn’t all that big of a deal.
• The IEA is forecasting oil demand will reach a new high this year due to China’s reopening.
• In response to the G-7 price cap, Russia announced a 0.5 mbpd oil production cut. There are two concerns beyond the obvious one that this action will lift prices. The first is that Russia may not be making this cut voluntarily but is finding that demand for its oil is falling.  Announcing a cut may be a measure to save face.  Second, cutting production is always a risky idea because once a well is shut in, in a short amount of time that production is lost without having to redrill.  Complicating matters further is that Russia was dependent on Western expertise to drill and maintain technically difficult oil fields.  Sanctions and disinvestment may lead to further output losses.  Oil prices initially rose on the report but failed to hold gains.  Oil markets are most likely worried about global recession weakening demand rather than the loss of supply.
  • As the Russia Urals discount widens, the Duma is considering legislation to limit the discount. If put into practice, it would likely lead to a lower supply.  There are reports suggesting that Russia’s discounts may be worse than the official price spreads indicate.
• China is working on an LNG deal with Qatar. As Qatar develops its North Field, it is apparently looking for long-term contracts to finance the development.
• Although Freeport began exporting LNG this week, regulators report that the plant has systemic safety concerns.
• The U.S. natural gas market is dealing with increased demand, especially from LNG, and rising production. However, inventory capacity is mostly fixed, meaning that price volatility is rising.  Complicating matters is that most U.S. inventory facilities are depleted gas wells where, to maintain integrity, gas is injected and withdrawn at a mostly steady pace.  This factor leads to a seasonal pattern of storage where gas is injected from April to October and withdrawn from November to March.  Storage seasonality is why price lows usually occur in January; however, if temperatures are moderate, stored gas must still come to market.  Exports come with their own set of difficulties.  Although European gas prices have declined due to mild temperatures, once the European refill season begins, export demand will likely increase.  Volatile natural gas prices will make planning difficult and could increase volatility for fertilizer and chemical prices as well.
• We are hearing of increasing concern over the future production from the Permian Basin. In some respects, this is nothing new.  A few years ago, some analysts were sounding the alarm that drilling practices were damaging reservoirs.  Now, firms operating in the region are considering consolidation which is rational if production has peaked.
• A growing number of long-term forecasts suggest that U.S. oil demand may be close to peaking. If true, the case for investing in future production would be hard to make. At the same time, the lack of refining investment could lead to strong margins for the foreseeable future.
• A warming trend over the Arctic may bring much colder temperatures to Europe and North America. If it persists, it could lead to a cold spring which could delay crop planting.

 Geopolitical News:

• Iran’s President Raisi is visiting China this week after being invited to Beijing by President Xi. This is the first visit to China by an Iranian president in more than two decades.  China and Iran have been increasing ties in recent years.  China has been willing to break with sanctions on Iran by purchasing Iranian oil (although at discounts).  China’s willingness to refuse to cooperate with U.S. sanctions has led to China becoming Iran’s largest trading partner.  China and Iran have a 25-year cooperation agreement, although little of the arrangement has been implemented so far.  We suspect Iran was keen to meet with Xi in the aftermath of the Chinese president’s recent visit to Riyadh.  Iran and Saudi Arabia have been at loggerheads since the Iranian revolution and, even before the revolution, both countries vied to dominate the Middle East.  Iran was likely concerned about China’s wooing the Saudis, even proposing to price oil in CNY.  China has also recently sided with the UAE on a five-decade dispute over three islands in the Persian Gulf that Iran seized after the British had left the region.  China is likely to find that managing relations in the Middle East is difficult as there are age old rivalries in play and showing favor to one party can infuriate another.

 Alternative Energy/Policy News:

• Ford (F, $13.07) has announced a $3.5 billion battery plant in Michigan. Stimulating such investments was a goal of the Inflation Reduction Act.  However, there is a complication.  Ford intends to license the battery technology from Contemporary Amperex Technology (CATL, CNY, 451.05), a Chinese company.  The plant will be a wholly owned subsidiary of the U.S. automaker and will create 2,500 jobs.  The licensing of Chinese battery technology, though, is quite controversial.  Ford was considering building the plant in Virginia, but Governor Youngkin withdrew his state’s bid due to the  connection to China.
  • To a great extent, Ford’s decision to license a Chinese company’s technology is an example of the difference between the business class and the political class when it comes to China. In simple terms, opposition to China is perhaps the only bipartisan issue.  No politician wants to be outflanked or seen as being “soft” on China.  On the other hand, business interests continue to want to work with China and take advantage of their manufacturing prowess.
  • Recently, China appeared to be working hard to improve commercial relations. The balloon controversy has scotched that effort and will make business interests wanting to work with China more difficult.
• Although EVs continue to dominate the news, fuel cell/hydrogen vehicles remain a potential competitor. Using hydrogen would avoid the range concern which plagues EVs, but the problem is that the hydrogen is derived from fossil fuels and isn’t all that environmentally friendly.  There is a whole “color coding” system for hydrogen, and oil firms are pressing regulators for more open rules on “green” hydrogen to capture tax credits.  However, the determination of what qualifies various colors of hydrogen  remains controversial.
• The search for EV metals is leading to the Arctic. The U.S. has even appointed an ambassador to the region.
• Electric car trips of any distance require careful planning. This account shows just how much planning is required.
• Commodity markets are notorious for boom/bust cycles. Although the long-term outlook for EV metals is favorable, we are seeing increasing inventories which could lead to a period of price retrenchment.  China’s solar sector is facing issues of overcapacity as well.
• Saudi Arabia is launching a domestic EV industry in part to reduce its own demand for oil to allow for greater exports. Indonesia, a major nickel producer, is considering developing a battery industry.
• China’s wind and solar industry generates enough electricity to meet its household demand.

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

Crude oil prices appear to have based but so far have failed to break above resistance at around $80-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 2.4 mb compared to a 2.0 mb build forecast.  The SPR was unchanged.

In the details, U.S. crude oil production rose 0.1 mbpd to 12.3 mbpd.  Exports fell 0.6 mbpd, while imports declined 0.2 mbpd.  Refining activity increased 2.2% to 87.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s increase was contra-seasonal.  So far, crude oil inventories have been rising this year, mostly because refinery operations have been weaker than normal.  As refining activity accelerates, we would look for commercial inventory accumulation to slow.

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.  For the next few months, we expect the SPR level to remain steady, so changes in total stockpiles will be driven solely by commercial adjustments.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $107.07.

Summer:

We don’t usually start thinking about summer until pitchers and catchers report to spring training.  By then, the Super Bowl has been played and we are only a couple of weeks away from the kick-off of the NCAA’s “March Madness” tournament.  However, we have been watching the gasoline markets and there are some concerns lurking around the bend.

Gasoline inventories are running about 14 mb below their five-year average.  Scaled to consumption, inventories are in line with normal, but that’s only because consumption has been weak.  We are approaching the usual peak in gasoline stockpiles, since inventories usually decline as refiners clear their winter grade gasoline from surplus to prepare for summer.  If we experience the usual drop in the coming weeks, stockpiles could be lower than normal and may trigger higher prices.  High gasoline prices are politically sensitive and may trigger another round of SPR releases.

At the same time, we are in the midst of a secular drop in gasoline consumption.  The following chart shows annual miles driven by passenger cars and light trucks.  In general, the trend in miles driven rose steadily from the early 1970s until the Great Financial Crisis in 2007.  We use gray bars to highlight periods when we did not hit a new high in the number of miles driven and note the number of months until a new peak occurred.  There was a small dip from 1973 to 1975, which was a product of the Arab Oil Embargo (which pushed up gasoline prices), and a more notable dip in the uptrend from 1979 to 1982, triggered by two U.S. recessions and a spike in prices caused by the disruptions from the Iran/Iraq War.  From 1983 until 2007, the rise in driving was relentlessly higher, with only short interruptions typically due to recessions or periods of high prices.  After 2007, though, we had a long gap before a new high was reached and the underlying trend clearly declined.

There are likely multiple reasons for the overall change in trend.  First, social media has led to friends being able to interact online, rather than needing to drive to meet in person.  Working from home and increased urbanization have also likely played a role.  Driving less, coupled with steady efficiency improvements, is leading to lower demand for gasoline.

The underlying factors reduce the chances of a gasoline crisis this summer, although the lack of inventory bears watching.  Probably the biggest factor that could push gasoline prices higher is crude oil pricing.

Market News:

• The tragic earthquake in Turkey has closed the Ceyhan oil export terminal in southern Turkey. The terminal moves about 1.0 mbpd, with two-thirds coming from Azerbaijan and one-third from Iraqi Kurdistan.  Coupled with news that the KSA increased prices to Asia, oil markets were supported this week.  We do note that the port of Ceyhan has reopened, but it’s unclear just how long it will take for oil flows to resume.
• The IEA has released its annual report on electricity. The report suggests that carbon emissions from electricity are trending lower as wind, solar, and nuclear power expand.
• As we have noted in earlier reports, the Biden administration has approved a drilling project in Alaska over the objections of environmentalists. Although the president campaigned on restricting drilling activity on federal lands, he has found that the courts have not sided with this goal.  At the same time, high oil prices tend to soften opposition, so we do expect this project to go forward.
  • The administration has been struggling with dissonant objectives on crude oil production. On the one hand, the White House tends to criticize oil companies for not increasing output to quell oil prices, but then on the other it talks about a possible windfall profits tax, which would tend to reduce the incentive for investment.
  • This is not just a U.S. issue. EU climate goals, which hope to reduce natural gas imports, are stifling investment in U.S. production and LNG capacity.  It may be adversely affecting investment in the Middle East as well.  The Qatari energy minister mused recently that the EU will eventually return to buying Russian gas.  If that is the expectation, it is foolhardy to expand capacity.
• The EIA is projecting record U.S. crude oil production (on an annual average basis) this year and next, although the growth rate is rather modest (0.1 mbpd this year and 0.4 mbpd in 2024). Much of that production is coming from the Permian Basin.
• Japan is trying to cut coal import costs by burning lower grade coal (which is almost certainly dirtier).
• Colombia’s President Petro made it clear during his campaign that he wanted to curtail the country’s oil and gas industry for climate change reasons. He has moved to ban oil exploration, a risky decision given that crude oil exports accounted for 34% of Colombia’s exports (excluding illegal substances).  Because oil is a depleting asset, cutting exploration will lead to falling output in the coming months.  Not only will this move hurt Colombia’s economy, it could also reduce global oil supplies.
• Asian oil imports hit a new record in January, and that has occurred before the full effects of China’s reopening have been felt.
• Oil and product prices have been stable recently, but much of that improvement is tied to a mild winter, which has reduced demand. Europe remains short of diesel, so prices could rise in the spring.
• Despite the recent drop in natural gas prices, fertilizer supplies remain tight and could lead to widespread grain shortages.

 Geopolitical News:

• The Senate has introduced a bill to block the sale of U.S. SPR oil to China. Although we understand the sentiment, in reality, one of the reasons for creating the reserves was to discourage hoarding.  Laws like this signal to China that it might not be able to get oil in a crisis, thus triggering stockpiling, which is then bullish for demand.
  • On the topic of hoarding, the EU’s demand for natural gas is reducing supplies available for emerging economies.
• Russia’s fleet of oil and product vessels is said to have reached 600. However, without Western insurance, Russia will still struggle to export oil and products.  For example, Turkey is requiring tankers moving through the Bosporus Strait to carry proper insurance.
  • Although the current price cap on Russian crude oil is far from perfect, there is some evidence that it is having an impact. Russia is considering taxing oil exports based on the price of Brent crude instead of the Urals price.  The latter has typically carried a hefty discount, and in January, the price averaged $49.48 per barrel.  Taking this step would clearly harm Russia’s oil companies.  This approach may be due to Russia’s widening budget deficit.
  • As Russia’s revenues decline, the margin loss is being captured by “middlemen” who facilitate Russian exports.
  • The G-7 has increased its sanctions on Russian energy by putting a price cap on Russian petroleum products. This measure coincides with the EU ban on importing Russian oil products.  It is likely that Asian nations will begin re-exporting product from Russia to Europe.
  • Russia is managing to evade many import restrictions through re-export arrangements with friendly nations. Iran has become a major trading partner for Russia.  Since Iran has been under sanctions for decades, it has become adept in circumventing them.  Russia is learning from Tehran’s experience.
  • However, restrictions on investment may lead to an over 40% decline in Russian oil output by 2035.
• Russia is said to be developing weapons to target underseas cables and pipelines.
• A recently leaked IAEA report suggests that the Iranian nuclear processing plant at Fordow is changing operations in a manner inconsistent with the 2015 JCPOA, but Iran has disputed the findings. In general, there is little doubt that Iran is increasing its uranium enrichment capabilities, but apparently the country doesn’t want to be called out on that by the UN.
  • Iran has detained “tens of thousands” of its citizens who engaged in the recent protests. Recently, the government unveiled a pardon process, but the terms appear rather restrictive.
  • In an attempt to stop the smuggling of dollars from Iraq to Iran, the U.S. has been restricting dollars going to Baghdad, causing harm to the Iraqi economy. The Iraqi dinar (IQD) has been depreciating, which will increase inflationary pressures on Iraq.

 Alternative Energy/Policy News:

• Although there is a rush to build battery capacity, the industry is not known for being all that profitable.
• There is a growing realization that the energy transition away from fossil fuels toward electric will require all sorts of minerals that simply might not be available.
• The Inflation Reduction Act (IRA) has subsidies designed to promote EVs, but the subsidies are restricted to U.S. automakers. Congress is looking to further restrict Chinese components from the supply chain and the subsidies, which may end up restricting overall supply.
  • Government programs limit EV subsidies to $55k for sedans and $80k for SUVs. The government is generally treating crossovers as SUVs.
  • The IRA subsidies may “price out” the EU and compel European companies to move operations to the U.S.
• Although the outlook for the metals critical to energy transformation is bullish, commodity markets are prone to short-term cycles of shortages and gluts.  A glut is apparently developing in cobalt.

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

Crude oil prices appear to have based but so far have failed to break above resistance at around $80-$82 per barrel.

(Source: Barchart.com)

Crude oil inventories rose 4.1 mb compared to a 1.0 mb draw forecast.  The SPR was unchanged.

In the details, U.S. crude oil production was unchanged at 12.2 mbpd.  Exports fell 1.2 mbpd, while imports rose 1.4 mbpd.  Refining activity declined 0.4% to 85.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Last week’s increase was contra-seasonal.  Generally, we expect this year to follow last year, meaning that the usual rise in inventories isn’t likely.

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.  For the next few months, we expect the SPR level to remain steady, so changes in total stockpiles will be driven solely by commercial adjustments.

Total stockpiles peaked in 2017 and are now at levels last seen in 2001.  Using total stocks since 2015, fair value is $107.01.

Market News:

• BP (BP, $36.31), has released its annual energy outlook. The research indicates that peak demand for fossil fuels will occur by 2035 at the latest but could occur by 2030 if policy leans against carbon emissions.  There are a number of factors behind the expected peak, but one of the most overlooked areas is improved consumption efficiency.  Research such as this makes it more difficult to argue for aggressive investment into future production.
• A normal response to supply shortages is hoarding since insecurity over supply leads consumers to build stockpiles to protect against future outages. Paradoxically, this activity can cause its own supply problems as this stockpiling becomes a source of additional demand.  We note that there are periods when U.S. commercial crude oil inventories are positively correlated to price.  If inventory is simply a residual of supply and demand, then a positive correlation would not be expected.  On this note, the German natural gas inventory manager says it intends to maintain a “buffer,” which we suspect means keeping a higher level of inventory than it would otherwise maintain.  Also, the German government is considering a “strategic” natural gas reserve, which would be another source of demand.  We have postulated, for some time, that as American hegemony wanes, one of the consequences would be insecurity of commodity supply, which would boost prices.  These reports from Germany provide evidence of such activity.
• The White House criticized Chevron (CVX, $187.30) for its decision to repurchase shares. The administration would prefer the company expand production, but once an environment is created that calls for the replacement of fossil fuels, rewarding shareholders rather than boosting output is a rational outcome.
• Whenever the price of an important commodity rises, politicians usually charge firms in those industries with “price gouging.” Although further investigation rarely confirms that suspicion, it persists.  Recently, Italian PM Meloni criticized gas station owners by accusing them of price gouging.  In response, they held a one-day strike.  Although closures of stations are rare, this event does highlight the potential for unrest due to high oil prices.
• One of the consequences of the war in Ukraine has been a restructuring of global oil flows. We also note that the EU is placing a ban on Russian product imports on February 5.  It is not obvious if the markets are ready for this action.
• Local governments in China have exhausted their funds in the battle against COVID and now find they lack the resources to buy natural gas.
• One of the side effects of fracking is earthquakes. Although none of these earthquakes are of a high magnitude,[1] they are enough to be felt and raise fears among homeowners that the quakes will trigger structural damage.  Tremors have been reported in Oklahoma and also now in Texas.  It is thought that the primary culprit is fracking wastewater.  Sand, water, and other chemicals are injected into the ground when a well is fracked.  The water usually surfaces and needs to be disposed of, and a cheap solution is to reinject it into the depleted well.  The water is thought to act as a catalyst for these earthquakes.  The solution is to force energy companies to dispose of the wastewater in another fashion, and although possible, changing the regulations would lift costs and eventually raise energy prices.
  • It should be noted that oil activity is said to be in a “boom” in Texas and New Mexico. It is having ripple effects outside of the oil and gas industry by lifting salaries and employment in other sectors of the economy.
• One of the bright spots for oil production is Guyana, which is expected to steadily boost production.
• The Biden administration’s decision to aggressively sell oil out of the SPR has been controversial. Although it is arguable that there are still ample supplies, as the previous chart showed, combining both the SPR and commercial stockpiles indicates that inventory levels have notably declined.  The House of Representatives has passed a bill that would limit the Department of Energy’s ability to tap the SPR. While it has no chance of passage, it does reflect the current level of concern.
• Warm weather has not just lowered natural gas prices in Europe, but it has also taken U.S. prices below $3.00 per MMBTU. Although inventory levels are rather close to their five-year average, we are in the period of the year with the strongest drawdowns, but because of mild temperatures, we actually saw a build in U.S. stocks.  Even if temperatures turn cold, it is likely we will begin the refill season in April with adequate stocks.  We do look for prices to recover in the spring and summer as LNG exports increase to ensure Europe has adequate supplies.
  • Despite low natural gas prices in Europe, ammonia producers on the continent have not responded with production increases. Ammonia is a critical element in fertilizers.

 Geopolitical News:

• Over the weekend, Iran was hit with a series of aerial attacks. Oil refineries and defense infrastructure were reportedly hit by drones.  The U.S. is suggesting that Israel was behind the widespread attacks, and apparently the U.S. was apprised of the operation.  Iranian media reported that the damage was light, but the fact that the attacks occurred is notable for a few reasons.  First, Israel has been reluctant to support Ukraine due to relations with Moscow (Russia and Israel cooperate in Syria); however, Iran is supplying arms to Russia so by attacking its defense infrastructure Israel could both help Ukraine and attack an avowed enemy.  Second, Israel must believe that Iran has limited scope to retaliate, likely assuming that it probably can’t do much in response between the protests and a weak economy.  Third, although there isn’t evidence that the U.S. directly participated, Washington appears to have abandoned a return to the JCPOA and thus is working on other ways to contain Iran.  This cooperation may include the actions Israel took over the weekend.  Still, the attacks on Iran create conditions where the war in Ukraine could expand.
  • Israel also attacked an arms convoy that was crossing from Iraq into Syria.
• Even with the lack of progress in Iran and the U.S.’s return to the JCPOA, diplomats haven’t completely cut off contact, mostly because they don’t perceive any other available options to restrain Iran’s nuclear program.
  • Despite this hope, there have been numerous reports recently that Iran has enough fissile material to make several nuclear weapons.
  • The EU is considering naming the Islamic Revolutionary Guard Corps as a supporter of terrorism. Iran is threatening the EU if it adopts that position.
• The U.S. has accused Iran of a “murder for hire” plot to assassinate an Iranian-American writer living in New York.
• Iraq is dealing with increased currency smuggling, which has led to the Iraqi dinar’s depreciation. It is suspected that Iran is using its allies in Iraq to acquire dollars and the drain is weakening the Iraqi currency.
• Although Russia and China have publicly declared their strong alliance, in reality, the two nations don’t necessarily align in certain areas. One of the more contentious areas is in central Asia.  Since these regions were formerly part of the Soviet Union, Russia tends to think of the “stans” as part of its sphere of influence.  However, China’s goal of building a Eurasian bloc, expressed by its “belt and road” project, means that China would like these nations to align with Beijing.  China has been using its economic heft to build relations, and we note that Russia is also making overtures to the stans by offering to sell natural gas in return for influence.  So far, the stans have been reluctant to fully sign on.  The central Asian nations are open to joint ventures but are reluctant to give Russia control of infrastructure.
• The EU has agreed on a price cap for natural gas, while the Intercontinental Exchange is creating a parallel contract in London to match the TTF price in Amsterdam ostensibly to skirt the cap.
• As Venezuela begins to emerge from sanctions, it is attempting to normalize its trading relationships. While under sanctions, it had used middlemen trading firms, likely for selling oil and to evade U.S. sanctions.  As conditions normalize, it is now demanding cash up front for exports in a sign that it is moving on from sanctions trading.

 Alternative Energy/Policy News:

• Polls show that the German public now supports nuclear power. Former Chancellor Merkel tried to phase out nuclear power after the Fukushima disaster, but high natural gas prices have changed public sentiment.
• We are beginning to see price discounting of EVs. Tesla (TSLA, $169.34) started the process, and now Ford (F, $12.94) is following suit.  Some of this action is due to rising inventories, especially at Tesla, but another factor is that the cars may simply be too expensive to compete against gasoline-fired vehicles.
• China is considering banning the exports of its solar technology. Since it dominates this industry, such an action would send up the cost of solar energy outside of China.
• Researchers at the University of Illinois Urbana-Champaign have taken an abandoned oil well and turned it into a geothermal energy storage system. The researchers injected 120^oF water into the well, and it maintained the temperature, suggesting that other abandoned wells could be repurposed for similar uses.
• In response to U.S. subsidies in the Inflation Reduction Act, the EU is planning to use tax credits to offer European businesses support for green energy.

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[1] Californians would not be impressed.

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