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

It appears that oil prices are settling into a broad trading range between $125 and $95 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 4.5 mb compared to a 1.5 mb draw forecast.  The SPR declined 5.6 mb, meaning the net draw was 10.1 mb.

In the details, U.S. crude oil production rose 0.2 mbpd to 12.1 mbpd.  Exports rose 0.8 mb, while imports fell 0.4 mbpd.  Refining activity declined 1.5% to 92.2% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  Clearly, this year is deviating from the normal path of commercial inventory levels.  Although it is rarely mentioned, the fact that we are not seeing the usual seasonal decline is a bearish factor for oil prices.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in 2004.  Using total stocks since 2015, fair value is $103.88.

With so many crosscurrents in the oil markets, we are beginning to see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $65 per barrel, so we are seeing about $30 of risk premium in the market.

Gasoline Demand

Last week, we noted that gasoline demand was weakening and that has been putting pressure on oil prices.  This week, we take a look at the number of licensed drivers in the U.S.

The data is annual, and the last available year is 2020 so we don’t know how this metric was affected by the pandemic.  On a trend basis, the number of drivers rose above trend in the early 1970s as baby boomers reached driving age.  As population growth slowed, the number of drivers fell steadily back to trend.  However, after the Great Financial Crisis, the number of drivers fell rapidly and has yet to recover.  It doesn’t appear to be the boomers.  In looking at the number of licensed drivers aged 65 and over, the growth rate is still 3% per year.  What we do find is that the number of drivers aged 29 years and younger declined over the past three years, falling 2.2% in 2020.  Social media might play a role, or the urbanization of younger households could play a role as well.

In observing the above chart, it again begs the question, “Why would anyone build additional refinery capacity if the number of drivers is falling below trend?”

 Market news:

• The long-awaited return of Nord Stream 1 occurred last week, but the amount supplied is underwhelming at only about 20% of capacity. President Putin announced the resumption, but warned that sanctions may reduce flows.  The Russians are claiming maintenance issues yet again, while Germany says there is no technical reason to reduce flows. As one would expect, natural gas prices jumped on the news.  These flow rates appear to be too low to build adequate supplies for winter.
  • We also note that Russia increased flows unexpectedly to other pipelines, threatening the pipeline’s integrity.
  • Although natural gas is a key input to electricity and home heating, it is also an important ingredient for petrochemicals. Russia’s reduced supplies of natural gas are threatening Germany’s petrochemical industry.
  • It’s not just Europe seeing high prices. As LNG is being diverted to Europe, Asian gas prices are rising.
• Although the lack of investment in oil and gas is a key reason for high energy prices, the disruption of trade and payments flows, triggered by the Ukraine war, has led to supply and price divergences. Over time, we do expect these flows to adjust to the new reality.  For the past few weeks, we have documented how Russian oil was flowing to India and China (although we note Beijing is cutting Russian purchases on price considerations).  This expansion reduced supplies to Europe; however, we are seeing Middle Eastern oil and African oil, which would usually end up in the Far East, now routing to Europe.  North Africa is also increasing supplies to Europe, but the infrastructure to increase supplies further isn’t in place to fully replace Russian energy.  There are reports that Russian energy exports are falling, although as we note below, this may not account for smuggling.
  • The EU is easing sanctions on third-party transactions to increase available supplies.
  • There are reports of increased smuggling efforts to increase Russian oil on world markets.
• The EU has put together a natural gas rationing plan to weaken Russia’s leverage, overcoming the free-rider problem that emerged as individual members of the union lobbied for exemptions. Spain and Portugal complained about the program as they obtain much of their natural gas from places other than Russia, so they didn’t feel the need to participate.  Although we suspect most nations understand the need for rationing, their logical hope is to force other nations to bear a higher burden of the cost.  In the end, an agreement was reached by making the deal less stringent than what Brussels wanted.  So far, the plan is voluntary, which has reduced its effectiveness.  We doubt this plan will do much to cut demand until it becomes mandatory.
  • Germany is expanding energy-reducing measures due to fears of reduced Russian supplies. Industry leaders are warning that continued cuts will adversely affect industrial output.  There are reports that ammonia production is being cut; the chemical is a key feedstock for fertilizer.
  • Germany is also trying to boost coal power generation, but supply issues are hampering that effort. It is also reconsidering its exit from nuclear power.
• The U.S. has announced an additional 20 mb of crude oil will be sold from the SPR. The DOE also laid out a plan to replenish the SPR but is considering fixed-price contracts that wouldn’t begin refilling the reserve until 2023.  We suspect this replenishment will not occur.
• The EU ban on tanker insurance for Russian oil is scheduled to become effective in December and the U.S. is increasing calls to use a price cap instead. The Biden administration fears that the insurance ban will be too effective, leading to tighter oil supplies.
• There is increasing evidence that the KSA is near its productive capacity for crude oil. OPEC+ production is well below its quotas.
• As U.S. LNG exports ramp up, impediments on pipeline construction, a favorite tool of the environmental lobby, have come under greater scrutiny. Recent court decisions are improving pipeline approvals which should reduce export bottlenecks.  The general stance of the Supreme Court on regulation may bolster this trend.
  • Meanwhile, Europe is expanding the number of its regassification facilities.
• Across the U.S. corn belt, propane is used in crop drying. Current inventories are tight relative to history.  U.S. exports have been strong, and rising petrochemical demand in Canada may reduce imports.  Farmers should consider locking in supplies now before harvest.
• Earnings reports suggest that exploration activity may finally be reacting to high oil prices.
• The administration intends to make energy company profits a political issue. Of course, such criticism usually eases investment, notwithstanding the above bullet point.
• Reports indicate that oil tanker orders are at new lows. Some of the lack of orders is due to uncertainty about future oil demand.  But, if this lack of orders persists, we could see oil prices rise on higher transportation costs.

Geopolitical news:

• Although China is buying more Russian energy, its investments into Russia through the “belt and road” project have fallen to zero. Beijing is trying to avoid Russian sanctions.
• One of the reasons given for President Biden’s trip to the Middle East was to reduce Chinese influence in the region. Washington fears that China is attempting to expand its footprint in the region as the U.S. slowly withdraws.  One area of interest for Beijing is Iraq.  However, China will have to navigate increasing intra-Shiite tensions.
• Iran announced it has arrested suspected Mossad spies who were conspiring to attack Iran’s “sensitive” sites. This action occurs just as evidence appears to show that Iran’s nuclear program is expanding rapidly.
  • Iran’s foreign minister canceled a trip to the U.N. for meetings on nuclear non-proliferation. The IAEA wants Iran to turn on monitoring devices on its nuclear facilities; Iran has refused.
  • The last of the former administration’s nuclear negotiators has been replaced, reducing the odds that Iran will return to the 2015 JCPOA.
• China and Australia have been at odds over pandemic policy. The PRC has retaliated against Australia by cutting imports.  But, as coal inventories fall, China may be forced to ease import bans on coal.
• Cryptocurrencies have been used in cybercrime and sanctions evasion for some time. The Treasury Department is investigating whether a U.S. crypto exchange facilitated Iranian transactions in violation of sanctions.

Alternative energy/policy news:

• Globalization and national security are often at odds. Sometimes, the lowest cost producer is in a country that is deemed a security problem.  At that point, tradeoffs can occur.  Does one simply continue to buy the product as cheaply as possible, or does one pay more for “safer” products?
  • We discuss nuclear power often as it can provide carbon-free baseload power, which is something that wind and solar struggle to produce. Unfortunately, most of the world’s nuclear power plants are constructed by China and Russia.  Complicating matters further, much of the uranium used comes from the former Soviet Union.  The nuclear power industry in the West is notorious for cost overruns.  It is possible that China and Russia construct them faster because they are less finicky about safety.  But, in any case, if nuclear is going to make a comeback in the West, it probably can’t rely on Russia and China to meet that demand.  The same case can be made for uranium stocks, which are the inputs to nuclear power.  US. production of uranium concentrate fell to near all-time lows last year.
  • Other key metals are under the control of China and Russia.
  • In Utah, a massive clean energy storage facility, which will generate green hydrogen from wind and solar to store until needed, relies on critical components from China.
  • Ford Motor’s (F, $12.81) plan to ramp up EVs depends on Chinese batteries.
• China seems to be developing an “all of the above” approach to energy security. We have documented China’s expansion of coal for electricity production.  But, at the same time, it is aggressively expanding solar power as well by taking steps to lower the cost of solar panels.
• Utilities are increasingly using battery storage for price arbitrage. If this practice expands, it will tend to reduce price volatility.
• Ford is moving aggressively to expand its battery supply and find lower cost materials for the batteries themselves. For example, the company is opting for iron and phosphorous batteries instead of the usual nickel and cobalt metals.  The batteries will still use lithium, but using U.S. sources means running afoul of environmentalists.
• General Motors (GM, $33.53) has secured a loan from the DOE for a battery venture.
• The “holy grail” of auto batteries continues to be solid state, which promise to go farther and recharge faster than current batteries.
• One of the problems with meeting climate targets is that auto turnover is slow, and therefore, gasoline autos will be with us for many years.
• For the past couple of weeks, we have been reporting on the heat wave that has plagued much of the U.S. and Europe. The heat is straining electrical grids in Europe, sending prices higher and increasing the risk of blackouts.
  • The heat in Texas has also reduced electricity available for bitcoin mining.
• Mexico’s resource nationalism has run afoul of the USMCA, leading to a call for talks.
• Separating carbon from hydrogen leaves a clean fuel that could replace fossil fuels. Of course, a classic high school chemistry experiment separates hydrogen from water. Accordingly, marriage of nuclear power to make hydrogen is in the works.  In related news, the DOE is partly funding a “hydrogen hub” in the Houston area.
• Extreme weather continues.
  • Here in St. Louis, we recently experienced rainfall totals that set new records. Over a six-hour period, rainfall exceeded nine inches. To put that in perspective, this area typically sees about seven inches of rain in July and August combined.  Over a 24-hour period, the city and surrounding area received about 25% of its annual rainfall.
  • China is experiencing a heatwave that is sending electricity demand to record levels; so is the Pacific Northwest.
  • The NOAA has released a new website to track hot weather.

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

It appears that oil prices are settling into a broad trading range between $125 and $95 per barrel.

(Source: Barchart.com)

Crude oil inventories fell 0.5 mb compared to a 1.0 mb draw forecast.  The SPR declined 5.0 mb, meaning the net draw was 5.5 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 11.9 mbpd.  Exports rose 0.7 mb, while imports fell 0.2 mbpd.  Refining activity declined 1.2% to 93.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  It is clear that this year is deviating from the normal path of commercial inventory levels.  Although it is rarely mentioned, the fact that we are not seeing the usual seasonal decline is a bearish factor for oil prices.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in 2004.  Using total stocks since 2015, fair value is $102.12.

With so many crosscurrents in the oil markets, we are beginning to see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $65 per barrel, so we are seeing about $35 of risk premium in the market.

Gasoline Demand

Gasoline demand has turned lower.  Although high prices may have been the culprit, gasoline demand was price insensitive for most of market history.  However, with the advent of work from home and increasing retirements, gasoline prices may have become more sensitive.

(Source:  EIA)

This easing of demand does appear to be lowering gasoline prices.

In observing the long-term history of gasoline demand, we note that by stripping out the monthly variation with a Hodrick-Prescott filter, it appears that underlying demand is weakening.

Gasoline demand rose strongly from the end of WWII into the mid-1970s, but the Iran-Iraq War’s price spike and its gasoline shortages led to a drop in demand that lasted about a decade.  Demand rose again in the early 1990s into the Great Financial Crisis, but since then demand has been mostly sideways.  This would suggest a secular change in gasoline demand is in place, which signals persistently weak demand.  Thus, the current slowdown may be part of a larger trend.

In observing the above demand chart, it does beg the question, “Why would anyone build additional refinery capacity if demand isn’t set to grow?”

 Market news:

• Later this week, we will find out if Russia will restart the Nord Stream 1 pipeline, which has been closed several weeks for maintenance. Early signs are not comforting, as some European deliveries were not made by Russian producers. There are also reports of Russian suppliers failing to offer supplies to European buyers.  It does appear that Russia will restart the pipeline as President Putin indicated that Russia would “fulfill it’s commitments” but warned that flows might fall short if additional sanctions prevent maintenance from being performed.   This looks like a quid pro quo – Putin will open flows if sanctions are reduced.  Although not directly related, the EU has agreed to ease sanctions on Russian banks to allow for food export payments[1].  In the meantime, the EU is starting to prepare for uncertain gas flows by establishing procedures to shut off gas to industrial users and encouraging other users to conserve.  The IEA has offered recommendations as well.  Although we are worried about supplies now, the real concern will be in wintertime. If Russia reduces flows of gas when it’s cold, the EU could be in deep trouble.
  • A number of sources have suggested that a Russian gas cutoff would have devastating economic effects for Europe. The German industrial sector would be especially at risk.  The German chemical industry is already warning that it cannot cut back further without closing completely.  The IMF warns the EU economy is at risk for a Russian gas embargo, and the European Commission is estimating a 1.5% decline in GDP.  Hungary and Italy are the EU nations at most risk from a loss of Russian natural gas.
• Although there has been widespread accusations of bad behavior by the oil industry to account for high product prices, the reality is, simply, there isn’t enough refining capacity. This isn’t just a U.S. problem; it’s global.  The reasons are complicated.  For one, for a long time, the industry’s profit margins have been lackluster.  The facilities are large, smelly, and potentially dangerous, so not wanting it in one’s backyard is understandable.  The lack of investment and the aging out of facilities, however, has led not just to tight product stocks but diminishing supplies of petrochemicals.
  • Another factor is that Russia’s refinery industry needs Western expertise to function, and China has been closing rudimentary “teapot” refineries, leading to lower production and exports. These factors are further crimping global product supplies.
  • An often overlooked factor is that refineries use natural gas to produce energy products. Rising natural gas prices, or in the case of Europe, outright shortages, will also crimp gasoline and distillate production.
  • A South African refinery was forced to shut down operations due to the lack of crude oil.
• The price chart at the top of this report suggests a weakening crude oil market. However, that may be more of a reflection of the speculative community than physical oil traders.  The latter indicate that there are large premiums between cash markets and futures benchmarks, suggesting the physical market remains tight.  If this persists, the futures markets will eventually reflect that higher price.
• Australia is a significant coal and natural gas producer, and yet, is facing a serious energy crisis. An ill-conceived electricity pricing structure, which underpriced electricity, led to outages.  Adding to pressure is an incomplete attempt to substitute renewables for coal and gas electricity generation.  Australia may be forced to restrict exports, which could hamper East Asian economies who rely on this energy source.
• China’s Zero-COVID policy has led to a drop in LNG imports as heavy industry slows. The new variants are increasing infections across China and may result in new lockdowns.  However, that didn’t help Japan, who just paid a record amount for an LNG delivery.
• The fire at the Freeport LNG facility has led to a decline in demand; interestingly enough, production has also slipped. However, once the facility returns to service (probably in September) the supply demand balance will become much more bullish for natural gas.
• A German bar, seeing shortages of cooking oil, offered beer for oil.
• A recent report suggests that, even with record high prices, world oil reserves have declined by 9%. There appears to be ample supplies, but the trend is disconcerting.

Geopolitical news:

• President Biden made it to the Middle East last week. The trip was a mixed bag of sorts.  On its face, the president was trying to normalize relations with a key ally, the KSA.    The U.S. has been concerned about Chinese and Russian encroachment in the region and is always worried about Iranian actions. The U.S. is working to support an Israeli/Gulf Nation coalition to contain Iran.  We note that Russian President Putin has been in the region this week, visiting Turkey and Iran. However, President Putin’s trip was prompted by high oil prices.  On that front, we doubt much will happen.  The consensus is growing that the Arab oil producers are near capacity.  Biden was warmly greeted in Israel and there was some movement to improve relations between Israel and the Arab Gulf states.  But the odds of getting appreciably more oil isn’t likely, despite comments suggesting otherwise.
  • It should be noted that in the aftermath of the meeting, the Saudis indicated they would work within OPEC+ for output decisions.
• The question of Russian oil continues to vex the West. Cutting off oil flows would reduce Russia’s income, but it is clear that Moscow is still finding buyers, many of whom are in Europe.  Russia has also rebalanced oil flows, sending more to China and India.  Simply put, there is little evidence to suggest sanctions have reduced Russia’s oil revenue.  The classic economic response to such a problem is to implement a tariff, which  would raise the price of Russian crude, making it less attractive to buyers.  Either Russia would be forced to stop selling crude to the tariff-implementing nations or would need to cut its price to world levels by the amount of the tariff, reducing Russia’s revenues.  Treasury Secretary Yellen offered up the tariff idea, but it went nowhere.  She then proposed a price cap. If a large enough group could come together, they could set a price that would reduce Russia’s revenue.  In theory, the price could be near marginal costs, which would make it reasonable to Russia to continue producing.  At first glance, this proposal seems wanting; after all, if a buyer could simply set the price, there is little need for markets.  However, there is a case to be made that if enough buyers participate, they could dictate a price.  Obviously, Russia could simply decide to stop selling oil, but that would be risky.  If wells are shut in, it’s not likely they will be restarted, and this action could lead to a permanent loss of global capacity.  In addition, Yellen is proposing a price that would not generate losses for Russia, so she claims they should accept it.
  • Interestingly enough, China, a key Russian ally, has not rejected the proposal outright.
  • So, what could go wrong? Such arrangements have been tried throughout history.  The U.S. had a scheme where oil had different prices depending on when it was produced; it simply led to regulation evasion.[2]  It’s not hard to see how Russia could game this arrangement.  Let’s say the price is $50 per barrel. Russia will sell you the oil at the price if you agree to sell something else to them below market prices, e.g., semiconductors.
  • Meanwhile, we are seeing energy flows adjust to sanctions. China is shifting oil imports to Russia, reducing flows from Saudi Arabia. Given the price difference, this makes sense.  Saudi extra light crude is trading at a nearly $40 per barrel premium to the Urals benchmark; prewar, this difference ran about $5 per barrel.  We have seen, in the past, that the Saudis would try to defend their market share in key markets. For example, in the late 1990s, the price war between Venezuela and Saudi Arabia was over the U.S. market.  We doubt such a conflict will emerge here for two reasons. First, the KSA is careful not to sour relations with Russia. Second, we don’t think the kingdom has the excess capacity to take such action.  In addition, it’s not just crude oil, as China is buying all types of energy from Russia.
  • One of the reasons the U.S. is so keen to set up this price-cap system is to try and thwart an EU proposal to deny Russian oil tankers’ insurance. Although China, Russia, India, or some other buyer could ensure the vessel, EU and British insurance firms provide 85% to 90% of all policies.  Some owners won’t sail without insurance from these sources and the Suez Canal Authority won’t accept any insurance other than EU or British policies.  The U.S. fears that if the EU plan goes through, Russian oil will become impossible to source and prices could soar.  The price cap is designed to postpone the insurance ban.
• Libya Prime Minister Abdul Hamid Dbeibeh, wants to fire the head of the nation’s National Oil Company, Mustafa Sanalla. Libya has been rocked by civil war ever since a coalition of EU nations and the U.S. ousted Moammar Gaddafi.  The nation is currently divided, with both sides fighting over control of oil revenues.  This fight has led to insecure oil flows which occasionally reduces global supplies.

 Alternative energy/policy news:

• Heat waves in Europe and the central U.S. dominated the news. In the former, wildfires have developed in several nations.  The U.S. has seen an uptick in fires as well.  Texas has been on the brink of blackouts for most of the summer.  Interestingly enough, solar power has been one of the factors that has allowed power to stay on in the Lone Star State.
  • Britain is facing record heat this week, leading the government to declare a national emergency. There is evidence to suggest that as the climate changes, jet streams are adjusting, leaving Europe unusually hot and dry.  Areas that are usually cool are facing record heat.  As we saw in the U.S. Pacific Northwest last summer, areas not usually hot suffer greatly from heat waves. In the U.K., for example, only about 5% of homes have air conditioning.  Until recently, it was never hot enough long enough to warrant the investment.  In addition, homes are designed to hold heat during the cold winter, making them even more of a problem during an unusually hot summer.  Thus, not only are European nations facing excessive heat, but wildfires too, with flames developing even within London.
  • As one would expect, fans and air conditioner demand is soaring in the U.K..
  • The RAF has halted flights from its largest air base as the runway tar softened in the heat.
  • The heat has killed more than 1,700 people in Spain and Portugal.
  • In the U.S., it is estimated that 40 million people are at risk from the current heatwave.
  • The question of climate change is politically charged. However, the majority of Americans, in a recent poll, note that weather extremes are affecting them.  It’s not that people don’t notice the climate change, it’s more likely that they don’t trust policymakers to fairly allocate the costs of mitigation.
  • China is reporting that high temperatures are adversely affecting industrial output. The heat is increasing strains on the electrical grid.
• At long last, Japan has finally relented and is restarting nuclear reactors. The reactors were closed after Fukushima.  Earlier this month, the government announced the return of five reactors.  It has decided that, by winter, four more will be restarted, bringing the total to nine.
• We continue to closely watch developments in geothermal power.
• Renewable energy firms are starting developments on old coal-fired generation sites because they are connected to the grid.
• This report lays out the path to replacing fossil fuels with renewables. One of the key findings is that regulation is hampering the efforts.
• One issue that bears watching are allegations that some solar panels are being manufactured by Uyghur forced labor.
• Carbon capture continues to attract investment; a trade group has formed to further boost the industry’s profile.
• Treasury Secretary Yellen is calling for an end to dependence on China for rare earth metals. The problem for mining, but especially processing, rare earth metals is the environmental costs.  The creation of these metals is especially “dirty”.  So, if the refining is going to occur in the U.S., it will be interesting to see where it occurs.
• As EVs become more popular, the market for home charging stations is heating up.

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[1] This is part of a deal to end the blockade on Ukraine grain, but it is still uncertain if the blockade will actually be lifted.  The details are daunting as the waters around Odessa are heavily mined and it isn’t clear if Russia will allow NATO minesweepers to clear a shipping channel.  It’s also not obvious that Ukraine will trust the Russians to clear the mines either.

[2] Marc Rich was to be indicted for this and other embargo evasions with Iran.  He fled to Switzerland.

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

Since early June, oil prices have fallen significantly, breaking the psychologically important point of $100 per barrel.  Technical support exists at $95 per barrel, so we will be watching to see if it holds.

(Source: Barchart.com)

Crude oil inventories rose 3.3 mb compared to a 1.5 mb draw forecast.  The SPR declined 6.9 mb, meaning the net draw was 3.6 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 12.0 mbpd.  Exports rose 0.4 mb, while imports fell 0.6 mbpd.  Refining activity rose 0.4% to 94.9% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories.  It is clear that this year is deviating from the normal path of commercial inventory levels.  Although it is rarely mentioned, the fact that we are not seeing the usual seasonal decline is a bearish factor for oil prices.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels seen in 2004.  Using total stocks since 2015, fair value is $101.09.

With so many crosscurrents in the oil markets, we see some degree of normalization.  The inventory/EUR model suggests oil prices should be around $65 per barrel, so we are seeing about $35 of risk premium in the market.

Gasoline demand:

In general, gasoline demand is price inelastic, which is “econ talk” for demand being insensitive to price.  Since substitutes for gasoline are mostly non-existent, consumers trying to adapt to higher prices are left with other methods, such as carpooling, combining trips, or using public transportation.  Unfortunately, data on public transportation is only available through Q1.  However, the data does suggest that ridership is well below pre-pandemic levels.  In the long run, demand can fall if car owners shift to more fuel-efficient vehicles; the work-from-home movement may also lead to lower structural demand.

At the same time, gasoline demand is very elastic to economic growth; as growth slows, demand declines.  We are seeing clear evidence of weakening demand.

Seasonally, this is where we usually see peak demand.  The fact that demand is falling and that it is usually price insensitive likely argues that the economy is weakening.

 Market news:

• As the above price chart shows, oil prices have come down hard recently. However, the IEA still says that the energy crisis remains a problem and is likely to get worse before conditions improve.
• In times of supply uncertainty, the hoarding instinct sets in; nations try to ensure they will have adequate supplies even if it means other nations are left short. We note that India has announced export curbs on diesel, an example of such behavior.  Meanwhile, Europe is aggressively buying up global LNG, which is denying the product to poorer nations.
  • US. refineries continue to run at high levels, which increases the odds of refinery issues.
  • Meanwhile, industrial energy users report that operations are being curtailed due to high prices.
  • Shippers are reportedly slowing their vessels to meet greenhouse emission regulations.
• Oil and gas workers in Norway went on strike; the government stepped in to end it.
• One of the characteristics of the postwar world in the U.S. has been the expansion of the regulatory state. Congress has tended to delegate the responsibility to agencies by granting them wide latitude.  This trend has created a backlash.  George Friedman has suggested that we are ending the era of the “rule of experts,” mostly because experts tend to have a narrow focus and, thus, when making recommendations their regulations can often ignore collateral issues that impose unexpected costs.  A recent Supreme Court ruling looks to counteract this state of affairs by reducing the ability of the regulatory agencies to impose rules not specifically granted by Congress.  This action notably affected the EPA’s ability to regulate greenhouse gasses.
• Although the Biden administration initially wanted to curtail new oil and gas leases, high prices have led the White House to walk back that position. For example, the Willow project in Alaska is still being considered.  This stance has not been well received by the environmental wing of the president’s party.  Interestingly enough, the new policy shift  hasn’t exactly thrilled the oil and gas industry either.
• As oil prices have increased, China has aggressively switched to coal and so has Europe. Russia has been increasing coal exports, which is making a comeback as oil and natural gas prices rise.
• A new surge in COVID cases in Shanghai has raised worries about another lockdown. If Beijing implements such policies, it would be bearish for oil prices.

 Geopolitical news:

It’s a big week in geopolitics and energy.

• President Biden is traveling to the Middle East this week. The broader context is stability in the region.  Since Obama, the U.S. has been trying to reduce its “footprint” in the Middle East to focus on the Asia-Pacific, the so-called “pivot to Asia” strategy.  In order to accomplish that, the U.S. has to create a regional security structure.  This area of the world remains important, not just for the oil markets but for the stability of Europe and South Asia.  Obama’s model, based on the ideas of Robert Baer, was that Iran was a reliable stabilizer.  Assigning Iran that role was what brought about the JCPOA.  Obama assumed that the next Democratic administration would finish normalizing relations with Tehran.  However, after Trump’s win in 2016, the focus of stabilization shifted to the Arab states and Israel.  The Abraham Accords became the model for such an arrangement.  It is now being referred to as a potential “Arab NATO.”  Although the Biden administration wanted to revive the JCPOA, as we have been documenting for a while now, there appears to be little chance of success.  Therefore, Biden seems to be shifting to working with the security arrangement created by the Abraham Accords.
• This is a complicated trip. Biden’s first stop is Israel, which is “between governments” at present.  From there, he is off to Riyadh to meet with the crown prince, who the president once labeled a pariah.  In general, presidents usually don’t make trips such as this without the agenda resolved.  In other words, although there is some concern that Mohammed bin Salman will disappoint the president, it is unlikely that Biden would have gone to the region if he believed he would come away empty handed.  However, it is also unlikely that the Kingdom of Saudi Arabia (KSA) will be able to expand production significantly.  The kingdom is the key reserve of global excess capacity.  If the KSA were to expand output to full capacity, it would mean the world has no production cushion.  There have been quiet concerns that the KSA has less capacity than it advertises.  It is still possible that MBS will publicly embarrass the president, as he has shown himself to be impetuous.  It’s not the most likely outcome, but one that has a higher probability than it would have had with the sons, rather than the grandsons, of King Saud.
  • At the same time, it is important not to forget that the U.S. and the KSA are long-term strategic allies. The Saudis operate in a difficult environment and having the U.S. as an ally is important.  For example, the U.S. is considering resuming the sale of offensive weapons to the KSA, a significant carrot.  Thus, it is quite possible that this visit may reset relations with the KSA, although we harbor serious doubts it will generate much in terms of oil sales.
  • It should be noted that OPEC+ continues to be unable to meet production targets.
• One potentially bearish factor for oil is sanctions violations. It is well known that China and India have been active buyers of Russian crude oil at deep discounts.  However, Europe continues to buy large quantities of oil and natural gas at high prices, leading to dramatic improvements in Russia’s external accounts.  One way the G-7 is thinking about addressing this issue is to create a coalition that agrees to buy Russian oil at around $60 per barrel.  It isn’t obvious how this would work; after all, if it’s effective, governments could simply set the price of oil globally.  The U.S. is warning that oil prices could rise further without the price cap.  Treasury Secretary Yellen is pitching the plan to China. Although China is an ally of Russia, so far, Beijing hasn’t rejected the plan.
  • Not only is Russia selling oil, but Iran’s sales have also been rising. The Biden administration hasn’t been actively enforcing Iranian sanctions, and sales, especially to China, have increased.  Iran has been using deceptive measures to skirt sanctions enforcement.  There are also reports that Russian oil products are finding a home in the Middle East, which can then export their own fuel oil to others.  This is part of the adjustment process to sanctions.  In fact, the “leaking” of Russian oil to world markets is weakening demand for oil from Venezuela and Iran, both also under some form of international sanctions.  That being said, the Brent-Urals crude oil spread remains above $30 per barrel, suggesting that the amount of Russian oil flowing into the system isn’t enough to narrow the spread.
  • Russian President Putin is expected to visit Iran next week.
  • Iran is hopeful that the global oil crisis will improve its bargaining position to return to the JCPOA.
  • The US. is claiming that Iran is planning to deliver armed drones to Russia. Such actions suggest Tehran doesn’t really think the JCPOA will go forward.
  • Venezuela, which has been subject to international sanctions, has resumed oil sales to the EU.
  • Gazprom (trading suspended) is demanding RUB for LNG.
• Meanwhile, on natural gas, there are growing worries that Russia is curtailing supplies to create a crisis this winter. The IEA is warning that Europe should prepare for a total suspension of Russian gas flows and also estimates such action by Russia would have devastating economic effects.  Germany and the Netherlands are already warning users they will need to curtail consumption.  Germany is taking steps to nationalize gas importers to prevent their failure.  Recently, the Nord Stream 1 pipeline was closed for maintenance, and there is great fear that Russia will not resume supplies.  A key part was being repaired in Canada, and the Canadians were reluctant to return it due to sanctions.  The EU petitioned Ottawa and the part is being returned.  Now we wait to see if gas flows restart.
  • Supply concerns have led France to use fuel oil for electricity production instead of natural gas.
  • Europe is aggressively buying up global LNG supplies; a large tender by Pakistan failed to find sellers, in part, because the EU outbid them.
• Russia has seized control of the Sakhalin gas project in retaliation for sanctions.
• At the same time, Russian courts have allowed Kazakh oil exports to continue; there was a threat by Russia to halt exports due to concerns over oil spills.
• General secretary of OPEC+, Mohammad Barkindo, passed away last week.
• The civil war in Libya has disrupted oil flows.
• Iran has begun yet another crackdown on dissidents in the midst of a severe inflation shock. We also note that there was a cyberattack on a steel mill that led to physical damage of the facility.
• The new government in Colombia is cooling investors on the energy sector.

 Alternative energy/policy news:

• The intelligence apparatus often tries to change policies in target nations. Authoritarian nations, given their control of the media, tend to have a “leg up” in the battle for opinion.  A good example of this recently is that China has been using social media to encourage environmental groups to oppose rare earths mining in the U.S. and Canada.  Although rare earths mining and processing is often environmentally “dirty,” it is also true that rare earths are critical in alternative energy production.  China dominates both mining and processing because it has been willing to absorb the environmental costs.[1]  However, as the West has realized its vulnerability in this area, there has been renewed interest in mining and processing rare earths outside of China.  Clearly, Beijing is trying to discourage such efforts.
• Although nuclear power remains controversial, there are elements in the environmental community that realize it may be necessary to expand nuclear power to reduce carbon emissions. One especially attractive technology is molten salt reactors.  Not only are the facilities smaller, but they should also be safer.
• One of the issues that concerns policymakers is that Russia and China are now at the forefront of nuclear reactor designs. The IEA estimates that nuclear power will need to double by 2050 to have any chance of reaching net zero emissions.
• Thermal technology could also be used to store production from wind and solar power. Currently, utilities must carry traditional redundant capacity to wind and solar capacity due to the natural interruptions of these sources.  Having storage would remove that need and improve the economics of renewables.  Germany is currently building a similar facility to hold hot water.  Finland is experimenting with using geothermal techniques and sand to store power as well.
  • Researchers are investigating if old mines could be used for pumped storage to store electricity.
• It is likely that carbon capture from the atmosphere will be required to have any chance of reaching climate goals. An Australian design suggests that solar power could be the key to creating the energy for carbon capture.
• It is also likely that as global temperatures rise, nations and some large firms may try geoengineering to improve conditions. These technologies could have unexpected effects, and so the scientific community has been reluctant to aggressively pursue them.  But, as temperatures rise, so will the drive to make such investments.  However, given that we will likely see such techniques deployed, the US. government is starting to fund research in a bid to control their implementation.
  • In the face of high heat, voluntary cutbacks to demand in Texas have, so far, avoided power disruptions. Bitcoin miners in the state suspended operations.
• Jet fuel made from bacteria may be more energy-dense that that from fossil fuels.

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[1] Lacking an effective tort bar is useful for such efforts.