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

(The Weekly Energy Update will not be published next week.  The report will return on September 15.)

Crude oil prices remain under pressure on fears of a deal with Iran and weakening economic growth.

(Source: Barchart.com)

Crude oil inventories fell 3.3 mb compared to a 2.5 mb draw forecast.  The SPR declined 3.1 mb, meaning the net draw was 6.4 mb.

In the details, U.S. crude oil production fell 0.2 mbpd to 12.0 mbpd.  Exports fell 0.8 mbpd, while imports were unchanged.  Refining activity rose 0.3% to 93.8% 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 the past months’ inventory changes are more consistent with seasonal behavior.  We will approach the usual seasonal trough for inventories in mid-September.

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 2003.  Using total stocks since 2015, fair value is $107.69.

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 $64 per barrel, so we are seeing about $24 of risk premium in the market.

Market news:

• There are grave concerns about how Europe will manage energy this winter. Natural gas inventories have been rising, but it is probable that the European economy, likely in recession now, will see weaker economic activity in the coming months.  However, conditions are improving and it is possible that, barring an unusually cold winter or some other crisis, the situation might be more manageable than it looked earlier this year.  Some of this improvement is due to European industrial consumers making adjustments.
  • However, even with an improved supply situation, consumer costs will be very high this winter. The U.K. government is warning households to expect an 80% increase in their energy bills.  Europeans are facing difficult choices over home heating or eating.
  • Although the focus remains on this winter, policymakers are starting to realize that disruptions will likely continue for the next several years, meaning a broader response is necessary.
  • As China’s economy slumps, it has been reselling LNG to Europe. Although the EU can certainly use the gas, the concern is that this development will make the EU increasingly dependent on Beijing.
• Russia has halted flows of natural gas over the Nord Stream 1 pipeline for maintenance. The shutdown is supposed to last three days, although there are worries that it could be extended.  One of the issues about these periodic shutdowns is that Russia doesn’t have extensive storage networks for natural gas.  We have been concerned that if Russia starts closing in wells, there could be a permanent loss of production.  Apparently, Russia is avoiding this outcome by massive flaring of natural gas.  In effect, Russia is simply burning the gas into the atmosphere rather than put it in the pipeline.  Flaring does avoid the issue of shutdowns.
  • Russia has suspended natural gas flows to the French industrial company Engie (ENGIY, $11.97) over a contract dispute.
• The Canadian natural gas market is mostly isolated. Although there are pipelines that interconnect to the U.S. system, they occasionally reach capacity, leading to large discounts on Canadian natural gas.  We are seeing that situation now as the chart below shows the U.S. market trading at a nearly $7.00 premium.

(Source:  Bloomberg)

• Canada’s energy industry is heavily dependent on pipelines to the U.S. It is facing numerous threats to close ageing pipelines which, if these blocks are successful, would “bottle up” Canadian oil and natural gas and lead to lower prices.
• Canada would benefit by building out an LNG infrastructure.
• We have been reporting on the negative impact of ESG on oil and gas production. We note that the state of Texas is restricting investments in firms that support ESG investing.
• As natural gas prices rise, ancillary gases are seeing price hikes too. In the U.K., high natural gas prices have made ammonia prices uneconomical.  Carbon dioxide is a by-product of ammonia production and now that gas is in short supply.  Carbon dioxide is used by beer and soft drink makers and is used by the meatpacking industry to stun animals before slaughter.  This situation shows the ripple effects caused by excessively high natural gas prices.
  • Although we haven’t said much about it in this report, we are closely monitoring the intersection of energy and agriculture. Drought is hurting crop yields, but high fertilizer costs look to cause food shortages.
• Elevated natural gas prices are triggering a surge in LNG infrastructure investments. In the immediate term, however, Freeport LNG has pushed back its full recovery until March 2023.
• So far, the Atlantic hurricane season has been quiet, which, given the tightness of energy markets, is remarkably fortunate. This report highlights the risk from tropical storms and how it could disrupt production and LNG exports.
• In Europe, data centers are stockpiling diesel fuel to power local generators in case of blackouts. Major tourist attractions have been dimming the lights to reduce costs.
• Semiconductor production is remarkably energy intensive.

 Geopolitical news:

• One issue we have been watching closely is the political tension caused by high U.S. energy prices juxtaposed with the geopolitical goal of supplying Europe with energy. With midterms looming, the administration is clearly sensitive to domestic energy prices.  The massive SPR withdrawal, which we document each week in the above data, is part of the response.  However, this goal of keeping domestic energy prices low is in conflict with exporting enough energy to keep European nations “onside” with supporting Ukraine.  Over the past week, we have been starting to see signs of cracking.  The U.S. energy secretary is warning U.S. refiners not to increase exports to Europe, and threatening “actions” for companies that don’t comply.  At this point, we don’t think the administration would ban exports, but the idea remains under consideration.
  • Energy nationalism isn’t just a U.S. issue as the U.K. has threatened to cut natural gas interconnecting pipelines to the continent.
• On the other hand, the Russian economy appears to be doing better than expected. Appears is a key word, because the Kremlin hasn’t been forthcoming with economic data since the war started.  A report out of Yale suggests the Russian economy has been crippled by sanctions, but there has been a notable pushback against this claim.  An article in The Economist suggests the Russian economy is holding up, in part, because Russia is still selling oil and natural gas.  Greek tankers seem to be the conduit of much of these sales; however, when the EU enforces new insurance rules later this year, those sales may dry up.  There is no doubt that sanctions have had a negative impact on Russia, but Russia’s reaction to them has also had an ill effect on the West as well.
• There are reports that Israeli warplanes (F-35s) penetrated Iranian airspace. Although unconfirmed, it appears this action was designed to test Iranian radar defenses.  Along with reports that the U.S. and Israel held exercises over the Red Sea to simulate an attack on Iran, this news does suggest the idea of an attack on Iran remains a possibility.
• We also note that tensions between Iraqi Kurds and Iran are escalating, with the latter trying to influence governance and policy in this region of Iraq. Although the Kurds themselves are divided, they are united on the goal of controlling oil and gas flows from their region.  Baghdad has never been comfortable with this arrangement, but at times has been forced to tolerate it.  At present, there is no national Iraqi government in place, and so it is likely that Iran is trying to keep the Kurds from expressing their independence.
  • The U.S. and Iran rarely agree on much, but there are reports Washington and Tehran are not comfortable with the lack of a government in Iraq and Muqtada al-Sadr’s behavior in preventing a new administration from forming. Tensions between Shiite groups aligned with al-Sadr and with Iran led to riots and some fatalities.  At present, the rioting has ended, but tensions remain high.  The crux of this issue between al-Sadr and the other Shiite groups is that Iraq has been governed, since the fall of Saddam Hussein, by a Shiite-dominated legislature that apportions power to all the various Shiite groups.  Much like Lebanon, those not part of al-Sadr’s group want to keep it that way.  Al-Sadr dominated the last elections and wants to control the legislature without sharing power.
• Despite the report above, the U.S., EU and Iran continue to negotiate a return to the JCPOA. The U.S. has responded to Iran’s recent demands, but it isn’t clear that Tehran will accept this proposal or call for additional negotiations.  Iran continues to make demands, suggesting that it isn’t in a rush to resume the pact.
  • Israel has sent its defense minister to Washington along with the head of the Mossad to discuss the negotiations. Israel has opposed the pact.
  • Swedish and German intelligence suggest Iran has been trying to acquire nuclear technology for weapons.
  • As we noted last week, Iran has been holding crude oil, condensate, and products offshore in tankers. It is estimated that this source could rapidly add around 90 mb of oil and related products to global oil supplies.  This expansion is one reason why the administration is pursing a resumption of the deal.
  • It is also becoming clear that the Kingdom of Saudi Arabia is leading an effort to offset the return of Iranian crude oil by pushing for OPEC+ production cuts. This is a clear sign from the KSA of its opposition to a resumption of the agreement.  The drop in oil prices at mid-week was said to be due to OPEC+ signaling no output reductions, which may be an indication that the Iran nuclear deal is stalled.
  • The U.S. Navy had a confrontation with Iranian naval forces in the Persian Gulf. The Iranians apparently tried to capture a U.S. surface drone.
• The sanctions on Russia have mostly removed Moscow from the dollar system. India is starting to settle trade with Russia in INR.  Although this decision clearly benefits India, it isn’t obvious what Russia will do with the INR.
• Fighting has intensified in Libya, which has been in a civil conflict since Qaddafi was ousted in 2011. Often when conflict rises, oil flows are adversely affected.

 Alternative energy/policy news:

• Renewable energy consumption is rising rapidly, with China holding the position of largest consumer.
• California is banning the sale of gasoline powered internal combustion engine vehicles by 2035. If the state holds to this plan, it will likely push automakers to expand EV production.
  • Last week, we noted that Texas was banning firms from conducting business with the state if they had an ESG policy that curtailed investment in fossil fuels. This appears to be a bid to sway national policy via state regulations.  California does similar actions, such as what the above bullet point suggests.  Given that California’s state GDP is 14.6% of U.S. GDP compared to 8.8% for Texas, businesses tend to pay closer attention to the former.
• EVs remain a high-cost vehicle choice. Although there are a few lower cost options, as the chart below suggests, getting into an EV is mostly a $40k+ purchase.

       (Source:  Axios)

• • One factor driving the price of EVs higher is the goal of giving the cars the same range as a gasoline powered vehicle. However, when “fill up” of electricity can be done daily in one’s garage, an EV with a much smaller range might be more practical for everyday use and be cheaper to make.
  • We remain bullish on metals required in the conversion away from fossil fuels because it doesn’t appear that the demand is impossible to fill. At the same time, miners continue to find that local opposition is delaying the building of new mines for the materials required for batteries.

• Where are the hurricanes? So far, this has been a remarkably quiet Atlantic hurricane season.  Strong wind shear in the Caribbean has dissipated tropical waves and there haven’t been a lot of squalls coming from Africa.  It’s still too early to declare an “all clear” as the usual peak is around September 10,  but, given the tightness of the energy markets, a slow hurricane season is a bit of good fortune.
• The Western U.S. is facing a hot week.
• China has seen some rain which has eased drought conditions, but energy conditions remain fraught. China has persistent water issues that appear to be worsening.  The drought is leading to greater coal use.
• Mexico announced the opening of a state-owned lithium miner.
• Nuclear power is making a comeback. We noted recently that Japan is reopening reactors closed after the Fukushima incident.  Germany is reconsidering its decision to end nuclear power.  So is California.  Although strong opposition will likely continue, nuclear offers carbon-free baseload electricity which is attractive.
• One response to climate concerns is geoengineering. Geoengineering is the process of using engineering interventions to cool the planet, reduce carbon in the atmosphere, adjust rainfall, etc.  These interventions are highly controversial because, in theory, they could change weather patterns that could disadvantage some areas of the world while supporting others.  They could also have unanticipated side effects.  Also, given that geoengineering could be introduced by private actors, there is grave concern about how to control the process.  At the same time, we are already seeing efforts by nations in the Middle East to change rainfall patterns through cloud seeding and other techniques.
  • Major oil companies are making further investments into carbon capture.
• Coal is a dirty fuel in more than one way since not only is it the most carbon intensive of fossil fuels, but it also creates water pollution and solid waste. These wastes often are laced with heavy metals.  However, researchers are taking that waste and are working to extract these metals for the potential use in batteries.
• The Danish energy minister is calling for the streamlining of permits for wind farms. We note that permitting issues were a key part of the Inflation Reduction Act.
• “Smart glass” a product that adjusts to light in a way to increase the efficiency of HVAC units in buildings, is expected to expand due to a provision in the Inflation Reduction Act.
• China is expected to continue to dominate the solar panel industry.  However, the emergence of U.S. industrial policy is expected to see the U.S. increase solar equipment manufacturing.

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

Crude oil prices remain under pressure on fears of a deal with Iran and weakening economic growth.

(Source: Barchart.com)

Crude oil inventories fell 3.3 mb compared to a 2.5 mb draw forecast.  The SPR declined 8.1 mb, meaning the net draw was 11.4 mb.

In the details, U.S. crude oil production fell 0.2 mbpd to 12.0 mbpd.  Exports fell 0.8 mbpd, while imports were unchanged.  Refining activity rose 0.3% to 93.8% 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 the past two weeks are consistent with seasonal behavior.  We will approach the usual seasonal trough for inventories in mid-September.

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 2003.  Using total stocks since 2015, fair value is $106.51.

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 $64 per barrel, so we are seeing about $24 of risk premium in the market.

Market news:

• In a surprise move, OPEC+ is apparently mulling production cuts in response to weaker prices and an apparent “disconnect” between the physical and futures markets.
• The Freeport LNG plant, which suffered a fire earlier this year, will be at 85% of capacity by late November and full capacity by March 2023. This restart is later and less than expected, leading to a decline in U.S. natural gas prices.
• The courts giveth and taketh away. An appellate court ruled against the Biden administration’s pause on oil and gas leases on Federal lands.  However, it isn’t clear if this ruling will lead to immediate new activity.  On the other hand, another court ruled oil companies can be held accountable for the impact of climate change.
  • We note that U.S. energy capital spending remains restrained.

 (Source:  Strategas)

• Russia announced a three-day closure of the Nord Stream 1 pipeline in late August. By itself, this isn’t a huge issue, but with natural gas supplies tight, the fear is that the three day closure will be extended.
  • There are rumors that German industry has stopped hedging natural gas for future purchases. This may suggest that (a) the costs of hedging have become prohibitive or (b) they intend to simply buy in the spot market and if the price is too high, they will stop buying.  In any case, if true, it would suggest the potential for a near halt of German industrial activity.
  • The primary link of European natural gas prices to the U.S. is through LNG and the earlier-mentioned Freeport news does dampen U.S. prices a bit. Still, American exports are lifting the price of U.S. natural gas.  There is a risk of political blowback.
• Santos Limited (STO, AUD, 7.52), an Australian oil company, announced a new project in Alaska.
• The EU is ramping up oil imports from Russia in advance of the December 5 ban.
• Canada and the EU are discussing future natural gas trade, with Canada building out LNG capacity on the Atlantic Coast for export to Europe. Although this idea might improve Europe’s natural gas situation in the long-term, it will probably not help the immediate need.
• Maximizing shareholder value isn’t just a U.S. energy company position as Saudi Aramco (2222, SAR, 39.50) is doing something similar.
• Norway is warning Germany it may be near its natural gas export capacity and won’t be able to increase supplies to the continent indefinitely.
• Colombia’s new president has announced new taxes on the oil industry.
• The Ukraine War has led the U.S. to increase oil exports to Europe.
• Higher energy prices are becoming a major burden to U.K. households.
• Aluminum is sometimes referred to as “molten electricity.” High electricity prices have led to a sharp drop in European aluminum output.
• High natural gas prices along with higher mining costs have sent fertilizer prices soaring. The cost of fertilizer is exacerbating food shortages in Africa.
• Despite talk about reducing carbon emissions, China is increasing investment in fossil fuel production.
• Even with a concerted effort to reduce oil usage in transportation, the expansion of plastic use will underpin demand for oil.

 Geopolitical news:

• Iran continues to add conditions to the most recent “final offer” from the EU to bring Tehran back to the nuclear deal. Despite these conditions to a final offer, Tehran is blaming the U.S. for the lack of progress on a deal.  As we noted last week, the market expects a jump in supplies if a deal is made, but we are not convinced.  Sanctions regimes tend to deteriorate over time and reports suggest that Iranian oil is “leaking” into the market already.
  • There are reports that the U.S. is “reassuring” Israel that resuming the nuclear deal won’t increase risks to the region.
  • At the same time, the JCPOA is not popular in Congress on either side of the aisle. The administration is taking a chance that returning to the agreement will significantly lift oil supplies.
  • Russia has been improving relations with Iran, and there is a risk that they could use Iran as a conduit to avoid sanctions.
• Recently, we have been reporting on political divisions in Iraq. The political tensions could very well undermine Iran’s influence on the country.
• Although the Gulf states, Israel, and perhaps Turkey are aligning against Iran, we do note that the Gulf nations are also cautiously opening diplomatic channels to Tehran. If the U.S. reduces its influence in the region, some degree of cooperation may be necessary.  As the U.S. moves its emphasis elsewhere, Russia is attempting to fill the void.
• Klaus Ernst, a Bundestag member from The Left party, is calling for “negotiations” with Russia not only to increase natural gas supplies but to open Nord Stream 2. The Left is not in the government and cooperating with Russia isn’t the policy of the current administration.  However, his comments raise concerns that support for sanctions against Russia may be under pressure.
• There is an interesting geopolitical ‘tug-of-war’ occurring between China and Russia over the Central Asian nations. Russia sees these nations as part of its sphere of influence whereas China wants them to feel free to export raw materials (include oil and natural gas) without concern over Moscow’s position.  We note that there has been a suspension of oil loadings on the Caspian pipeline system, which may or may not be due to Russian interference.
• Mexico’s President Andrés Manuel López Obrador is taking steps not just to intervene in the oil industry but also to undermine efforts to diversify with renewables. His policy of resource nationalism may not lead to more oil production (it isn’t clear the state oil company can do this without foreign assistance) but could lead to less overall energy supply.
• There are reports that China is expanding its capacity to smuggle oil through tanker transfers in the open ocean. The U.S. is increasing efforts to tighten sanctions on Russia.
• Poland banned Russian coal imports and is now scrambling to build stockpiles.

 Alternative energy/policy news:

• We continue to closely monitor drought, water levels, and temperatures around the world.
  • In China, a tributary of the Yangtze River has run dry. Hot temperatures in China are boosting coal usage.  Sichuan province has shut down all industrial activity for five days due to shortages of electricity.  The province is increasing its consumption of coal for electricity, but that hasn’t been enough yet to overcome the drought and the loss of hydropower.  Silicon production has been affected by the power outages.  The Shanghai Bund light show has been cancelled due to electricity shortages and EV owners are finding supplies tight.  Here are some pictures of China’s drought.
  • In Europe, hot weather and low water levels have reduced hydropower from Norway, reduced nuclear power output, and cut coal shipments. Although the Rhine River levels have improved modestly recently, the chart below shows current levels relative to history.

(Source:  Adam Tooze)

• High temperatures, unexpected flooding, and other weather events are contributing to inflation. The weather has interrupted shipping, damaged crops, and reduced productivity.  Adding to worries is that, so far, the Atlantic hurricane season has been quiet, but history shows that tropical storm activity tends to rise into mid-September.
• One of our observations is that we live in a multi-variant world but create univariate narratives. Thus, that the current drought and heat are solely caused by greenhouse gases is a common theme.  Clearly, this isn’t the sole cause otherwise how does one explain earlier drought periods when greenhouse gases were much less prevalent?  This isn’t to say that greenhouse gases don’t matter as there is solid evidence that they do have an impact, but the current crisis is likely affected by other factors as well.
• The Inflation Reduction Act has funding for carbon capture projects.
• The SEC is proposing broad greenhouse gas rules for publicly traded companies. In their current form they would impose these rules on Europe as well.
• Although there are numerous Gigafactory projects in Europe, nearly all of them are facing serious delays.
• Lithium is the current state of the art for batteries, but research on other battery chemical mixes continues and there is growing evidence that sodium solid state batteries may prove to be a much better alternative. Not only is sodium plentiful and inexpensive, but the battery should last longer and charge much faster.  However, the battery probably wouldn’t be used initially in transportation since salt is heavy, but could be used in industrial settings and for utilities.  As the science improves, we could see this later used in transportation.
• Although Australia and Chile dominate lithium mining, China dominates processing of the metal.
• Will Germany close its remaining nuclear plants? The economics ministry says they will close on schedule, but there is a rising call to keep them running.  Meanwhile, in the U.S., utilities with nuclear facilities are seeing better performance.  Japan is turning the reactors back on to offset the risk of fewer LNG supplies.
• The gas emissions from farming have become major news in Europe. The Netherlands is implementing nitrogen restrictions on dairy farming that will end up reducing milk supplies and put farmers out of business.  We are seeing a strong negative reaction.  A similar plan in Canada is also upsetting farmers.
• Ford (F, $15.31) announced a workforce restructuring to shift toward EV production.
• Greenland is drawing new attention for sourcing rare earths. European automakers are increasing their focus on Canada as a source for battery metals.

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

Crude oil prices remain under pressure on fears of a deal with Iran and weakening economic growth.

(Source: Barchart.com)

Crude oil inventories fell 7.1 mb compared to a 0.3 mb build forecast.  The SPR declined 3.4 mb, meaning the net draw was 10.2 mb.

In the details, U.S. crude oil production was steady at 12.2 mbpd.  Exports rose 2.9 mb, while imports were unchanged.  Refining activity dipped 0.8% to 93.5% 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 this week’s outsized decline is consistent with seasonal behavior.  We will approach the usual seasonal trough for inventories in mid-September.

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 $104.45.

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 $64 per barrel, so we are seeing about $24 of risk premium in the market.

Market news:

• Oil prices have been coming under pressure mostly on fears of slowing demand, and weak economic data from China have been particularly worrisome. Weaker demand has taken US. retail gasoline prices below $4 per gallon.  Last month, futures markets were weaker than physical price markers, but even the physical markets are now showing signs of weakness.  OPEC+ recent demand forecasts confirm softening consumption, although some of this may be self-serving.  If the cartel wanted to justify its modest production increase, citing slowing demand would be a reasonable assertion.
• Meanwhile, we are seeing nations take steps to moderate consumption to reduce prices and ensure adequate supplies. The U.K. is preparing for energy shortages by creating plans to ration energy.  The Indian Parliament recently passed conservation measures.
• As we noted last week, German natural gas inventories have risen rapidly. However, even with this inventory accumulation, regulators are still pressing for further cuts in current usage to avoid rationing.  Despite this news, natural gas prices are surging in Europe.
• As energy company profitability soars, in the U.K., there is a movement to use these profits for “green” investments. If this becomes a norm, fossil fuel supplies will remain constrained.
• The Ukraine War and subsequent sanctions have disrupted physical supply chains. As the war continues, consumers and producers are working to restructure energy infrastructure.  Germany, Portugal, and Spain are considering a plan to build natural gas pipelines through France from the Iberian peninsula to bring LNG to central Europe.  Kazakhstan is considering a plan to transmit crude oil through the Azeri pipeline network to avoid Russian pipelines.  Also, Azerbaijan itself is likely to become an important supplier of oil and natural gas to the EU.  Although these actions will take time, the more that supply chains adjust, the more supply will equalize and bring prices down in currently high priced markets.
  • Egypt will ration electricity to reduce domestic natural gas consumption in a bid to increase exports.
  • Meanwhile, Hungary is receiving Russian natural gas through the Turkstream pipeline that runs through Serbia. Hungary has generally opposed EU sanctions against Russia.
  • Power shortages have led to the closure of a second aluminum smelter in Europe.
• At the same time, resource hoarding is always a temptation. Australia is considering actions to reduce LNG exports to ensure ample domestic supplies.
• Although there has been disruption to crude oil flows due to the war, the IEA suggests that Russian production has fallen only modestly. In contrast to OPEC+, the IEA is projecting higher demand this year due to fuel switching away from natural gas.
• Although new refining projects are considered impossible in the U.S., it hasn’t prevented global refinery building from occurring. However, this new capacity may not relieve product shortages in all markets.
• OPEC’s recent market analysis could lay the groundwork for a production cut. At the same time, Saudi Aramco (2222, SAR, 39.80) claims it can produce 12.0 mbpd.

 Geopolitical news:

• We saw conflicting trends on the JCPOA/Iranian situation. The EU has proposed a plan to end the IAEA’s investigation of suspect weapons sites in exchange for Tehran disclosing what it knows.  In addition, the EU has also suggested a way to circumvent U.S. sanctions on the Iranian Revolutionary Guard Corp.   Reports suggest that the U.S. is considering these changes, and Iran is on board as well.  The EU offer was said to be final, but, in dealing with Iran, it is hard to say when negotiations end.  Iran did deliver a response, but it was not to accept or reject the deal, but rather to negotiate further.   Iran is simultaneously trying to suggest it is “flexible” while suggesting that the U.S. isn’t negotiating in good faith.   At press time, the EU was still examining the Iranian response.  One element of the response is that Iran wants compensation if the U.S. withdrawals again from the deal.  It’s not clear to us if an administration in office could bind a subsequent administration to such an arrangement without legislation or treaty.  Thus, this could be a deal killer.  We also note Iran wants the U.S. to end the IAEA’s investigation into Iran’s violation of the pact earlier.  Again, the IAEA is an independent agency of the UN and the U.S. can’t order them to back away from this investigation (nor should the administration do this, IOHO). Talks appear to have reached the “fish or cut bait” stage, as the U.S. stance is either accept the deal or walk away.  We do note that if the administration does allow these changes, the political blowback could be considerable.  At the same time, Iran claims it is sitting on 100 mb of crude oil and natural gas condensate that would hit the market immediately.  If this is true, it would make a major impact on oil prices, but we have our doubts about this claim.  It is clear that the sanctions has been eroding for some time and to the best of our knowledge, these inventory numbers have not been independently verified.  Complicating matters further:
  • S. intelligence agencies suggest Iran has trained Russian soldiers on the use of drones.
  • There are reports that Iran tried to arrange for the assassination of John Bolton, the former National Security Director. To add insult to injury, Tehran only wanted to spend $300k for the effort.
  • Although it would likely be difficult to directly tie Iran to the attack on author Salman Rushdie (although the lack of ties didn’t stop SoS Blinken from making the connection), the fatwa issued against him by Iranian clerics was almost certainly a factor. We do note that Iran has officially denied any involvement.
• There are reports that President Xi is planning to visit the Kingdom of Saudi Arabia this week, although these plans have not been confirmed. Closer ties between Beijing and Riyadh will not sit well with the U.S.  We also note that there may be something of a market share war developing between Iran, the KSA, and Russia.  China has become a favorite market for Russian oil.  Xi may be making this trip to maintain relations.  We do note that China and the KSA are working on oil and gas investments jointly, and China does appear to be replacing the U.S. as a key market for the Saudis.
• Prince Alwaleed bin Talal made large investments in Russian oil and gas firms just before the attack on Ukraine. Although there is some element of plausible deniability, the optics are unfavorable.  Moreover, it suggests closer ties between the KSA and Russia, which could become increasingly problematic for the U.S.
• Intra-Shiite tensions in Iraq have the potential to cause a civil conflict. Essentially, the fight is between al-Sadr and other Shiite groups.  The former wants to create a government based on majority rule while the latter wants proportional representation.  The inability to come to an agreement may lead the KSA and Iran to become involved.

 Alternative energy/policy news:

• With the Inflation Reduction Act now signed into law, a backlash against economists for pushing for a carbon tax is developing. To some extent, this makes sense as using other tools can be more politically popular.  However, from an efficiency standpoint, a carbon tax would still be a superior policy, but obviously, if you can’t get it passed, holding on to that policy to the exclusion of all others makes little sense.  What the bill is really all about is industrial policy.  Government shaping the economy is nothing new but is generally considered legitimate only in cases of clear market failure.  Since a carbon tax was never implemented, it really hasn’t been proven that a market failure exists.
  • Despite the lack of a carbon tax or a carbon price, market participants are increasingly behaving as if one exists.
  • The bill is poised to create an EV production boom in the Midwest.
• There is great excitement in the environmental community over the new measures but one potential concern is the lack of workers to build out the plan.
• Germany is extending the life of its three remaining nuclear power plants.
• Any commodity activity disturbs something. Whether its drilling, ranching, farming, or mining, something or someone gets disturbed.  As demand for lithium rises, opposition to mining or brining has emerged.  Although such opposition may be overcome, higher costs are likely to result.
• As we noted last week, the price of EVs continues to climb. Ford’s (F, $16.18) announcement of substantial price increases on its F-150 “Lightning” EV pickup is the most recent example of this issue.
• There is growing evidence that the Arctic is warming faster than other parts of the world. The impact is difficult to estimate, but we would expect greater weather variability from this situation.
• Much of the Midwest, parts of the Southwest, Florida, and the Atlantic coast could become subject to extreme heat events in the coming decades. But the real worry is heat in areas unprepared. The linked map shows the areas of installed air conditioning.
• Hot weather just isn’t an inconvenience. The drought and warm weather is affecting industrial activity in Germany.  In China, power shortages, caused by hot weather, are causing car and battery plants to suspend operations.  Tech firms have also temporarily shut down.
• Delays of utility-scale solar projects are steadily rising. These delays may be tied to trade restrictions which have recently been eased.
• California looks ready to extend the life of the Diablo Canyon nuclear power plant that was scheduled for decommissioning.
• Increasingly, we are seeing an “all of the above” strategy in energy investment. Investing in renewables doesn’t necessarily preclude investing in fossil fuels.
• Although wood burning is not necessarily environmentally friendly, it appears Germans are considering it in the face of rising fossil fuel prices. Wood pellets are also seeing rising demand in Europe and Asia.
• This recent report from the Peterson Institute details China’s dominance in rare earths processing.

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

Prices are testing long-term support near $90 per barrel for crude oil.

(Source: Barchart.com)

Crude oil inventories rose 4.5 mb compared to a 1.5 mb draw forecast.  The SPR declined 4.7 mb, meaning the net draw was 0.2 mb.

In the details, U.S. crude oil production was steady at 12.1 mbpd.  Exports fell 1.0 mb, while imports rose 1.2 mbpd.  Refining activity declined 1.2% to 91.0% 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.  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 $104.04.

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 Prices

One of the challenges in determining “how high” gasoline prices truly are is to find the proper scaling variable.  The most common metric is to deflate the current price by some price index.  Although that method is sound (it compares gasoline prices to other items), it doesn’t, in our opinion, capture the centrality of gasoline prices.  After all, a commuter often has limited ability to substitute either a fuel (cars tend to only use gasoline) or a travel method (car sharing requires coordination, public transportation varies by locale).

As an alternative to using a price index, we take the nominal hourly wage for a non-supervisory worker and divide into that wage the current average national price of gasoline.  This measure calculates how many gallons of gasoline a worker can purchase for an hour’s worth of work.  The scaling method isn’t perfect as it doesn’t take into account taxes and benefit costs, for example, but it does allow us to compare the current price to history.

The below chart shows that calculation along with the Presidential Approval Ratings.  On the left axis, the higher the number, the more gallons one can buy with an hour’s worth of work.  So, the higher the reading, the better off the worker is.  Over time, the average is 8.6 gallons.  As the chart shows, we are well below that level at present.  It’s also clear that Presidential Approval Ratings and the number of gallons one can buy “rhyme.”  The two variables are not perfectly correlated.  There are several spikes in approval tied to wars or other geopolitical events that sometimes occur with lower gallon per hour readings.  But, overall, President Biden’s low approval ratings is not being helped by falling gallon per hour numbers.

Market news:

• The current energy crisis has a multitude of factors behind it. Green power hasn’t come online as fast as hoped, and fossil fuel production has not responded to higher prices for a number of reasons.  This article provides a summary, and this podcast, from Odd Lots, highlights the differences between consumer goods (especially technology) and energy products.  With consumer tech, when a better product hits the market, the old technology disappears rapidly.  That is not the case with energy.
• OPEC+ met this week to set production targets. The cartel agreed to a cosmetic increase of 0.1 mbpd, which fulfills the White House’s goal of an increase, but will not have any significant impact on supply.
• It appears the EU is rethinking its stance on banning insurance firms from selling protection on Russian crude oil shipments. The U.S. has been concerned for some time that the program could unexpectedly reduce sales and drive oil prices higher.  The G-7 is considering other measures to reduce the profitability of Russian crude oil without curtailing supply.
• As it has become apparent that Russia is an unreliable supplier of natural gas, Germany is moving rapidly to build LNG regassification capacity.
• In light of the energy crisis, coal has made a dramatic recovery, with global demand set to have a record high in 2022. The EU is reducing Russian purchases on its way to an outright ban.
• West Virginia has banned five major Wall Street banks from doing business with the state over their policies toward lending to fossil fuel companies.
• In periods of shortages, nations often turn to hoarding. For energy producers, the temptation is to reduce exports in order to provide oil, natural gas, or coal at lower prices domestically.  Bans can be hard to enforce, and after such actions consuming nations often become hoarders themselves, stockpiling due to the insecurity of supply.  When that happens, the relationship between inventory levels and price becomes positive while under normal circumstances, the relationship is negative.  So far in oil, that correlation inversion hasn’t occurred yet.  We note that Australia is considering mandating a reduction in coal exports, which may be an early warning of hoarding activity.  In addition, Australia’s LNG exports might be curtailed to ensure domestic prices remain below global ones.
• Russian LNG supplies to India have been cut, forcing India to ration gas by cutting supplies to industrial users.
  • We also note that Russia has signaled to Germany that repairs on Nord Stream 1 are not its responsibility.
  • France claims it will have fully filled its natural gas inventories by November 1.
• Demand for hydraulic fracking equipment has been strong, which is leading to constrained supply. The lack of equipment could prevent oil production from rising.
• Power companies report a shortage of key distribution equipment as hurricane season heads into its active period.
• Baker/Hughes (BKR, $25.50) is selling its Russian business unit to a local management team.

 Geopolitical news:

• Protestors have stormed the Iraqi Parliament twice recently, due to anger over the potential for a government run by groups other than Moqtada al-Sadr. They are especially upset by the candidacy of Mohammed al-Sudani, who is backed by Iran. The protestors are also calling for a new constitution.  The worry is that if the political unrest escalates, it might disrupt oil production at some point.
• Although Iran is pressing to resume JCPOA talks, U.S. officials suggest a deal is “highly unlikely.” Meanwhile, the U.S. is considering expanding sanctions against the smuggling network that is selling Iranian crude oil.
  • Iran is trying to improve relations with India, but is struggling to make progress.
• OPEC+ is showing no signs of ending Russia’s membership.
• When a company makes direct investment into a foreign nation, the risk of expropriation exists. Miners are facing such a threat in Kyrgyzstan.

 Alternative energy/policy news:

• The “big news” this week was the unexpected agreement between the Democrat leadership in Congress and Sen. Manchin (D-WV) on climate regulation. Although this bill isn’t as ambitious as earlier versions (which Manchin opposed) it is surprisingly expansive.  It includes clean energy tax credits for nuclear power, clean hydrogen, and direct carbon capture.  Incentives to buy EVs, including tax credits, were included, as were aids for solar power.  There are some sticks, too.  These include a fee on methane emissions, which could boost the cost of drilling, especially for natural gas.  There are also taxes for oil imports.  We doubt this bill will get any support from the GOP and it isn’t completely clear it will get unanimous Democratic support.  But for now, the agreement is something of a breakthrough, and we will be watching to see if it actually passes.
  • We are also closely watching another bill that can’t go through reconciliation but would streamline the permitting process for oil and gas drilling along with pipeline construction. While permitting delays have been a favorite tactic of environmentalists, this bill would put a two-year limit on objections, meaning that the project either get approved or rejected in a shorter time frame.  This bill could be filibustered, so it must gain some GOP support.
  • Another interesting sidelight is that the bill offers tax incentives for making EVs using minerals from nations with which the U.S. has free trade agreements. Sadly, there aren’t any.
• Even with the aforementioned bill, EVs continue to struggle for adoption. Prices are high since the market for low cost EVs is still rather small.  The majority of EVs reside in a handful of states.
• Last week, we noted the unusual weather events we were seeing across the country. It is clear (especially in St. Louis and vicinity) that the infrastructure isn’t adequate for such events.  Hot weather continues across the country with some 100 million Americans affected.  Although the notion of climate change remains polarized, polling does suggest that unusual weather events are increasingly being tied, in the mind of the public, to climate change.
  • As temperatures rise in Singapore, the city-state is investigating various methods to manage heat.
• Farming is a source of greenhouse gases; steers and dairy cows emit CO₂, for example. At the same time, they are a source of food.  Taking steps to curtail agriculturally based gases will raise food costs – a step that is rarely politically popular.  The Netherlands and Canada are considering such steps, triggering a backlash from farmers.  Given soaring food prices, these steps appear rather mistimed.
• Lyondell (LYB, $86.50) is closing a refinery in Texas, but is considering repurposing it to process recycled plastic.
• German automakers are turning to China’s Contemporary Amperex Technology (CATL, ¥534.92) for auto batteries for EVs.
  • Ganfeng Lithium (GNENF, $9.32) is planning to build a solid state EV battery facility. Solid state batteries hold the promise of longer range and faster recharging.
• Is sand a viable, cheap, alternative to other batteries for utilities? Finnish researchers are testing the concept.  The idea is that sand can hold heat and that heat can be tapped for a number of different applications.
• S. regulators have certified a small nuclear design.
• Under hot and dry conditions, wind can falter. Texas is reporting a drop in renewables output, further constraining electricity supply.  Interestingly enough, hot weather can also curtail nuclear power. In France, as temperatures rise, river water used to cool reactors becomes too hot, forcing utilities to restrict output.
  • Warm weather is also lowering the water level of the Rhine River, nearly closing it to shipping. If it closes, coal shipments might be adversely affected.
• New England utilities are finding that expanding solar capacity is reducing demand during daylight hours.
• Aurora Hydrogen, a startup, is testing the concept of making hydrogen from natural gas with a process that generates no CO₂.

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