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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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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