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It’s artificial, but is still real and prices will tick higher

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SEB - analysbrev på råvaror

SEB - Prognoser på råvaror - CommodityDonald’s tweet on Friday that the OPEC cartel is keeping oil prices artificially high sent Brent crude down to an intraday low of $72.88/bl. The market later in the day totally disregarded the tweet sending Brent to its highest close of the week at $74.06/bl, up $0.4/bl on the day, +2% w/w and the highest close since November 2014. Of course Donald is totally right. The market is artificially tight because the OPEC+ cartel has deliberately cut production. In total its production is down 1.7 m bl/d versus Oct 2016. In our view there were deliberate cuts of 2,052 k bl/d in February if we cut out involuntary cuts of 810 k bl/d and production gains of 1,146 k bl/d. Of course Donald is right that it is the OPEC+ cartel which is driving the market. Tell us something new! That has been the case since their decision in October 2016. Of course the cartel has been lucky since their strategy has been supported by synchronised global growth and very strong oil demand growth as well as production in Venezuela falling like a rock. If it had not been for the very strong global oil demand growth their strategy would probably have been very close to failure since US crude oil production is reviving so strongly. In our estimate they will not be able to exit their cuts in 2019 without driving global inventories back up again. That is why an extension of their agreement to 2019 is on the agenda for the meeting in Vienna on June 20/21/22. So the market is artificially tight but it is the oil market reality of today. They are cutting, oil demand is strong, inventories are going down and prices are moving higher. The OPEC+ cartel will in our view be in control of the market in 2019 unless we have a global recession. They can put some of their cuts back into the market, but not all. Any involuntary production cuts by Venezuela, Libya, Mexico or possibly Iran will of course be welcomed by the deliberate cutters in the group.

Bjarne Schieldrop, Chief analyst commodities at SEB

Bjarne Schieldrop, Chief analyst commodities

If it had not been for cuts by the OPEC+ cartel since January 2017 we would probably have had an oil price still somewhere around $50-55/b

Since a 2017 high of 3059.7 in May 2017 the commercial OECD oil inventories have declined 218 million barrels which equals a 0.8 m bl/d daily draw down on average through the period. On average through that period the production of OPEC+ has been 1.4 m bl/d below its October 2016 production level in a mix of deliberate cuts, gains and involuntary cuts. Since the world is bigger than the OECD inventories there has probably been some inventory draws in non-OECD stocks as well. So while the OECD drawdown implied global deficit since May 2017 is 0.8 m bl/d the actual deficit may have been higher, but probably not higher than the net effective cuts of OPEC+ of 1.4 m bl/d over the same period. So yes, our view sides with Donald Trump that if it had not been for cuts by the OPEC+ cartel since January 2017 we would probably have had an oil price still somewhere around $50-55/b or even maybe sub-$50/bl.

There have however hardly been any negative responses to the OPEC+ cartel’s actions up until now on Friday with the tweet by Donald Trump. Not even Donald has acted before now even though production cuts have been going on since the start of 2017. Mostly the action by the cartel has been viewed positively across the board. I cannot remember to have seen any negative takes on it before now. Mostly the take has been that OPEC+ has been doing the world a favour.

OPEC+ has driven the global oil sector out of its investment hysteresis and out of its deep, dark abyss of despair and back into action

Through its cuts, inventory draws and higher prices OPEC+ has driven the global oil sector out of its investment hysteresis and out of its deep, dark abyss of despair and back into action. That is probably a good thing since it will help to reduce the risk for a significant undershoot in supply down the road due to the deep investment cuts in new conventional supply since 2014. And the jury is still out whether we will be able to dodge that bullet when the pipeline of legacy green field conventional oil investments from before 2014 starts to run dry in 2020. Our view is that there is clearly upside price risk due to this on this time horizon.

For the time being we remain bullish for Brent crude oil prices as OPEC+ cuts are intact, their agreement will and must be extended to 2019 at their June 20/21/22 in order to avoid raising inventories in 2019. For the rest of 2018 we expect inventories do draw lower with added supply risk due to Venezuela, Libya and possibly Iran.

If Donald wants to do something he can sign the sanction waivers on May 12 in order to safeguard Iranian crude oil supply. Else his dear voters and consumers are likely to face higher gasoline prices this summer.

Ch1: OPEC+ deliberate cuts, involuntary cuts and gains

OPEC+ deliberate cuts, involuntary cuts and gains

Ch2: OPEC+showing who are doing what versus October 2018

OPEC+showing who are doing what versus October 2018

C3: Crude and product weekly inventory data versus start of year. Heading lower. Down 23 m bl last week

Crude and product weekly inventory data versus start of year. Heading lower. Down 23 m bl last week

Analys

OPEC+ will likely unwind 500 kb/d of voluntary quotas in October. But a full unwind of 1.5 mb/d in one go could be in the cards

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Down to mid-60ies as Iraq lifts production while Saudi may be tired of voluntary cut frugality. The Brent December contract dropped 1.6% yesterday to USD 66.03/b. This morning it is down another 0.3% to USD 65.8/b. The drop in the price came on the back of the combined news that Iraq has resumed 190 kb/d of production in Kurdistan with exports through Turkey while OPEC+ delegates send signals that the group will unwind the remaining 1.65 mb/d (less the 137 kb/d in October) of voluntary cuts at a pace of 500 kb/d per month pace.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Signals of accelerated unwind and Iraqi increase may be connected. Russia, Kazakhstan and Iraq were main offenders versus the voluntary quotas they had agreed to follow. Russia had a production ’debt’ (cumulative overproduction versus quota) of close to 90 mb in March this year while Kazakhstan had a ’debt’ of about 60 mb and the same for Iraq. This apparently made Saudi Arabia angry this spring. Why should Saudi Arabia hold back if the other voluntary cutters were just freeriding? Thus the sudden rapid unwinding of voluntary cuts. That is at least one angle of explanations for the accelerated unwinding.

If the offenders with production debts then refrained from lifting production as the voluntary cuts were rapidly unwinded, then they could ’pay back’ their ’debts’ as they would under-produce versus the new and steadily higher quotas.

Forget about Kazakhstan. Its production was just too far above the quotas with no hope that the country would hold back production due to cross-ownership of oil assets by international oil companies. But Russia and Iraq should be able to do it.

Iraqi cumulative overproduction versus quotas could reach 85-90 mb in October. Iraq has however steadily continued to overproduce by 3-5 mb per month. In July its new and gradually higher quota came close to equal with a cumulative overproduction of only 0.6 mb that month. In August again however its production had an overshoot of 100 kb/d or 3.1 mb for the month. Its cumulative production debt had then risen to close to 80 mb. We don’t know for September yet. But looking at October we now know that its production will likely average close to 4.5 mb/d due to the revival of 190 kb/d of production in Kurdistan. Its quota however will only be 4.24 mb/d. Its overproduction in October will thus likely be around 250 kb/d above its quota  with its production debt rising another 7-8 mb to a total of close to 90 mb.

Again, why should Saudi Arabia be frugal while Iraq is freeriding. Better to get rid of the voluntary quotas as quickly as possible and then start all over with clean sheets.

Unwinding the remaining 1.513 mb/d in one go in October? If OPEC+ unwinds the remaining 1.513 mb/d of voluntary cuts in one big go in October, then Iraq’s quota will be around 4.4 mb/d for October versus its likely production of close to 4.5 mb/d for the coming month..

OPEC+ should thus unwind the remaining 1.513 mb/d (1.65 – 0.137 mb/d) in one go for October in order for the quota of Iraq to be able to keep track with Iraq’s actual production increase.

October 5 will show how it plays out. But a quota unwind of at least 500 kb/d for Oct seems likely. An overall increase of at least 500 kb/d in the voluntary quota for October looks likely. But it could be the whole 1.513 mb/d in one go. If the increase in the quota is ’only’ 500 kb/d then Iraqi cumulative production will still rise by 5.7 mb to a total of 85 mb in October.

Iraqi production debt versus quotas will likely rise by 5.7 mb in October if OPEC+ only lifts the overall quota by 500 kb/d in October. Here assuming historical production debt did not rise in September. That Iraq lifts its production by 190 kb/d in October to 4.47 mb/d (August level + 190 kb/d) and that OPEC+ unwinds 500 kb/d of the remining quotas in October when they decide on this on 5 October.

Iraqi production debt versus quotas
Source: SEB calculations, assumptions and graph, Bloomberg actual production data to August
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Analys

Modest draws, flat demand, and diesel back in focus

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U.S. commercial crude inventories posted a marginal draw last week, falling by 0.6 million barrels to 414.8 million barrels. Inventories remain 4% below the five-year seasonal average, but the draw is far smaller than last week’s massive 9.3-million-barrel decline. Higher crude imports (+803,000 bl d WoW) and steady refinery runs (93% utilization) helped keep the crude balance relatively neutral.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

Yet another drawdown indicates commercial crude inventories continue to trend below the 2015–2022 seasonal norm (~440 million barrels), though at 414.8 million barrels, levels are now almost exactly in line with both the 2023 and 2024 trajectory, suggesting stable YoY conditions (see page 3 attached).

Gasoline inventories dropped by 1.1 million barrels and are now 2% below the five-year average. The decline was broad-based, with both finished gasoline and blending components falling, indicating lower output and resilient end-user demand as we enter the shoulder season post-summer (see page 6 attached).

On the diesel side, distillate inventories declined by 1.7 million barrels, snapping a two-week streak of strong builds. At 125 million barrels, diesel inventories are once again 8% below the five-year average and trending near the low end of the historical range.

In total, commercial petroleum inventories (excl. SPR) slipped by 0.5 million barrels on the week to ish 1,281.5 million barrels. While essentially flat, this ends a two-week streak of meaningful builds, reflecting a return to a slightly tighter situation.

On the demand side, the DOE’s ‘products supplied’ metric (see page 6 attached), a proxy for implied consumption, softened slightly. Total demand for crude oil over the past four weeks averaged 20.5 million barrels per day, up just 0.9% YoY.

Summing up: This week’s report shows a re-tightening in diesel supply and modest draws across the board, while demand growth is beginning to flatten. Inventories remain structurally low, but the tone is less bullish than in recent weeks.

US DOE oil inventories
US crude inventories
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Analys

Are Ukraine’s attacks on Russian energy infrastructure working?

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Brent crude rose 1.6% yesterday. After trading in a range of USD 66.1 – 68.09/b it settled at USD 67.63/b. A level which we are well accustomed to see Brent crude flipping around since late August. This morning it is trading 0.5% higher at USD 68/b. The market was expecting an increase of 230 kb/d in Iraqi crude exports from Kurdistan through Turkey to the Cheyhan port but that has so far failed to materialize. This probably helped to drive Brent crude higher yesterday. Indications last evening that US crude oil inventories likely fell 3.8 mb last week (indicative numbers by API) probably also added some strength to Brent crude late in the session. The market continues to await the much heralded global surplus materializing as rising crude and product inventories in OECD countries in general and the US specifically.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

The oil market is starting to focus increasingly on the successful Ukrainian attacks on Russian oil infrastructure. Especially the attacks on Russian refineries. Refineries are highly complex and much harder to repair than simple crude oil facilities like export pipelines, ports and hubs. It can take months and months to repair complex refineries. It is thus mainly Russian oil products which will be hurt by this. First oil product exports will go down, thereafter Russia will have to ration oil product consumption domestically. Russian crude exports may not be hurt as much. Its crude exports could actually go up as its capacity to process crude goes down. SEB’s Emerging Market strategist Erik Meyersson wrote about the Ukrainian campaign this morning: ”Are Ukraine’s attacks on Russian energy infrastructure working?”. Phillips P O’Brian published an interesting not on this as well yesterday: ”An Update On The Ukrainian Campaign Against Russian Refineries”. It is a pay-for article, but it is well worth reading. Amongst other things it highlights the strategic focus of Ukraine towards Russia’s energy infrastructure. A Ukrainian on the matter also put out a visual representation of the attacks on twitter. We have not verified the data representation. It needs to be interpreted with caution in terms of magnitude of impact and current outage.

Complex Russian oil refineries are sitting ducks in the new, modern long-range drone war. Ukraine is building a range of new weapons as well according to O’Brian. The problem with attacks on Russian refineries is thus on the rise. This will likely be an escalating problem for Russia. And oil products around the world may rise versus the crude oil price while the crude oil price itself may not rise all that much due to this.

Russian clean oil product exports as presented by SEB’s Erik Meyersson in his note this morning.

Russian clean oil product exports
Source: SEB, Kepler, Macrobond

The ICE Gasoil crack and the 3.5% fuel oil crack has been strengthening. The 3.5% crack should have weakened along with rising exports of sour crude from OPEC+, but it hasn’t. Rather it has moved higher instead. The higher cracks could in part be due to the Ukrainian attacks on Russian oil refineries.

The ICE Gasoil crack and the 3.5% fuel oil crack has been strengthening. The 3.5% crack should have weakened along with rising exports of sour crude from OPEC+, but it hasn't. Rather it has moved higher instead. The higher cracks could in part be due to the Ukrainian attacks on Russian oil refineries.
Source: SEB graph and calculations, Bloomberg data

Ukrainian inhabitants graphical representation of Ukrainian attacks on Russian oil refineries on Twitter. Highlighting date of attacks, size of refineries and distance from Ukraine. We have not verified the detailed information. And you cannot derive the amount of outage as a consequence of this.

Ukrainian inhabitants graphical representation of Ukrainian attacks on Russian oil refineries on Twitter.
Source: Twitter. Not verified
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