Analys
Market likely to rewrite all Brent crude forecasts for 2018

Exactly two weeks ago we argued that Brent crude would probably reach $65/b before Christmas. And wow has that delivered quicker than we thought. Of course yesterday’s 3.5% jump to $54.27/b (intraday high of $54.44/b) did come on the back of the political events in Saudi Arabia. Princes, billionaires and ministers were arrested and accused of corruption while the real reason of course was to secure the way to the throne for Prince Mohammed Bin Salman (MBS). In our view the events in Saudi Arabia this weekend were merely a catalyst which drove the oil price higher and more quickly than expected. In general we see little reason to be concerned for the supply of Saudi Arabia’s production. That was probably also the main view by European traders yesterday as Brent crude traded only marginally up in the European season (aligned with some positive moves in metals) before US traders came into the market and kicked it higher.
What is really at the heart of why we think everyone now will revise their Brent crude forecasts for 2018 is the realisation that the Brent crude 1 month contract, the Brent “spot price”, is not really what the US shale oil players are getting for their crude oil. Whatever unhedged oil the US shale oil players currently are producing they will only get $57.3/b or the WTI 1 month price. And they won’t even get that as there is a transportation cost from the well-head to Cushing Oklahoma as a discount to that as well.
More importantly is what’s dictating shale oil players’ profitability for new investments, new drilling and additional wells. That is not the front month WTI price but the 1.5 year forward WTI price (the WTI 18 month contract) at which they can hedge new investments. And that price yesterday closed at only $53.3/bl. I.e. for new investments US shale oil players are only offered $53.3/bl for delivery at Cushing Oklahoma which is far away from the current Brent 1mth price of $64/b.
The WTI 18 mth contract traded as high as $57.4/b earlier in the year. So while the Brent 1mth price is rising to new highs of the year and highest since 2015, the WTI 18mth contract is still 3 dollar lower than its high this year and not at all giving a strong stimulating investment push for shale oil producers.
This is clearly a dream come true for OPEC. That they can have a high Brent 1mth price close to $65/b while at the same time not giving a strong price stimulus to US shale oil producers as they are only offered $53.3/bl on the curve. Yes, Christmas did indeed come early for OPEC this year! Then of course the question is whether Christmas will last all of 2018 or not. So what is at the heart of this Christmas present?
It is two-fold.
One is the increasing Brent crude oil backwardation with the Brent 1mth contract trading at a $5.1/bl premium to the the Brent 18mth contract. This comes partly as a result of the constant draw down in global crude oil inventories and partly due to the increasing net long Brent speculative positioning. And yes there is a relationship between backwardation and speculative length. When net length is increasing the backwardation is increasing.
At the moment net long Brent is at an all-time high. That will of course not last for ever. So in the next market turn when specs pull out the level of backwardation will soften somewhat as well. However, assume that OPEC+ will “hold” the market all through 2018 so that inventories continue yet lower. Not necessarily steeply lower but at least ticking lower. Then the Brent crude oil backwardation should not fall back to zero. Rather it should hold up at some level and then strengthen with declining stocks. In perspective the Brent 1 to 18 mth backwardation time spread traded around $7/b from mid-2011 to mid-2014 when Brent crude traded around $110/b. So the $5/b backwardation may be a bit rich as we are not quite back to a 2011-2014 situation quite yet.
The second and more important one is the increasing Brent to WTI spread we have witnessed this year. And it is not just in the front of the curves where the spread has widened out. It has happened all along the curve. In January the Brent 18mth to WTI 18 mth spread only traded at $1/b while it now trades at close to $6/bl.
When we look at global oil inventories they have been drawing down relentlessly since mid-March this year. In the US we have seen that oil product stocks have drawn down to normal with middle distillate stocks there down to below now ahead of winter. US crude stocks have however been a much more tedious and slow draw down as they in total still stand more than 100 mbl above a fair normal. However, if we split out the US mid-Continent which contains Cushing Oklahoma stocks where the WTI crude is priced we see that non-mid-Continent US crude stocks have been drawn down rapidly. The mid-Continent stocks however are actually now higher than a year ago and rising. And since this is where the WTI crude is priced it is holding down the WTI price.
The WTI crude curve is actually still in contango at the front end of the curve due to this. And since stocks in the mid-Continent are rising higher there is an increasing risk that the WTI crude price might break down into deeper front end contango and an even wider Brent to WTI spread and thus a lower WTI 1mth price.
We are thus likely going to witness a yet widening divergence between Brent and WTI crude oil price. Especially in the front. That is also why the net long speculative positions in WTI is not at an all-time-high as is the case with Brent positions. And those with a long position in WTI are at risk for a break-down in the WTI prices as the mid-Continent stocks continues to rise.
A key question for us at the moment (which we are unable to answer) is whether the rising crude stocks in the US mid-Continent now is due to natural bottlenecks due to lack of pipeline investments or whether it is due to damaged infrastructure following the Hurricane Harvey.
If it is the first then the bottleneck is probably of a lasting character. Then US shale producers have probably reached the short/medium term transportation capacity of getting their oil to the market. It will of course not last for ever as there is always possible to lay more pipes, but it takes time. In that case the Brent crude oil price can continue to rally without having to worry too much because the WTI price which then is stuck in surplus in the mid-US Continent. Then there is no point for US shale oil producers to increase production as they cannot easily get it to market. And the subdued WTI price will be the one telling them not to invest more and not to produce more since it will be low due to high mid-Continent stocks.
If the rising mid-Continental stocks are due to Hurricane Harvey damages then it might be quicker to mend. Then the Brent to WTI spread should contract from current levels once the Harvey damage is mended.
Looking at the US mid-Continent stocks we see that they started to rise at the end of August which was right at the time of Hurricane Harvey and has gone up by some 10 mbl since then. However, this might not be a good indication that Harvey is the culprit as inventories normally rise some 4 mbl during this period anyhow.
We are not quite sure whether it is Hurricane Harvey damage which drives US mid-Continental stocks higher or whether it is structural under investments in pipelines. However, as US shale oil production continues to rise (as we think it will in 2018) the pressure in terms of utilization of US oil pipeline transportation capacities will be increasingly taxed which is likely to hold the Brent – WTI price spread high.
So Brent crude oil price forecasts for 2018 are likely going to be revised up across the board as they now are likely to incorporate a more substantial Brent – WTI 1mth price spread for 2018. Current Brent crude 2018 Bloomberg consensus forecast currently stand at $56/bl with market pricing at $62/bl while SEB’s standing forecast from September is $55/bl.
The fundamental assumption for most forecasting methodologies is still that US shale oil is on the margin. For a long time the assumption has been that US shale oil can deliver almost unlimited at WTI $50/b. That assumption is now breaking down. US shale oil producers have not made money this year with investors now DEMANDING that they deliver profits and not just promises. While it is difficult to say exactly at what level they will create profits it is natural to shift the shale oil base floor price assumption from $50/bl to $55/bl. I.e. assuming that US shale oil production is not going through the roof with a WTI 18 mth price at $55/b. I.e. the WTI price is allowed to trade at $55/bl both in spot and on the curve without creating surplus havoc in the global market.
We thus expect revisions of Brent crude oil forecasts to assume a WTI 1mth crude price delivered at around $55/bl next year and then with a Brent 1mth to WTI 1mth price spread to Brent on top of some $5-7/bl thus placing Brent forecasts for 2018 at around $60-62/bl. Such assumptions are likely to affect our own Brent crude oil forecast for 2018 when we revise it in February next year.
Ch1) US commercial crude oil stocks less the US mid-continent are drawing down rapidly
Getting close to normal by end of year
Ch2) US mid-Continent stocks (Pad2) have however rising and above last year.
This is where WTI crude is priced in Cushing Oklahoma and is why the WTI crude curve has front end contango with risk for deeper contango
Ch3) US shale oil regions
Ch4) Not all shale oil producers need to pass through Cushing Oklahoma
But the exact magnitude and location of bottlenecks getting shale oil to the U.S. Gulf we don’t know.
Looks like Eagle Ford and Permian have more options to bypass Cushing getting right to the US Gulf.
Are Eagle Ford and Permian producers actually getting a price closer to seaborne crude prices than to WTI?
Ch5) Brent and WTI crude curves moving higher over last two weeks
Ch6) Brent 1mth contract has rallied to close to $65/b.
Steepening Brent backwardation and widening Brent – WTI crude spreads has left the WTI 18 mth contract in the doldrums no higher than $53.3/b
Ch7) The WTI 18 mth forward price at $53.3/b still short of year high of $57.4/b
Ch8) Brent 1mth to WTI 1mth crude spread has blown out
Ch9) And US crude oil is flushing out of the US as exports as a result of the strong widening in Brent to WTI
But as we see above it is not flowing out of the US mid-Continent where WTI is priced
Ch10) US shale oil players are kicking drilling rigs out of the US at a WTI 18mth curve price of $50/bl
They can of course drill more but then they are begging a higher forward WTI price.
Risk for a smoke and mirror in these statistics as shale players are currently running some 100 drilling rigs more than they need.
They need to kick they out in order to align drilling with completions which still ran at a surplus in September as they drilled more than they completed.
We expect shale players to kick out 5-10 rigs every week to Christmas.
It will be sentiment bullish, but unlikely to impact completions all that much in 2018 as they have a load full of DUCs they can complete in 2018
Ch11) US shale players kicking out rigs at a WTI18 curve price of $50/bl
Ch12) Will shale players hold their horses as the mid-term WTI forward price moves higher?
Good reasons to believe that they will kick out more drilling rigs at WTI curve $50/b as investors demand profits
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
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

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.

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.

Analys
Modest draws, flat demand, and diesel back in focus

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.

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.


Analys
Are Ukraine’s attacks on Russian energy infrastructure working?

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.

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.

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.

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.

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