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Analys

Shale oil denial once again?

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SEB - Prognoser på råvaror - CommodityPrice action – Dollar headwinds driving speculators to take money off the table
Equities across the board rebounded 0.7% ydy following the recent North Korea driven sell-off. The USD Index however gained 0.4% on the day which helped to drive all commodity indices lower with the overall Blbrg commodity index down 0.7% with energy losing the most. Brent crude sold down 2.6% closing at $50.73/b while the longer dated Brent Dec 2020 contract only lost 1% closing at $52.62/b.

Since a Brent crude oil price low of $44.35/b in June 21st net long speculative WTI positions have moved in only one direction – up. Since then the number of net long speculative WTI contracts have increased by 156,000 contracts (+42%) or 156 mb. As of Tuesday last week the number of net long speculative WTI contracts stood at 532,000 contracts which was the 7th highest speculative position over the past 52 weeks. Except for the release of the US EIA’s monthly Drilling Productivity report there was little in the news that warranted the 2.6% sell-off in Brent crude oil prices other than speculators taking money off the table following 7 consecutive weeks of rising long bets.

Crude oil comment – Shale oil denial once again?
What puzzles us a lot is graph 2 below. It shows the US EIA’s projection of US crude oil production coming out of Lower 48 states (i.e. ex Gulf of Mexico and Alaska). Thus it basically constitutes US shale oil production even though it includes a million or two of US crude production which is not shale oil as well.

What the the US EIA STEO August report projects is that from January to September the marginal, annualized Lower 48 crude oil production growth has averaged 1.25 mb/d. That we buy into. Then however, from October 2017 onwards their projected growth rate then suddenly collapse to a marginal annualized growth rate of only +0.2 mb/d all to the end of 2018 (on average).

When the US shale oil production was booming from 2011 to 2015 the story was always that yes, production is growing strongly now, but next year it will taper off. The tapering off never happened before the oil price collapsed and all breaks were on. During 2012, 2013 and 2014 the US shale oil production grew relentlessly at an annual pace of 1 mb/d.

Thus even if the market is fully aware of US shale oil these days. Fully aware that rigs are rising and productivity is rising. The story still looks a bit the same in terms of what the US EIA currently is projecting in its August STEO report. Yes, shale oil is growing at a strong marginal, annual pace now, but from October onwards it is all going to slow sharply. Thus shale oil awareness is definitely there but is it again too pesimistic in terms of volumes delivered down the road just as was the case consistently from 2012 to 2014/15. Still some kind of shale oil denial in a way in terms of production down the road.

Yesterday the US EIA released its drilling productivity report (DPR) and its DUC’s report (Drilled wells and uncompleted wells). First out the reports stated a projection that US shale oil production will increase by 117 kb/d mth/mth to September. That equals a marginal, annualized pace of 1.4 mb/d per year. The puzzle is that the EIA projects that this strong growth rate is going to suddenly fall back in October onwards.

What was further revealed was that the number of completed wells per month continued to rise by 25 wells mth/mth to 859 wells in July. Completions were however still trailing way behind the number of wells drilled by more than 200 wells. Wells drilled reached 1075 wells in July which also was an increase mth/mth by 28 wells. Thus completions are rising but are still solidly trailing behind drilling of wells.

For US shale oil production to slow down we first need to see a halt in the number of drilling rigs being added into operation. Only 2 implied shale oil rigs were added last week, but the number is still rising marginally rather than falling. But yes, that part is slowing down. The next step then is to see that completions manage to catch up with drilling. I.e. completions needs to move from a July level of 859 wells completed to at least 1075 wells drilled. Then the last step is that completions start to draw down the now very high DUC inventory which has seen an increase of 1595 wells since November 2016 now standing at 6154 wells.

So during the unavoidable (some time in the future) draw down period of DUCs we need to see that completions move above drilled wells per month in order to draw down the DUC inventory. I.e. the number of wells completed should move above 1075 wells per month unless of course the number of drilling rigs declines. A lower oil price or reduced access to capital is typically the driving forces which would lead to a reduction in drilling rigs. Captial spending and profitability is definitely at the top end of the agenda these days in the shale oil space.

In terms of the DUC inventory build up. In perspective the 1595 wells added since November last year equates to some 5-600 million barrels of additional producible oil within a three year time frame. That is if we assume 350,000 barrels of oil from each well during the first three years of production on average for all wells.

In this perspective it is difficult to understand the US EIA’s projection that US L48 crude oil production growth is going to slow sharply from October onwards. Drilling rigs are still rising (although slowly) and completions still has a lot of catching up to do just to get up to speed with drilling and then some to draw down the DUC inventory.

Not surprisingly we are bullish for US crude oil production for 2018 where we expect US crude oil production to increase y/y by 1.5 mb/d rather than the US EIA’s y/y projecting that US crude oil will only increase 0.6 mb/d y/y to 2018.

OPEC will have a lont on its hands in 2018 and will likely need to manage supply all through to the end of 2018 rather than to end of Q1-17.

(Data for drilling and completions etc in this report were for the regions Anadarko, Bakken, Eagle Ford, Niobrara and Permian and are from the US EIA.)

Ch1 – Net long specs in WTI reached the 7th highest in a year last Tuesday
A strong, long rise in net long spec since the price low in late June
Sideways price action during most of August with no success to the upside when Brent hit $53.64/b.
Then dollar headwinds and North Korea risk aversion. Both pushing specs to take money off the table
Oil prices in graph are averaged over weeks ending Tuesday. Same as specs reporting

Net long specs in WTI reached the 7th highest in a year last Tuesday

Ch2 – US EIA STEO August report projects a sharp slowdown in marginal growth in US L48 crude oil production from October onwards
How is that possible when drilling rig count is still rising and completions are still working hard catching up rising as well.

US EIA STEO August report projects a sharp slowdown in marginal growth in US L48 crude oil production from October onwards

Ch3 – Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)
Today’s level looks unimpressive versus 2014 levels. But they need to be adjusted with productivity improvements

Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)

Ch3 – Productivity adjusted – Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)
If we productivity adjust the historical data of number of wells drilled and completed with productivity then:

a) Number of drilled wells today per month is 40% higher then the previous peak in September 2014

b) Number of completed wells is 11% higher than the previous peak in October 2014

If completions catches up to current drilling then completions will run 40% higher than the previous peak in October 2014 in productivity adjusted terms.

Productivity adjusted - Completions of shale wells rising as they try to catch up to drilled wells per month which is also rising (US EIA August DUC report)

Ch 4 – Strong rise in DUC (uncompleted wells) inventory since November last year
Equating it to oil it has increased close to 600 mb since Nov last year in terms of oil from first three years of production each well

Strong rise in DUC (uncompleted wells) inventory since November last year

Kind regards

Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking

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Analys

Brent gains on positive China data and new attacks on Russian oil processing

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Positive China data and further attacks on Russian oil processing facilities lifts Brent yet higher. Brent crude gained 4.1% last week with a close on Friday 15 March at USD 85.3/b. Continued declines in US inventories, a bullish oil market outlook from the IEA and damages on Russia’s Rosneft Ryazan oil processing plant by Ukrainian drones helped Brent crude to break above the USD 85/b level. This morning Brent is adding another 0.4% to USD 85.7/b driven by a range of additional attacks on Russian refineries over the weekend and positive Chinese macro data also showing Chinese apparent oil demand  up 6.1% YoY for Jan+Feb.

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

Brent crude is getting a steady tailwind from declining US oil inventories. Steady and continued declines in US inventories since the start of the year has been nudging the oil price steadily higher but there has clearly been some resistance around the USD 85/bl level. US inventories continued that decline in data also last week with commercial crude and product stocks down 4.7 m b. Total US stocks including SPR declined 4.1 m b to 1580 m b which is now only 2 m b above the low point on 30 December 2022 at 1578 m b. These persistent declines in US oil inventories is a clear reflection of the global market in deficit where demand is sufficiently strong, cuts by OPEC+ are sufficiently deep while US shale oil production is close to muted with hardly any growth projected from Q4-23 to Q4-24.

Bullish report from IEA last week indicates that further inventory declines is to be expected. The monthly report from IEA last week gave an additional boost to this picture as it lifted projected oil demand for 2024 by 0.2 m b/d, reduced non-OPEC production by 0.2 m b/d and thus increased its estimated call-on-OPEC by 0.4 m b/d for 2024. The world will need steadily more oil from OPEC every quarter to Q3-24 and by Q4-24 the world will need 0.8 m b/d more from the group than it did in Q4-23. That is great news for OPEC+. There is no way that they’ll move away from current strategy of ”Price over volume” with this backdrop. The report from IEA last week is indicating that the gradual declines in US inventories we have seen so far this year will likely continue. And such a trend will give continued support for oil prices in the coming quarters. Oil price projections are lifted in response to this and last out is Morgan Stanley which raises its Q3-24 Brent forecast by US 10/b to USD 90/b.

SEB’s Brent crude forecast for 2024 is USD 85/b (average year) which implies that we’ll likely see both USD 70/b as well as USD 100/b some times during the year.

Attacks on Russian oil processing will mostly impact refining margins and crude grade premiums as crude supply is unlikely to be disrupted. The Ukrainian drone attacks on Russian oil infrastructure has surprised the market as many of them are deep within Russia. Facilities in Russia’s Samara region which is more than 1,000 km away from the Ukrainian border were attacked on Saturday. Oil processing plants and oil refineries are highly complex structures. If damaged by drones they can potentially be out of operation for extended periods. Plain oil transportation systems are much simpler and easier and faster to repair. The essence here is that we’ll likely not lose any oil supply while we might lose oil refining capacity due to these attacks. Most of the impact from these attacks should thus be on refining margins and not so much on crude oil prices. But when diesel cracks, gasoil cracks and gasoline cracks goes up then typically also light sweet crude prices goes up. As such there is a spillover effect from damages to Russian oil refineries to Brent crude oil prices even if we don’t lose a single drop of Russian crude oil production and supply.

Total US crude and product stocks incl. SPR has been ticking lower and lower so far this year and are now only 2 m b/d above the low-point in late December 2022. This is a solid indication that the global oil market is running a deficit.

Total US crude and product stocks incl. SPR
Source: SEB graph and calculations, Blbrg data

Total commercial crude and product stocks (excl. SPR) has been ticking lower and lower so far this year. This has helped to nudge oil prices steadily higher. 

Total commercial crude and product stocks (excl. SPR)
Source: SEB graph and calculations, Blbrg data

Brent crude looks very fairly priced at around USD 85/b versus current US commercial oil inventories

Brent crude looks very fairly priced at around USD 85/b versus current US commercial oil inventories
Source: SEB graph and calculations, Blbrg data

Call-on-OPEC by IEA: World will need more and more oil from OPEC through the year. In Q4-24 the world will need 0.8 m b/d more oil from OPEC in Q4-24 than in Q4-23.  

World will need more and more oil from OPEC through the year.
Source: SEB graph, IEA data

ARA refining margins have moved up so far this year => Refineries want to process more crude oil and thus they want to buy more crude oil.

ARA refining margins
Source: SEB calculations and graph, Blbrg data
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Analys

When affordable gas and expensive carbon puts coal in the corner

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Coal and nat gas prices are increasingly quite normal versus real average prices from 2010 to 2019 during which TTF nat gas averaged EUR 27/MWh and ARA coal prices averaged USD 108/ton in real-terms. In the current environment of ”normal” coal and nat gas prices we now see a darkening picture for coal fired power generation where coal is becoming less and less competitive over the coming 2-3 years with cost of coal fired generation is trading more and more out-of-the money versus both forward power prices and the cost of nat gas + CO2. Coal fired power generation will however still be needed many places where there is no local substitution and limited grid access to other locations with other types of power supply. These coal fired power-hubs will then become high-power-cost-hubs. And that may become a challenge for the local power consumers in these locations.

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

When affordable gas and expensive carbon puts coal in the corner. The power sector accounts for some 50% of emissions in the EU ETS system in a mix of coal and nat gas burn for power. The sector is also highly dynamic, adaptive and actively trading. This sector has been and still is the primary battleground in the EU ETS where a fight between high CO2 intensity coal versus lower CO2 intensity nat gas is playing out.

Coal fired power is dominant over nat gas power when the carbon market is loose and the EUA price is low. The years 2012, 2013, 2014, 2015 were typical example-years of this. Coal fired power was then in-the-money for around 7000 hours (one year = 8760 hours) in Germany. Nat gas fired power was however only in the money for about 2500 hours per year and was predominantly functioning as peak-load supply.

Then the carbon market was tightened by politicians with ”back-loading” and the MSR mechanism which drove the EUA price up to EUR 20/ton in 2019 and to EUR 60/ton in 2021. Nat gas fired power and coal fired power were then both in-the-money for almost 5000 hours per year from 2016 to 2023. The EUA price was in the middle-ground in the fight between the two. In 2023 however, nat gas was in-the-money for 4000 hours while coal was only in-the-money for 3000 hours. For coal that is a dramatic change from the 2012-2015 period when it was in the money for 7000 hours per year.

And it is getting worse and worse for coal fired generation when we look forward. That is of course the political/environmental plan as well. It is still painful of course for coal power.

On a forward basis the cost of Coal+EUA is increasingly way, way above the forward German power prices. Coal is basically out-of-the money for more and more hours every year going forward. It may be temporary, but it fits the overall political/environmental plan and also the increasing penetration of renewable energy which will push aside more and more fossil power as we move forward. 

But coal power cannot easily and quickly be shut down all over the place in preference to cheaper nat gas based power. Coal fired power will be the primary source of power in many places with no local alternative and limited grid capacity to other sources of power elsewhere.

The consequence is that those places where coal fired power generation cannot be easily substituted and closed down will be ”high power price hubs”. If we imagine physical power prices as a topological map, geographically across Germany then the locations where coal fired power is needed will rise up like power price hill-tops amid a sea of lower power prices set by cheaper nat gas + CO2 or power prices depressed by high penetration of renewable energy.

Coal fired power generation used to be a cheap and safe power bet. Those forced to rely on coal fired power will however in the coming years face higher and higher, local power costs both in absolute terms and in relative terms to other non-coal-based power locations.

Coal fired power in Germany is increasingly very expensive both versus the cost of nat gas + CO2 and versus forward German power prices. Auch, it will hurt more and more for coal fired power producers and more and more for consumers needing to buy it.

Coal fired power in Germany is increasingly very expensive
Source: SEB calculations and graph, Blbrg data

And if we graph in the most efficient nat gas power plants, CCGTs, then nat gas + CO2 is today mostly at the money for the nearest three years while coal + CO2 is way above both forward power prices and forward nat gas + CO2 costs. 

EUR/MWh
Source: SEB calculations and graph, Blbrg data

Number of hours in the year (normal year = 8760 hrs) when the cost of coal + CO2 and nat gas + CO2 in the German spot power market (hour by hour) historically has been in the money. Coal power used to run 7000 hours per year in 2012-2016, Baseload. Coal in Germany was only in-th-money for 3000 hours in 2023. That is versus the average, hourly system prices in Germany. But local, physical prices will likely have been higher where coal is concentrated and where there is no local substitution for coal in the short to medium term. Coal power will run more hours in those areas and local, physical prices need to be higher there to support the higher cost of coal + CO2.

Number of hours in the year
Source: SEB calculations and graph, Blbrg data
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Analys

War-premium back on the agenda?

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During yesterday’s trading session, Brent Crude made significant gains, marking the largest increase in global oil prices in approximately five weeks. The front-month contract is presently trading at USD 84.3 per barrel, reflecting a robust increase of USD 2.55 per barrel (above 3%) compared to Monday morning’s opening price.

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

Furthermore, US crude inventories, excluding those held in the Strategic Petroleum Reserve (SPR), experienced a notable decline for the first time in seven weeks. This decline suggests a heightened global demand for crude oil, which has played a pivotal role in driving up prices (further details below).

Additionally, of considerable significance is Ukraine’s unexpected success in executing precise drone strikes targeting key Russian oil infrastructure. Yesterday, Ukrainian drone strikes triggered a fire at Rosneft’s Ryazan plant, which has a daily production capacity of 340,000 barrels near Moscow. This facility is a significant provider of motor fuels for the capital region and stands as one of Russia’s largest crude-processing facilities. Notably, this incident marks the third Ukrainian drone attack on Russian refineries this week, following similar incidents at the Novoshakhtinsk and Norsi refineries.

Ukrainian strikes in Russian territories ”appear to aim at disrupting, if not influencing, the Russian elections,” Putin stated in an interview with the RIA Novosti news service released Wednesday. He added, ”Another objective seems to be securing leverage for potential negotiation purposes.”

i.e., we believe the statements suggest that Ukrainian strikes in Russian regions are perceived by Putin as strategic moves with dual purposes. Firstly, they are seen as attempts to disrupt or influence the upcoming elections in Russia, potentially destabilizing the political landscape or casting doubt on the legitimacy of the electoral process. Secondly, they are interpreted as efforts to gain leverage in possible negotiation scenarios, implying that Ukraine seeks to strengthen its bargaining position by demonstrating its capability to inflict economic and strategic damage on Russia.

From a market perspective, it’s crucial to highlight the escalating conflict between Ukraine and Russia, which poses a significant threat to global energy markets. Russia’s role as a major oil and gas supplier is paramount, and any disruptions in its energy infrastructure could lead to widespread supply shortages and price volatility worldwide. The recent drone strikes are a clear reminder that geopolitical tensions continue to impact global oil markets. The fading ”war-premium” should now be factored in more significantly, indicating a need to brace for increased volatility ahead.


An overall significant drawdown of US inventories. In the U.S., commercial crude oil inventories, excluding those in the Strategic Petroleum Reserve, dropped by 1.5 million barrels from the prior week to 447.0 million barrels, about 3% below the five-year average. Total motor gasoline inventories fell by 5.7 million barrels, also about 3% below the five-year average. Distillate fuel inventories rose by 0.9 million barrels, approximately 7% below the five-year average. Propane/propylene inventories increased by 0.7 million barrels, marking an 8% rise compared to the five-year average.

Overall commercial petroleum inventories decreased by 4.7 million barrels. Over the past four weeks, total products supplied averaged 19.9 million barrels per day, up by 1.0% from the same period last year. Motor gasoline product supplied averaged 8.7 million barrels per day, down by 1.3% from the same period last year. Distillate fuel product supplied averaged 3.7 million barrels per day over the past four weeks, up by 0.5% from the same period last year. Jet fuel product supplied increased by 2.0% compared to the same four-week period last year.

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