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USD weakness, inventory draws and a pinch of Venezuela concerns

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SEB - analysbrev på råvaror

SEB - Prognoser på råvaror - CommodityLast week Brent crude gained 9.3% w/w with a close of $52.52/b on Friday. WTI gained comparably much (+8.6%) with a close of $49.71/b. The main gains were in the front end of the crude curves leading to a substantial flattening of the forward curves. Brent crude Dec 2020 only gained 2.6% with a close of $54.72/b and thus a way smaller gain than in the front end of the forward curves. For WTI the front end contract now only sits $0.34/b below the 18 mth forward WTI contracts which closed the week at $50.05/b.

Continued inventory draws last week underpinned the crude oil price rally and the flattening of the forward crude curves. Weekly inventory data last week saw draws of 16 mb of which 10 mb were in the US while a reduction of 8.6 mb in floating storage also took a solid bite. Over the past 5 weeks inventories have drawn down some 70 mb in weekly data. Thus inventory draws kicked in and accelerated almost on the clock as we entered stronger seasonal consumption in Q3-17. Since mid-March weekly data indicate an inventory draw of 104 mb of which 76 mb took place in the US while 18 mb were drawn in floating storage. Refineries are rapidly coming back online with increased crude oil consumption as a result. There are still more refineries to come back online both in Asia and LatAm while Europe and Africa are mostly all up and running. We expect continued draws in H2-17.

Saudi Arabia of course added some extra fuel on the fire last week as they promised exports of no more than 6.6 mb/d in August. That would be their lowest monthly export since early 2011 (not including oil products). From Jan-May Saudi Arabia exported 7.17 kb/d. If it sticks to 6.6 mb/d exports in August it will be a reduction of 705 kb/d y/y versus its pledged production cut of 490 kb/d. The lower export pledged in August of course coincide with high domestic summer demand in Saudi Arabia. As such it remains to be seen whether the export cap of 6.6 mb/d remains in place after August. What it shows more than anything is determination by the Saudi energy minister Al-Falih. Determination to draw inventories down and the time to do it is H2-17 before US shale oil revival extends too far in 2018. It is thus possible that Saudi Arabia maintains its export cap beyond August.

The softening in the US dollar has definitely underpinned the whole crude oil rally. It has underpinned a rally in the whole commodity complex. Over the past 5 weeks Bloomberg’s commodity index has gained 8.3% with 11.9% in Energy, 8.3% in Agri, 7% in Industrial metals and 1% in precious. The USD index has declined a substantial 4.1% over the period with half of the overall commodity index gain being a nominal impact from a softer dollar. IMF’s upgrade last week of growth in Europe, Japan and China while downgrading US growth from 2.3% to 2.1% (little hope for promised tax cuts) is the example in case which drives the dollar lower. US growth has been ahead of the curve for a long time and now the rest of the world is catching up. If the dollar weakness continues it will undoubtedly drive commodity prices in general and oil prices specifically higher in nominal terms. With the 4.1% USD Index decline over the past 5 weeks the Brent crude Dec 2020 contract has gained 5.5%. Thus almost all of this can be attributed to the dollar effect.

The deteriorating situation in Venezuela probably adds some support to oil prices as well. A national election was held this weekend to vote for members of a National Constituent Assembly. This Assembly will have no fixed term, it will have powers to rewrite the constitution. It will supersede the National Assembly and hand Nicolas Maduro close to dictatorial power and end close to six decades of democracy. At least 10 people were killed in clashes during the election this weekend and some 120 people have been killed in uprisings since April. Venezuela probably holds the world’s largest oil reserves (297 billion barrels) and produced 1.97 mb/d in June (Blberg) which is close to exactly equal to the production cap under the current OPEC production agreement. Its production has however deteriorated steadily due to lack of investments with production standing at 2.37 mb/d back in July 2015. The main concern in the oil market following the election is possible sanctions by Donald Trump. The US buys a third of Venezuela’s oil exports. Extensive US sanctions could make it almost impossible for international oil companies to work in Venezuela. For now the market is awaiting reactions from Donald Trump.

Today equities are up across the board, industrial metals are up 1% and Brent crude traded as much as 0.8% higher before now trading flat at $52.5/b. Thus so far this morning crude oil is lagging behind the gains in industrial metals. Crude oil is trading cautiously following five consecutive days of solid gains. A slight negative this morning is the USD Index which gains 0.3%. We expect to see further oil inventory draws also this week. If the USD Index also continues on its softening trend the two drivers are likely to push crude oil prices yet higher also this week. Money managers have added net long positions for 4 weeks in a row now but probably have room to add more. Producers are likely to sell into the forward crude prices. This is likely to hold back gains for medium term crude prices while inventory draws and investor appetite continues to push upwards in the front leading to a yet flatter crude curve. Potentially shifting the curves into backwardation.

The crude oil inventory draws taking place at the moment are of course real and they will draw down more during H2-17. Still it is important to remember that they are artificially managed by a 1.8 mb/d cut by OPEC and some non-OPEC members. Currently they help to draw down invnetories and to flatten curude curves. When needed however, the volumes will be put back into the market some time in 2018 or 2019.

Ch 1: Inventories in global weekly data drew 16 mb last week.
Over the past 5 weeks inventories have drawn down 70 mb in weekly data

Inventories in global weekly data drew 16 mb last week

Oil

Ch2: US crude and product stocks now well below last year
And down y/y first time since 2014

US crude and product stocks now well below last year

Ch3: The USD Index has moved down 9.6% since the start of the year
More specifically it has moved down 4.2% since crude oil prices bottomed out in June 21st.
It is now the weakest since a brief sell-off in February 2016.
However, it needs to decline another 15% to get down the the weakness it had in 2014.

The USD Index has moved down 9.6% since the start of the year

Ch4: If we had had USD weakness as in 2014 we should nominally have had an oil price of close to $60/b

If we had had USD weakness as in 2014 we should nominally have had an oil price of close to $60/b

Ch5: Crude oil forward curves flattened substantially last week
As investors and refineries bought the front while producers probably sold into the rally out on the curve

Crude oil forward curves flattened substantially last week

Ch6: The 1 to 6mth crude time spreads got close to zero

The 1 to 6mth crude time spreads got close to zero

Ch7: And crude time spreads of 1mth to 18mth were not far away either
With WTI 1mth closing just $0.34/b below the 18mth on Friday and trading just $0.19/b below today

And crude time spreads of 1mth to 18mth were not far away either

Ch8: A word of caution though. The tightness is not so evident in the Brent crude oil spot market
Dated Brent still trades at a $0.5/b discount to the 1mth contract in a sign that deficit of crude oil is still not quite yet here

A word of caution though. The tightness is not so evident in the Brent crude oil spot market

Ch9: US oil players added 2 rigs last week

US oil players added 2 rigs last week

Oil

Ch10: Global refineries are rapidly getting back on line consuming more crude oil
More to come in Asia, ME and LatAm

Global refineries are rapidly getting back on line consuming more crude oil

Ch11: Deteriorating crude production in Venezuela
Production could be hit hard by possible US sanctions

Deteriorating crude production in Venezuela

Ch12: Net long managed money probably has room to add more length
Even though length has been added 4 weeks in a row now

Net long managed money probably has room to add more length

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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