Analys
The show must go on in Vienna
Along with the market, we expect an extension of oil production cuts from OPEC and Russia at the upcoming OPEC meeting in Vienna on November 30. OPEC is sailing with a strong tailwind, as a draw on global stocks has started, and compliance reached more than 100% in both OPEC and non-OPEC in October for the first time. For H1 2018, we see compliance with proposed cuts as less of a problem; instead, market focus will move to global stocks, which will likely start to flatten as the seasonal tailwind has swept through and there is higher activity in US shale after oil traded above USD 60.
High expectations
According to a Bloomberg survey, oil traders and analysts unanimously expect OPEC and Russia to prolong their production cuts on Thursday. Behind the scenes, however, it seems as though Saudi Arabia and Russia are still debating what course to follow, particularly regarding the duration of the extension.
Russia’s economy minister said last week that the OPEC/non-OPEC production cuts hurt Russia’s economic growth on October, through lower oil production, and indirectly, through lower investment activity. That was the first negative comment about the pact from a high-ranking Russian official. Despite the signs that Russian policy makers may be having second thoughts, they will agree to an extension in the end, in our view. Anything but an extension supported by Russia would have a significant negative impact on prices.
Putin crowns himself OPEC king
OPEC gatherings still influence oil prices, but Saudi Arabia’s voice no longer matters most in the media. Since he engineered Russia’s pact with OPEC 12 month ago, President Vladimir Putin has emerged as the group’s most influential player, in our view. Putin is now calling all the shots.
Cuts implemented successfully
Over the past year, OPEC and several other key producers, including Russia, have agreed to cut production by 1.8 million bbl/d to reduce a global glut, formally defined as returning global stocks to normal levels, i.e. their five-year average. The group reached more than 100% compliance for the first time in October. That’s a striking and surprising fact, in our view, and the market has reacted to OPEC’s success by trading oil at higher prices.
Will not reach target
Given the impressive compliance, it is striking, in our view, that OPEC is so far from its target of draining global stocks. Inventories are lower, but we believe the strong seasonal effect of the US driving season this year is the key factor behind that. The target should have been reached in May, but will not be reached by the November meeting, and it would be surprising if normal stock levels were reached before OPEC’s spring meeting in May/June 2018.
Saudi Arabia supports an extension
It has become obvious that Crown Prince Mohammed bin Salman, who has emerged as Saudi Arabia’s leading economic force, was the architect of the Saudi policy U-turn in Doha in 2016, leading up to the cut at the meeting in Vienna in November 2016. In our view, this was confirmed by the replacement of Ali al-Naimi, after two decades as oil minister, with the more politically-oriented Khalid al-Falih.
Prince Mohammed has put the divestment of Aramco at the top of his agenda, and that is the basis of Saudi policy and its willingness to cut production in return for a short-term rise in the oil price. The Aramco IPO should top the board’s agenda and will take place during the second half of 2018, according to al-Falih during a state visit to Russia earlier this autumn.
Costly mistake
The savvy players recognise the danger of cutting production. History is repeating itself. Higher prices have triggered a reverse in the US production drop, extending the time it takes for the market to balance, and pushing the volume share away from OPEC and toward two non-cut participants, the US and recently also Libya.
US shale flattening
In our model, which has served us well since the cycle collapse in 2014, we see around an 80-day lag from peak to trough in prices, before a new activity direction in rig count, and we see around 80 more days before an impact on production. In other words, a 160-day lag in production from a new price direction. After the recent oil price rally, rig counts will start to increase in our model, and early data are already confirming this new trend, which will have a negative impact on oil prices.
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Brent rallied 2.5% last week on bullish inventories and bullish backdrop. Brent crude gained 2.5% last week with a close of the week of USD 89.5/b which also was the highest close of the week. The bullish drivers were: 1) Commercial crude and product stocks declined 3.8 m b versus a normal seasonal rise of 4.4 m b, 2) Solid gains in front-end Brent crude time-spreads indicating a tight crude market, and 3) A positive backdrop of a 2.7% gain in US S&P 500 index.
Brent falling back 1% on diesel concerns this morning. But positive backdrop may counter it later. This morning Brent crude is pulling back 0.9% to USD 88.7/b counter to the fact that the general backdrop is positive with a weaker USD, equity gains both in Asia and in European and US futures and not the least also positive gains in industrial metals with copper trading up 0.4% at USD 10 009/ton. This overall positive market backdrop clearly has the potential to reverse the initial bearish start of the week as we get a little further into the Monday trading session.
Diesel concerns at center stage. The bearish angle on oil this morning is weak diesel demand with diesel forward curves in front-end contango and predictions for lower refinery runs in response this down the road. I.e. that the current front-end strength in crude curves (elevated backwardation) reflecting a current tight crude market will dissipate in not too long due to likely lower refinery runs.
But gasoline cracks have rallied. Diesel weakness is normal this time of year. Overall refining margin still strong. Lots of focus on weakness in diesel demand and cracks. But we need to remember that we saw the same weakness last spring in April and May before the diesel cracks rallied into the rest of the year. Diesel cracks are also very seasonal with natural winter-strength and likewise natural summer weakness. What matters for refineries is of course the overall refining margin reflecting demand for all products. Gasoline cracks have rallied to close to USD 24/b in ARA for the front-month contract. If we compute a proxy ARA refining margin consisting of 40% diesel, 40% gasoline and 20% bunkeroil we get a refining margin of USD 14/b which is way above the 2015-19 average of only USD 6.5/b. This does not take into account the now much higher costs to EU refineries of carbon prices and nat gas prices. So the picture is a little less rosy than what the USD 14/b may look like.
The Russia/Ukraine oil product shock has not yet fully dissipated. What stands out though is that the oil product shock from the Russian war on Ukraine has dissipated significantly, but it is still clearly there. Looking at below graphs on oil product cracks the Russian attack on Ukraine stands out like day and night in February 2022 and oil product markets have still not fully normalized.
Oil market gazing towards OPEC+ meeting in June. OPEC+ will adjust to get the price they want. Oil markets are increasingly gazing towards the OPEC+ meeting in June when the group will decide what to do with production in Q3-24. Our view is that the group will adjust production as needed to gain the oil price it wants which typically is USD 85/b or higher. This is probably also the general view in the market.
Change in US oil inventories was a bullish driver last week.
Crude oil time-spreads strengthened last week
ICE gasoil forward curve has shifted from solid backwardation to front-end contango signaling diesel demand weakness. Leading to concerns for lower refinery runs and softer crude oil demand by refineries down the road.
ARA gasoline crack has rallied towards while Gasoil crack has fallen back. Not a totally unusual pattern.
Proxy ARA refining margin with 40% gasoil crack, 40% gasoline crack and 20% bunker oil crack.
ARA diesel cracks saw the exact same pattern last year. Dipping low in April and May before rallying into the second half of the year. Diesel cracks have fallen back but are still clearly above normal levels both in spot and on the forward curve. I.e. the ”Russian diesel stress” hasn’t fully dissipated quite yet.
Net long specs fell back a little last week.
52-week ranking of net long speculative positions in Brent and WTI as well as 52-week ranking of the strength of the Brent 1-7 mth backwardation
So far this week, Brent Crude prices have strengthened by USD 1.3 per barrel since Monday’s opening. While macroeconomic concerns persist, they have somewhat abated, resulting in muted price reactions. Fundamentals predominantly influence global oil price developments at present. This week, we’ve observed highs of USD 89 per barrel yesterday morning and lows of USD 85.7 per barrel on Monday morning. Currently, Brent Crude is trading at a stable USD 88.3 per barrel, maintaining this level for the past 24 hours.
Additionally, there has been no significant price reaction to Crude following yesterday’s US inventory report (see page 11 attached):
- US commercial crude inventories (excluding SPR) decreased by 6.4 million barrels from the previous week, standing at 453.6 million barrels, roughly 3% below the five-year average for this time of year.
- Total motor gasoline inventories decreased by 0.6 million barrels, approximately 4% below the five-year average.
- Distillate (diesel) inventories increased by 1.6 million barrels but remain weak historically, about 7% below the five-year average.
- Total commercial petroleum inventories (crude + products) decreased by 3.8 million barrels last week.
Regarding petroleum products, the overall build/withdrawal aligns with seasonal patterns, theoretically exerting limited effect on prices. However, the significant draw in commercial crude inventories counters the seasonality, surpassing market expectations and API figures released on Tuesday, indicating a draw of 3.2 million barrels (compared to Bloomberg consensus of +1.3 million). API numbers for products were more in line with the US DOE.
Against this backdrop, yesterday’s inventory report is bullish, theoretically exerting upward pressure on crude prices.
Yet, the current stability in prices may be attributed to reduced geopolitical risks, balanced against demand concerns. Markets are adopting a wait-and-see approach ahead of Q1 US GDP (today at 14:30) and the Fed’s preferred inflation measure, “core PCE prices” (tomorrow at 14:30). A stronger print could potentially dampen crude prices as market participants worry over the demand outlook.
Geopolitical “risk premiums” have decreased from last week, although concerns persist, highlighted by Ukraine’s strikes on two Russian oil depots in western Russia and Houthis’ claims of targeting shipping off the Yemeni coast yesterday.
With a relatively calmer geopolitical landscape, the market carefully evaluates data and fundamentals. While the supply picture appears clear, demand remains the predominant uncertainty that the market attempts to decode.
Brent crude has fallen USD 3/b since the peak of Iran-Israel concerns last week. Still lots of talk about significant Mid-East risk premium in the current oil price. But OPEC+ is in no way anywhere close to loosing control of the oil market. Thus what will really matter is what OPEC+ decides to do in June with respect to production in Q3-24 and the market knows this very well. Saudi Arabia’s social cost-break-even is estimated at USD 100/b today. Also Saudi Arabia’s purse is hurt by 21% US inflation since Jan 2020. Saudi needs more money to make ends meet. Why shouldn’t they get a higher nominal pay as everyone else. Saudi will ask for it
Brent is down USD 3/b vs. last week as the immediate risk for Iran-Israel has faded. But risk is far from over says experts. The Brent crude oil price has fallen 3% to now USD 87.3/b since it became clear that Israel was willing to restrain itself with only a muted counter attack versus Israel while Iran at the same time totally played down the counterattack by Israel. The hope now is of course that that was the end of it. The real fear has now receded for the scenario where Israeli and Iranian exchanges of rockets and drones would escalate to a point where also the US is dragged into it with Mid East oil supply being hurt in the end. Not everyone are as optimistic. Professor Meir Javedanfar who teaches Iranian-Israeli studies in Israel instead judges that ”this is just the beginning” and that they sooner or later will confront each other again according to NYT. While the the tension between Iran and Israel has faded significantly, the pain and anger spiraling out of destruction of Gaza will however close to guarantee that bombs and military strifes will take place left, right and center in the Middle East going forward.
Also OPEC+ wants to get paid. At the start of 2020 the 20 year inflation adjusted average Brent crude price stood at USD 76.6/b. If we keep the averaging period fixed and move forward till today that inflation adjusted average has risen to USD 92.5/b. So when OPEC looks in its purse and income stream it today needs a 21% higher oil price than in January 2020 in order to make ends meet and OPEC(+) is working hard to get it.
Much talk about Mid-East risk premium of USD 5-10-25/b. But OPEC+ is in control so why does it matter. There is much talk these days that there is a significant risk premium in Brent crude these days and that it could evaporate if the erratic state of the Middle East as well as Ukraine/Russia settles down. With the latest gains in US oil inventories one could maybe argue that there is a USD 5/b risk premium versus total US commercial crude and product inventories in the Brent crude oil price today. But what really matters for the oil price is what OPEC+ decides to do in June with respect to Q3-24 production. We are in no doubt that the group will steer this market to where they want it also in Q3-24. If there is a little bit too much oil in the market versus demand then they will trim supply accordingly.
Also OPEC+ wants to make ends meet. The 20-year real average Brent price from 2000 to 2019 stood at USD 76.6/b in Jan 2020. That same averaging period is today at USD 92.5/b in today’s money value. OPEC+ needs a higher nominal price to make ends meet and they will work hard to get it.
Inflation adjusted Brent crude price versus total US commercial crude and product stocks. A bit above the regression line. Maybe USD 5/b risk premium. But type of inventories matter. Latest big gains were in Propane and Other oils and not so much in crude and products
Total US commercial crude and product stocks usually rise by 4-5 m b per week this time of year. Gains have been very strong lately, but mostly in Propane and Other oils
Last week’s US inventory data. Big rise of 10 m b in commercial inventories. What really stands out is the big gains in Propane and Other oils
Take actual changes minus normal seasonal changes we find that US commercial crude and regular products like diesel, gasoline, jet and bunker oil actually fell 3 m b versus normal change.
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