Analys
An age of unprecedented oil volatility


We are living in a time of unprecedented volatility in oil. That is the consequence of a twin shock: both demand is collapsing and supply is rising. Oil prices are now more volatile than they were in the Great Financial Crisis (that started in 2008) or the oil price war of 2014-2016.

The sheer drop in prices over a short timespan has rarely been seen before. Neither in 2008 nor 2014 did we see such a sharp decline. If we were to annualise the price decline we have seen in the past two weeks, it will outpace the price declines of 2008 and 2014.

The protagonist seeks vengeance
As we discussed in Post OPEC meeting note -OPEC’s Greek Tragedy, the events of 5th and 6th March profoundly changed the oil markets. The Organization of the Petroleum Exporting Countries (OPEC) and its partner countries (collectively known as OPEC+) failed to reach an agreement on policy. We believe that OPEC is functionally dead as a result. Since 2017, OPEC has been reliant on Russia to endorse OPEC’s policy and even though Russia has habitually failed to follow through with implementation of quotas in full, the unity has been symbolically important as Saudi Arabia has been willing to cut more than its fair share to compensate. With Russia’s betrayal to this alliance, Saudi Arabia is now slashing prices and raising production. The chart below shows the Saudi official selling price of Arab light crude oil to Asia as a spread over the average cash Dubai price and Oman crude oil future price. Saudi Arabia is selling oil at close to a US$3/bbl discount to its peers. After Saudi Arabia refused to participate in the Joint Technical Committee originally scheduled for March 18th, the meeting was cancelled.
To be clear, Saudi Arabia now has its own agenda: to inflict maximum pain on Russia and it doesn’t seem to care which casualties it will take with it. Saudi Arabia intends to expand capacity to 13 million barrels per day from 12 million barrels per day currently. Saudi Arabia was producing 9.6 million barrels per day in February 2020. If Saudi Arabia produces at capacity, the world will be awash with oil.

Twin shocks drive extreme contango
This supply shock is coming at a time when demand is severely hampered by COVID19. This double-whammy has caused extreme contango in the oil markets. The day before the OPEC meetings, oil was in mild contango, with the difference between 1st and 36th contract only between US$2bbl and US$3bbl (WTI and Brent). On 19th March 2020, the contango has become extreme, with the difference between 1st and 36th contract between US$17/bbl and US$18/bbl (WTI and Brent). Only in the depths of the 2008 Great Financial Crisis had we seen contango this deep.

Where will this end?
The pain from the 2014-2016 oil price war is still raw in OPEC countries’ memories, yet it failed to deter Saudi Arabia from engaging in a fresh price war with Russia. We don’t think that the group will change course anytime soon. We don’t think the rest of OPEC can operate without Saudi Arabia. Saudi has been responsible for most of the group’s swing-production – i.e. building spare production capacity that can be used in times of demand surges or supply outages.
We doubt that the rest of the world will be able to adjust to this new reality quickly. Most global oil companies do not use the Saudi Aramco (state oil company in Saudi Arabia) model of keeping redundant capacity. Shuttering production for most oil companies is slow and costly to the point of putting the company’s finances under fatal strain.
There have been discussions, confirmed by US Energy Secretary Dan Brouillette of the possibility of a joint US-Saudi oil alliance. It was only one of many strategies discussed by policy makers in the US and we doubt that the US will partake in a cartel that it has been criticizing for decades. But desperate times may call for desperate measures. After all, the OPEC cartel was designed on the Texan oil practices from the 1930s to 1970s2.
More likely, we believe that the US will allow market economics to trim back on production. Our working assumption is that the breakeven price for oil production in the US is US$50/bbl. With WTI prices at US$25/bbl at the time of writing, US oil producers are going to suffer and we expect bankruptcies to soar. In the 2014-2016 oil price war, rigs in operation in the US fell by two-thirds. The US is dominated by shale oil production, which does not have the same lengthy lead times for switching on and off production as traditional oil production. But the decline in rigs came at a time when technological improvements to production techniques were rising fast. So, the ultimate decline in production was not that steep. This time, rigs in operation which have already been declining for a year could be matched by commensurate declines in production. The US could in effect become the world’s new swing producer.

Analys
Crude stocks fall again – diesel tightness persists

U.S. commercial crude inventories posted another draw last week, falling by 2.4 million barrels to 418.3 million barrels, according to the latest DOE report. Inventories are now 6% below the five-year seasonal average, underlining a persistently tight supply picture as we move into the post-peak demand season.

While the draw was smaller than last week’s 6 million barrel decline, the trend remains consistent with seasonal patterns. Current inventories are still well below the 2015–2022 average of around 449 million barrels.
Gasoline inventories dropped by 1.2 million barrels and are now close to the five-year average. The breakdown showed a modest increase in finished gasoline offset by a decline in blending components – hinting at steady end-user demand.
Diesel inventories saw yet another sharp move, falling by 1.8 million barrels. Stocks are now 15% below the five-year average, pointing to sustained tightness in middle distillates. In fact, diesel remains the most undersupplied segment, with current inventory levels at the very low end of the historical range (see page 3 attached).
Total commercial petroleum inventories – including crude and products but excluding the SPR – fell by 4.4 million barrels on the week, bringing total inventories to approximately 1,259 million barrels. Despite rising refinery utilization at 94.6%, the broader inventory complex remains structurally tight.
On the demand side, the DOE’s ‘products supplied’ metric – a proxy for implied consumption – stayed strong. Total product demand averaged 21.2 million barrels per day over the last four weeks, up 2.5% YoY. Diesel and jet fuel were the standouts, up 7.7% and 1.7%, respectively, while gasoline demand softened slightly, down 1.1% YoY. The figures reflect a still-solid late-summer demand environment, particularly in industrial and freight-related sectors.


Analys
Increasing risk that OPEC+ will unwind the last 1.65 mb/d of cuts when they meet on 7 September

Pushed higher by falling US inventories and positive Jackson Hall signals. Brent crude traded up 2.9% last week to a close of $67.73/b. It traded between $65.3/b and $68.0/b with the low early in the week and the high on Friday. US oil inventory draws together with positive signals from Powel at Jackson Hall signaling that rate cuts are highly likely helped to drive both oil and equities higher.

Ticking higher for a fourth day in a row. Bank holiday in the UK calls for muted European session. Brent crude is inching 0.2% higher this morning to $67.9/b which if it holds will be the fourth trading day in a row with gains. Price action in the European session will likely be quite muted due to bank holiday in the UK today.
OPEC+ is lifting production but we keep waiting for the surplus to show up. The rapid unwinding of voluntary cuts by OPEC+ has placed the market in a waiting position. Waiting for the surplus to emerge and materialize. Waiting for OECD stocks to rise rapidly and visibly. Waiting for US crude and product stocks to rise. Waiting for crude oil forward curves to bend into proper contango. Waiting for increasing supply of medium sour crude from OPEC+ to push sour cracks lower and to push Mid-East sour crudes to increasing discounts to light sweet Brent crude. In anticipation of this the market has traded Brent and WTI crude benchmarks up to $10/b lower than what solely looking at present OECD inventories, US inventories and front-end backwardation would have warranted.
Quite a few pockets of strength. Dubai sour crude is trading at a premium to Brent crude! The front-end of the crude oil curves are still in backwardation. High sulfur fuel oil in ARA has weakened from parity with Brent crude in May, but is still only trading at a discount of $5.6/b to Brent versus a more normal discount of $10/b. ARA middle distillates are trading at a premium of $25/b versus Brent crude versus a more normal $15-20/b. US crude stocks are at the lowest seasonal level since 2018. And lastly, the Dubai sour crude marker is trading a premium to Brent crude (light sweet crude in Europe) as highlighted by Bloomberg this morning. Dubai is normally at a discount to Brent. With more medium sour crude from OPEC+ in general and the Middle East specifically, the widespread and natural expectation has been that Dubai should trade at an increasing discount to Brent. the opposite has happened. Dubai traded at a discount of $2.3/b to Brent in early June. Dubai has since then been on a steady strengthening path versus Brent crude and Dubai is today trading at a premium of $1.3/b. Quite unusual in general but especially so now that OPEC+ is supposed to produce more.
This makes the upcoming OPEC+ meeting on 7 September even more of a thrill. At stake is the next and last layer of 1.65 mb/d of voluntary cuts to unwind. The market described above shows pockets of strength blinking here and there. This clearly increases the chance that OPEC+ decides to unwind the remaining 1.65 mb/d of voluntary cuts when they meet on 7 September to discuss production in October. Though maybe they split it over two or three months of unwind. After that the group can start again with a clean slate and discuss OPEC+ wide cuts rather than voluntary cuts by a sub-group. That paves the way for OPEC+ wide cuts into Q1-26 where a large surplus is projected unless the group kicks in with cuts.
The Dubai medium sour crude oil marker usually trades at a discount to Brent crude. More oil from the Middle East as they unwind cuts should make that discount to Brent crude even more pronounced. Dubai has instead traded steadily stronger versus Brent since late May.

The Brent crude oil forward curve (latest in white) keeps stuck in backwardation at the front end of the curve. I.e. it is still a tight crude oil market at present. The smile-effect is the market anticipation of surplus down the road.

Analys
Brent edges higher as India–Russia oil trade draws U.S. ire and Powell takes the stage at Jackson Hole

Best price since early August. Brent crude gained 1.2% yesterday to settle at USD 67.67/b, the highest close since early August and the second day of gains. Prices traded to an intraday low of USD 66.74/b before closing up on the day. This morning Brent is ticking slightly higher at USD 67.76/b as the market steadies ahead of Fed Chair Jerome Powell’s Jackson Hole speech later today.

No Russia/Ukraine peace in sight and India getting heat from US over imports of Russian oil. Yesterday’s price action was driven by renewed geopolitical tension and steady underlying demand. Stalled ceasefire talks between Russia and Ukraine helped maintain a modest risk premium, while the spotlight turned to India’s continued imports of Russian crude. Trump sharply criticized New Delhi’s purchases, threatening higher tariffs and possible sanctions. His administration has already announced tariff hikes on Indian goods from 25% to 50% later this month. India has pushed back, defending its right to diversify crude sourcing and highlighting that it also buys oil from the U.S. Moscow meanwhile reaffirmed its commitment to supply India, deepening the impression that global energy flows are becoming increasingly politicized.
Holding steady this morning awaiting Powell’s address at Jackson Hall. This morning the main market focus is Powell’s address at Jackson Hole. It is set to be the key event for markets today, with traders parsing every word for signals on the Fed’s policy path. A September rate cut is still the base case but the odds have slipped from almost certainty earlier this month to around three-quarters. Sticky inflation data have tempered expectations, raising the stakes for Powell to strike the right balance between growth concerns and inflation risks. His tone will shape global risk sentiment into the weekend and will be closely watched for implications on the oil demand outlook.
For now, oil is holding steady with geopolitical frictions lending support and macro uncertainty keeping gains in check.
Oil market is starting to think and worry about next OPEC+ meeting on 7 September. While still a good two weeks to go, the next OPEC+ meeting on 7 September will be crucial for the oil market. After approving hefty production hikes in August and September, the question is now whether the group will also unwind the remaining 1.65 million bpd of voluntary cuts. Thereby completing the full phase-out of voluntary reductions well ahead of schedule. The decision will test OPEC+’s balancing act between volume-driven influence and price stability. The gathering on 7 September may give the clearest signal yet of whether the group will pause, pivot, or press ahead.
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