Analys

An age of unprecedented oil volatility

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5 år sedan

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27 mars, 2020

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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.

2-month implied volatility of Brent crude oil — Source: Bloomberg, WisdomTree, data available as of close 19 March 2020.

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.

Bren and WTI oil prices — Source: Bloomberg, WisdomTree, data available as of close 19 March 2020.

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.

Saudi official selling price of oil to Aisa — Source: Bloomberg, WisdomTree, data available as of close 19 March 2020.

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.

Before and after OPECs meeting — Source: Bloomberg, WisdomTree, data available as of close 19 March 2020.

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.

US oil production and rig count — Source: Bloomberg, WisdomTree, data available as of close 19 March 2020.

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Saudi won’t break with OPEC+ to head calls for more oil from Trump

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3 dagar sedan

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28 januari, 2025

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Rebounding after yesterday’s drop but stays within recent bearish trend. Brent crude sold off 1.8% yesterday with a close of USD 77.08/b. It hit a low on the day of USD 76.3/b. This morning it is rebounding 0.8% to USD 77.7/b. That is still below the 200dma at USD 78.4/b and the downward trend which started 16 January still looks almost linear. A stronger rebound than what we see this morning is needed to break the downward trend.

Bjarne Schieldrop, Chief analyst commodities, SEB

Saudi won’t break with OPEC+ to head calls for more oil from Trump. OPEC+ will likely stick to its current production plan as it meets next week. The current plan is steady production in February and March and then a gradual, monthly increase of 120 kb/d/mth for 18 months starting in April. These planned increases will however highly likely be modified along the way just as we saw the group’s plans change last year. When they are modified the focus will be to maintain current prices as the primary goal with production growth coming second in line. There is very little chance that Saudi Arabia will unilaterally increase production and break the OPEC+ cooperation in response to recent calls from Trump. If it did, then the rest of OPEC+ would have no choice but to line up and produce more as well with the result that the oil price would totally collapse.

US shale oil producers have no plans to ramp up activity in response to calls from Trump. There are no signs that Trump’s calls for more oil from US producers are bearing any fruits. US shale oil producers are aiming to slow down rather than ramp up activity as they can see the large OPEC+ spare capacity of 5-6 mb/d sitting idle on the sideline. Even the privately held US shale oil players who account for 27% of US oil production are planning to slow down activity this year according to Jefferies Financial Group. US oil drilling rig count falling 6 last week to lowest since Oct 2021 is a reflection of that.

The US EIA projects a problematic oil market from mid-2025. Stronger demand would be the savior. Looking at the latest forecast from the US EIA in its January STEO report one can see why US shale oil producers are reluctant to ramp up production activity. If EIA forecast pans out, then either OPEC+ has to reduce production or US shale oil producers have to if they want to keep current oil prices. The savior would be global economic acceleration and higher oil demand growth.

Saudi Arabia to lift prices for March amid tight Mid-East crude market. But right now, the market is very tight for Mid-East crude due to Biden-sanctions. The 1-3mth Dubai time-spread is rising yet higher this morning. Saudi Arabia will highly likely lift its Official Selling Prices for March in response.

US EIA January STEO report. Global demand and supply growth given as 3mth average y-y diff in mb/d and the outright 3mth average demand diff to 3mth average supply in mb/d. Projects a surplus market where either US shale oil producers have to produce less, or OPEC+ has to produce less.

Global demand and supply growth given as 3mth average y-y diff in mb/d and the outright 3mth average demand diff to 3mth average supply in mb/d. — Source: SEB graph and calculations, US EIA data

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Brent rebound is likely as Biden-sanctions are creating painful tightness

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3 dagar sedan

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27 januari, 2025

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Bearish week last week and dipping lower this morning on China manufacturing and Trump-tariffs. Brent crude traded down 4 out of five days last week and lost 2.8% on a Friday-to-Friday basis with a close of USD 78.5/b. It hit the low of USD 77.8/b on Friday while it managed to make a small 0.3% gain at the end of the week with a close that was marginally below the 200dma. This morning it is trading down 0.4% at USD 78.2/b amid general market bearishness. China manufacturing PMI down to 49.1 for January versus 50.1 in December is pulling copper down 1.3%. Trump threatening Colombia with tariffs.

Rebound in crude prices likely as Dubai time-spreads rises further. The Dubai 1-3mth time-spread is rising to a new high this morning of USD 3.7/b. It is a sign that the Biden-sanctions towards Russia is making the medium sour crude market very tight. Brent crude is unlikely to fall much lower as long as these sanctions are in place. Will likely rebound.

Asian buyers turning to the Mid-East to replace Russian barrels. Amin Nasser, CEO of Saudi Aramco, said that the new sanctions are affecting 2 out of 3.4 mb/d of Russian seaborne crude oil exports. Strong bids for Iraqi medium and heavy crudes are sending spot prices to Asia to highest premiums versus formula pricing since August 2023. And Europe is seeing spot premiums to formula pricing at highest since 2021 (Argus).

Strong rise in US oil production is a losing hand. A lot of Trump-talk about a 3 mb/d increase in US oil production. Occidental Petroleum CEO Vicki Hollub commented in Davos that it is possible given the US resource base, but it is not the right thing to do since the global market is oversupplied (Argus). Everyone knows that OPEC+ has a spare capacity of 5-6 mb/d on hand. The comfort zone is probably to have a spare capacity of around 3 mb/d. FIRST the group needs to re-deploy some 3 mb/d of its current spare capacity and THEN the US and the rest of non-OPEC+ can start to think about acceleration in supply growth again. Vicki Hollub understands this and highly likely all the other oil CEOs in the US understands this as well. Donald Trump calling for more US oil will not be met before market circumstances allows it. Even sanctions on Iran forcing 1.5-2.0 mb/d of its crude exports out of the market will first be covered by existing surplus spare capacity within OPEC6+ and not the US.

US oil drilling rig count fell by 6 to 472 last week and lowest since October 2021. Current decline could be due to winter weather in the US but could also be like Hollub commented in Davos arguing that US oil production growth is not the right thing to do.

1-3mth time-spreads in USD/b. Dubai to yet higher level this morning. Even Brent and WTI are rebounding. Could be some extra spike since we are moving towards the end of the month. But it is still indicating a very tight market for medium sour crude as a result of the latest Biden-sanctions.

US oil drilling rig count down 6 last week to lowest level since October 2021

Non-OPEC, non-FSU production to grow 1.4 mb/d in 2025. Third weakest in 4 years. Though still a bit more than total expected global oil demand growth of 1.1 mb/d/y (IEA)

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Brent testing the 200dma at USD 78.6/b with API indicating rising US oil inventories

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1 vecka sedan

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23 januari, 2025

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Brent touching down to the 200dma. Brent crude traded down for a fifth day yesterday with a decline of 0.4% to USD 70/b. This morning it has traded as low as USD 78.6/b and touched down and tested the 200dma at USD 78.6/b before jumping back up and is currently trading up 0.2% on the day at USD 79.1/b.

The Dubai 1-3mth time-spread is holding up close to recent highs. The 1-3mth time spreads for WTI and Brent crude have eased significantly. The Dubai 1-3mth spread is however holding up close to latest high. Indian refiner Bharat is reported to struggle to get Russian crude for March delivery (Blbrg). The Biden-sanctions are clearly having physical market effects. So, the Dubai 1-3mth time-spread holding on to recent high makes a lot of sense. I.e. it was not just a spike on fears.

US oil inventories may have risen 6 mb last week (API). Actual data later today. The US DOE will release US oil data for last week later today. The US API last night indicated that US crude and product stocks may have risen close to 6 mb last week. This may be weighing on the oil price today.

Brent and WTI 1-3mths time-spreads have fallen back while Dubai is holding up