Analys
Why Brent 1mth at $65/b is reachable before Christmas
Crude oil price action – Brent crude 1mth Inching 1% higher WoW amid dollar headwinds. Brent to WTI crude spreads continues to widen
Brent crude inched 1% higher over the past week with a close of $57.75/b while the longer dated Dec-2020 gained 0.4% to $54.75/b.
The energy complex in total gained 0.6% while the other commodity sub-indexes all experienced losses from a marginal 0.03% loss for metals to a more substantial 1.7% and 1.8% for Agri and precious respectively.
Overall commodities lost 0.4% over the week and thus slightly less than dollar headwind from a 0.7% stronger USD index.
Compared to the 0.4% gain in the Brent Dec-2020 the WTI Dec-2020 instead fell back 0.3% to $50.08/b.
The spread between longer dated Brent and WTI prices thus continued to expand last week rising to $4.67/b for the Dec-2020 horizon.
The further expansion in Brent – WTI crude spreads was even more pronounced on the Dec-2018 horizon where it expanded 0.7% to $4.35/b., the highest since November 2015.
Brent crude oil comment – Why Brent 1mth at $65/b is reachable before Christmas
Declining US shale oil rig count is likely going to allow the mid-term WTI crude curve to move from current $51/b up towards the high of the year of around $56-57/b
Increasing US crude production is placing increasing strains on US crude oil export bottlenecks leading to further widening in the Brent to WTI crude spreads.
As a result mid-term forward Brent crude prices have the potential to move to $61-62/b when mid-term WTI moves to $56-57/b.
Further global inventory draws are likely to add yet steeper backwardation to the Brent crude curve which would allow the Brent 1mth contract to rise towards $65/b ($3-4/b above the Brent mid-term crude forward prices).
However, the 2018 crude oil market balance could be challenging as US shale oil players are likely going to drill less and complete more.
At the moment there is a tug of war between short term bullish drivers, real and visible, versus bearish concerns for 2018.
Bullish short term drivers are likely to win in the short term while medium term bearish drivers are likely going to come back and bite the market in the … in 2018.
There has been lots of comments that it would be unwise for Brent crude 1mth to move above $60/b because that would stimulate US shale oil production too much.
The thing is that it is not the 1mth Brent crude contract which sends stimulating price signals to US shale oil producers all that much. Rather it is the medium term forward WTI curve contracts which do so.
Typically it is the 1-3 year forward WTI contract price level which is what US shale oil players can sell and hedge new and existing production at. These forward prices are setting the level of profitability for new shale oil wells and production.
There has been lots of comments that it would be unwise for Brent crude 1mth to move above $60/b because that would stimulate US shale oil production too much.
The thing is that it is not the 1mth Brent crude contract which sends stimulating price signals to US shale oil producers all that much. Rather it is the medium term forward WTI curve contracts which do so.
Typically it is the 1-3 year forward WTI contract price level which is what US shale oil players can sell and hedge new and existing production at. These forward prices are setting the level of profitability for new shale oil wells and production.
The Brent 1mth contract reached its highest price level since March 2015 in late September ($59.49/b) and is trading just $1.6/b shy of that level today at $57.88/b.
Conversely the medium term WTI forward prices have set no such new ytd highs. If we look at the rolling WTI 18 mths contract (1.5 years forward) it reached a high of the year in early January of $57.39/b.
That was real shale oil stimulus resulting in lots of additional shale oil rigs and drilling. On Friday however it closed at no more than $51.02/b with the highest price this side of the summer being $51.7/b
In late September we commented that “Brent was set free to rally on increasing backwardation and widening spread to WTI”. The argument was that we can get a higher Brent 1mth price without stimulating US shale oil production because of an increasing Brent backwardation and an increasing Brent to WTI crude spread both in the front and on the curve.
At the moment we see that US shale oil players are kicking out shale oil drilling rigs. Just last week they kicked out 7 shale oil rigs. Since early August they have kicked out 30 oil rigs and 24 implied shale oil rigs.
Assuming a 6 week lag between price action and rig count reaction this shedding of US oil rigs is taking place at a forward WTI18 mth crude price of $50-51/b (6 weeks ago).
The US shale oil players are thus sentiment wise telling the market that WTI at a medium term forward price level of $50/b is not enough for them to keep the current rig count running.
They are kicking out rigs at $50/b. Thus while empirical market experience from May 2016 to July 2017 was that the US shale oil rig count inflection point was around $47/b (18mth forward) it has now clearly shifted higher than $50-51/b.
We believe that the market dynamic with respect to US shale oil is much about trial and error. Having figured out that it is now no longer at $47/b and that it is now also higher than $50-51/b it now remains to figure out where it has moved too. Thus the next test should now be to figure out where the US shale oil rig count change versus WTI 18mth forward price level relationship inflection point has moved to. I.e. the market should allow the forward WTI18mth contract to move upwards. Acceptable moves upwards in perspective of what we have seen earlier this year would be that the WTI 18 mth contract moves to $55-56/b.
One reason why such a move higher for the WTI 18 mth price horizon is reasonable to expect is because even though the WTI crude curve is in contango at the very front end of the curve there is still an overall backwardation in the forward WTI curve structure. The consequence of this is that shale oil producers now have to sell at a discount to front end prices if they want to sell forward hedging their future production. This typically leads to reluctance and reduced forward selling by producers. Consumers however experience the opposite. Consumers can now buy forward at a discount to front end prices which typically leads to more forward buying. Thus less forward selling and more forward buying should typically help to lift the mid-term forward crude prices higher both for Brent and WTI.
Thus if we assume that the mid-term WTI forward crude prices has potential to move $5/b higher it would allow the Brent mid-term crude price to shift $5/b higher as well which would allow the Brent 1mth contract to shift $5/b higher as well. If we in addition assume that the Brent to WTI crude price spread on the curve expands a further $1/b then the Brent crude curve can shift yet another dollar higher. Add another dollar in further steepening Brent backwardation and the front end Brent has another dollar on the upside. Thus a total $2/b extra on widening Brent – WTI spread and further Brent backwardation steepening.
Thus in total the Brent 1mth contract has an upside potential of another $7/b. The move would place the 18 mth WTI price at $56/b versus ytd high in early January of $57.39/b and current $51/b. It would place the Brent 18 mth contract at $61/b and a new ytd high and highest since April 2015 and it would place the Brent 1mth contract just shy of $65/b. And still US shale producers would not be stimulated with a higher forward price than WTI 18mth at $56/b. Maybe that is where the US shale oil rig count to WTI18mth inflection point has shifted to? At the moment it is at least higher than $51/b given data since early August.
The sentimental drivers for such a move higher is going to be further draw downs in inventories (yes, market is running a deficit due to OPEC+ production cuts), further reductions in US shale oil rig count (yes, we expect US shale players to kick out 5-10 rigs every week to Christmas to balance drilling versus completions), further accumulation of net long Brent spec into the backwardated Brent crude curve with positive roll yield, emergence of geopolitical risk premium in crude prices as stocks move lower, stronger and stronger signals from Saudi Arabia and Russia that they are willing to extend cuts to end of 2018 topped up with forecasts pointing to a cold US winter ahead (stronger La Nina event) with US Atlantic coast mid-distillate stocks now below 5yr average.
However, there is a reason for why Saudi Arabia and Russia both are signalling elevated willingness to extend current production cuts all to the end of 2018. They are concerned for the oil market balance in 2018. And with good reason. Since November 2016 when OPEC+ decided to cut production there has been a veritable shale oil drilling party with an accumulation of 1735 uncompleted wells and the accumulation continued also in September adding another 179 uncompleted wells lifting the total to 7270 uncompleted wells. In comparison the shale players completed 10161 wells over the 12mths to September and on average 847 wells per mth.
Thus if 2017 was a US shale oil drilling party then 2018 may be a shale oil completion party. US shale oil completions have been rising every month since January. In December 2016 completions stood at a low of 645 wells rising to 1029 in September and still rising. If completions average 1100 wells per month in 2018 then it would be 30% higher than the average of 847 in the 12 mths to September. In our view the US shale oil players today have too many active drilling rigs. They should spend their money on completions rather than drilling. That is what creates oil and cash flow. Thus the natural thing to expect is a further decline in the drilling rig count. Maybe another 100 to 200 rigs down and at the same time to expect a further increase in completions and eventually a draw down in the inventory of drilled but yet uncompleted wells.
At the moment the market is in a tug of war between short term bullish drivers which are very true, very visible and very strong versus real concerns for the oil market balance for 2018. We expect the short term bullish drivers will win in the short term while the medium term issues will hit back at the market in the medium term.
Ch1: US shale oil players are kicking out drilling rigs with WTI 18 mth contract at $51/b
Ch2: US shale oil rig count change to WTI mid-term forward price breaking up. Inflection point shifting higher. Rigs being kicked out at WTI $50-51/b
Ch3: Brent crude 1 to 18 mth time spread – Increasing backwardation as inventories falls
Stronger backwardation allows the 1mth contract to rise higher without stimulating US shale production on the forward WTI curve
Ch4: Rolling Brent 18mth price spread to the rolling WTI 18mth crude price
The spread is expanding as the US crude production is increasing
Higher spread will allow the Brent18 mth contract to move relatively higher versus the WTI curve without stimulating US shale oil production
More to come as US crude production continues to rise
Ch5: WTI 18mth forward crude oil price. Still lots of room on the upside before getting back to ytd high
Ch6: Crude oil forward curves. Brent in backwardation, more to come. Front end WTI in front end contango to flip into front end backwardation
Ch7: Brent 1mth to WTI 1mth contract price spread makes a jump to $6/b
Ch7: Resulting in a big jump in US crude oil exports
This will drain US crude inventories and flip front end WTI contango into backwardation
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
Selling down on a ”deal”. Brent crude fell 6.2% last week with accelerated weakness towards the end of the week. Close of the week at $87.33/b and low of the week (and on Friday) of $85.8/b. Brent is falling another 4% this morning to $83.7/b on confirmation by Iran that a MoU text has been reached and that it will be signed on Friday this week.
So what is this ”deal” worth? Talk on the desk here this morning is that it is much like ”putting lipstick on a pig” where Trump has to sell this at home as a victory where ”the SoH has reopened”, the nuclear issue will be ironed out over the coming 60 days (or maybe 600 days?) and US consumers are getting a lower gasoline price and maybe US republicans survives the midterm elections.
The importance for Iran is that it emerges as the defacto winner of this war in the eyes of the non-US public world. That Iran now onwards is the ”ruler of the SoH” (combo of geography and new weapons systems like drones) or more softer: ”the guarantor of safe passage through the SoH”.
Iran doesn’t need nuclear weapons any more. Nuclear deterrence doesn’t work any more. Ukraine has made many attacks deep into Russia without being nuked in return. Plenty of Iranian ballistic rockets blasts over Israel but Iran wasn’t nuked in return.
There is no trust between the US and Iran. We don’t know all the details yet of the MoU. But what we do know is that there is no trust between the US and Iran what so ever. This is probably more like a descriptive text on how they can cooperate in a way where both sides keeps tactical leverage. Neither side makes irreversible concessions. Violations can be punished quickly. Cooperation produces immediate benefits.
This is a fragile structure. It can easily break down. There may be details which cannot be overcome. To be seen on Friday. The US has to show that it is willing put enough force behind managing and restraining Israel versus Hezbollah in Lebanon. We have seen that Netanyahu hasn’t listened all that much to Trump’s directives and wishes. This could be a major obstacle.
A gradual reopening is tactically preferable for Iran. A tactical leverage for Iran right now is that global oil stocks have been drawn down towards painful and increasingly dangerous levels with increasing risks for oil price spikes in mid-July to August. This together with US midterm elections on 3 November gives tactical leverage to Iran. Iran probably doesn’t want to fully give up on that leverage. A rapid, full reopening where global stocks are able to refill over the coming 60 days will significantly erode that leverage. If Iran reinstates a closure of the SoH after 60 days (if talks break down again), then the effect won’t be that impactful in terms of prices and the US midterm elections.
So a gradual and partial reopening where global markets gets the oil they need while they are unable to rebuild stocks could be a practical middle way for both parties. Trump can sell it as ”the SoH has reopened” and get affordable gasoline for US consumers. Iran can sell it as ”the SoH has fully reopened, but there is some friction” so flow is only 60-80% of normal.
Not much real demand destruction below $100/b. What we do know is that there is not much real price pain demand destruction for oil globally at an oil price below $100/b. A lot of demand-shock destruction. Fear. But demand should now come roaring back towards normal with fear for exceptionally high prices now is rapidly receding.
Sudden China demand destruction due to EVs? Bullocks. EV share of total Chinese carpool now around 13%. Share of new sales of EVs has reached 50%. This is a very gradual process. It doesn’t make oil demand fall like a rock over night. When EV new sales share reaches 100%, then the gasoline car pool will contract by some 5-10% per year. But that is only gasoline. Sudden reduction in Chinese oil demand is more about shock and risk.
Chinese crude oil imports will come roaring back. At what price? Today’s ”neutral” oil price is $70/b. That is the five year price which has steadily traded around the $70/b mark over the past 3-4 years. With still a risky picture one would think that China and the rest of the world will be big buyers of oil in the range of $70-85/b.
Global demand will likely snap back towards normal, forecasted demand and growth at such prices.
Physical reopening is a gradual process. The physical and practical reopening of the SoH will likely be gradual rather than sudden. And that probably suites Iran tactically as well.
Brent M1 price versus the Brent 5-yr (today’s ”normal” price)
Market is starting to take US/Iran headlines with a pinch of salt. Brent crude rose $2.8/b yesterday to an official close of $112.1/b. But after that it traded as low as $108.05/b before ending late night at around $109.7/b. Through the day it traded in a range of $106.87 – 112.72/b amid a flurry of news or rumors from Iran and the US. ”US temporary sanctions during negotiations” (falls alarm). ”We will bomb Iran” (not anyhow),… etc. While the market is still fluctuating to this kind of news flow, it is starting to take such headlines with a pinch of salt.
We’ll see. Maybe, maybe not. The Brent M1 contract is trading at $110.2/b this morning which very close to the average ticks through yesterday of $110.4/b.
Trump with bearish, verbal intervention whenever Brent trades above $110/b it seems. What seems to be a pattern is that Trump states something like ”very good negotiations going on with Iran”, ”New leaders in Iran are great,..”, ”Great progress in negotiations,…”, ”Deal in sight,..” etc whenever the Brent M1 contract trades above $110/b. An effort to cool the market. These hot air verbal interventions from Trump used to have a heavy bearish impact on prices, but they now seems to have less and less effect unless they are backed by reality.
As far as we can see there has been no real progress in the negotiations between the US and Iran with both sides still standing by their previous demands.
Iran is getting stronger while the cease fire lasts making a return to war for Trump yet harder. Iran is naturally in constant preparation for a return to war given Trump’s steady threats of bombing Iran again. Iran is naturally doing what ever is possible to prepare for a return to war. And every day the cease fire lasts it is better prepared. This naturally makes it more and more difficult and dangerous for the US to return to warring activity versus Iran as the consequences for energy infrastructure in the Persian Gulf will be more and more severe the longer the cease fire lasts. Israel seems to see it this way as well. That the war is not won and that current frozen state of a cease fire gives Iran opportunity to rebuild military and politically.
Global inventories are drawing down day by day. How much? In the meantime the Strait of Hormuz stays closed. There is varying measures and estimates of how much global inventories are drawing down. Our rough estimate, back of the envelope, is that global inventories are drawing down by at least some 10 mb/d or about 300 mb/d in a balance between loss of supply versus demand destruction. Other estimates we see are a monthly draw of 250-270 mb/d. The IEA only ’measured’ a draw in global observable stocks of 117 mb in April with oil on water rising 53 mb while on shore stocks fell 170 mb. But global stocks are hard to measure with large invisible, unmeasured stocks. As such a back of the envelope approach may be better.
Oil products is what the world is consuming. Oil product prices likely to rise while product stocks fall. Strategic Petroleum Reserves (SPR) are predominantly crude oil. Discharging oil from OECD SPR stocks, a sharp reduction in Chinese crude imports and a reduction in global refinery throughput of 6-7 mb/d has helped to keep crude oil markets satisfactorily supplied. But global inventories are drawing down none the less. And oil products is really what the world is consuming. So if global refinery throughput stays subdued, then demand will eventually have to match the supply of oil products. The likely path forward this summer is a steady draw down in jet fuel, diesel and gasoline. Higher prices for these. Then, if possible, higher refinery throughput and higher usage of crude in response to very profitable refinery margins. And lastly sharper draw in crude stocks and higher prices for these. But some 6 mb/d of oil products used to be exported through the Strait of Hormuz. And it may not be so easy to ramp up refinery activity across the world to compensate. Especially as Ukraine continues to damage Russian refineries as well as Russian crude production and export facilities.
Watch oil product stocks and prices as well as Brent calendar 2027. What to watch for this summer is thus oil product inventories falling and oil product premiums to crude rising. Another measure to watch is the Brent crude 2027 contract as it rises steadily day by day as the Strait of Hormuz stays closed and global oil inventories decline. The latter is close to the highest level since the start of the war and keeps rising.
The Brent M1 contract and the Brent 2027 prices and current price of jet fuel in Europe (ARA). All in USD/b
Our back of the envelope calculation of the global shortage created by the closure of the Strait of Hormuz. Note that 3.5 mb/d of discharge from SPR is also a draw. Note also that ’Forced demand loss’ of 2.5 mb/d is probably temporary and will fall back towards zero as logistics are sorted out leaving ’Price demand loss’ to do the job of balancing the market. Thus a shortfall of at least 9 mb/d created by the closure. More if SPR discharge is included and more if Forced demand loss recedes.
Brent is climbing higher. Front-month is at USD 106.3/bl this morning, close to a weekly high and a USD 9/bl jump from Mondays open. This is the move we flagged as a risk earlier in the week: the market shifting from ”a deal is around the corner” to ”this is going to take longer than we thought”.
Analyst Commodities, SEB
During April, rest-of-year Brent remained remarkably stable around USD 90/bl. A stability which rested on one single assumption: the SoH reopens around 1 May. That assumption is now slowly falling apart.
As we highlighted yesterday: every week of delay beyond 1 May adds (theoretically) ish USD 5/bl to the rest-of-year average, as global inventories draw 100 million barrels per week. i.e., a mid-May reopening implies rest-of-year Brent closer to USD 100/bl, and anything pushing into June or July takes us meaningfully higher.
What’s changed in the last 48 hours:
#1: The US military has formally warned that clearing suspected sea mines from SoH could take up to six months. That is a completely different timescale from what the financial market is pricing. Even a political deal tomorrow does not immediately reopen the strait.
#2: Trump has shifted his tone from urgency to ”strategic patience”. In yesterday’s press conference: ”Don’t rush me… I want a great deal.” The market is reading this as a president no longer feeling pressured by timelines, with the naval blockade running in the background.
#3: So far, the military activity is escalating, not de-escalating. Axios reports Iran is laying more mines in SoH. The US 3rd carrier strike group (USS George H.W. Bush) is arriving with two countermine vessels. Trump yesterday ordered the US Navy to destroy any Iranian boats caught laying mines. While CNN reports that the Pentagon is actively drawing up plans to strike Iranian SoH capabilities and individual Iranian military leaders if the ceasefire collapses. i.e., NOT a attitude consistent with an imminent deal!
Spot crude and product prices eased off the early-April highs on a combination of system rerouting and deal optimism. Both now weakening. Goldman estimates April Gulf output is reduced by 14.5 mbl/d, or 57% of pre-war supply, a number that keeps getting worse the longer this drags on.
Demand-side adaptation is ongoing: S. Korea has cut its Middle East crude dependence from 69% to 56% by pulling more from the Americas and Africa, and Japan is kicking off a second round of SPR releases from 1 May. But SPRs are finite.
Ref. to the negotiations, we should not bet on speed. The current Iranian leadership is dominated by genuine hardliners willing to absorb economic pain and run the clock to extract concessions. That is not a setup for a rapid resolution. US/Israeli media briefings keep framing the delay as ”internal Iranian divisions”, the reality is more complicated and points toward weeks and months, not days.
Our point is that the complexity is large, and higher prices have only just started (given a scenario where the negotiations drag out in time). The market spent April leaning on the USD 90/bl rest-of-year assumption; that case is diminishing by the hour. If ”early May reopening” is replaced by ”June, July or later” over the next week or two, both crude and products have meaningful room to reprice higher from here. There is a high risk being short energy and betting on any immediate political resolution(!).
Vattenfalls och Industrikrafts kärnkraftsbolag Videberg Kraft har valt Rolls-Royce SMR
Selling down on a ”deal”
Sommarväder skapar prisrally på elbörsen
Oil product price pain is set to rise as the Strait of Hormuz stays closed into summer
