Analys
The long game is the wrong game (from short term intervention to longer term structural battle)
OPEC yesterday decided to roll existing cuts over for another 9 months lasting all the way to March 2018. Maintaining production cuts also in Q1-18 was however communicated as a measure mainly to avoid driving inventories higher again in the demand wise seasonally weak first quarter of the year. To the surprise of many the market did not take the deal well and Brent crude oil fell $4.6% to a close of the day of $51.46/b with a low of the day of $51.03/b.
In hindsight we can now clearly say that there must have been a substantial amount of anticipation in the market for not only an extension of cuts but also for deeper cuts. Saudi Arabia’s communication to the market ahead of the meeting has clearly been misinterpreted when he stated that OPEC “will do whatever it takes” to draw inventories down to the 5 year average. The market view must have been that what OPEC & Co. did in H1-17 was far from enough. Thus “whatever it takes” should be MORE. Thus the moment Khalid Al-Falih said to reporters in Vienna yesterday at 10:20 CEST that “deeper cuts are not needed”, that was when the oil price started to fall. Long speculative positions which had run hard into the meeting and then instead ran for cover when the oil price started to tumble.
When OPEC launched the cuts last year they were dubbed as a “short term intervention”. Now it increasingly starts to look like a long haul structural battle. We do think that OPEC’s decision to cut will drive inventories down towards normal by the end of the year. Thus yesterday’s decision by OPEC & Co. is in our view making $60/b a sensible target for the front month Brent crude at the end of 2017. Thus as such we think that yesterday’s sell-off should be used as a buying opportunity. At the same time however it is likely leading to another 9 months during which a positive crude oil price signal leads US shale oil production to accelerate yet more.
US shale oil production has accelerated massively since November when OPEC & Co. decided to cut production. US crude oil production is now up more than 600 kb/d since the start of December 2016 which is more than the total 558 kb/d in pledged cuts from the 11 countries which have joined OPEC in cutting production at the moment. Their cuts are now basically wiped out. The US shale oil stimulus from the price gains following OPEC’s decision to cut in November has added some 250 shale oil rigs to the market. If we assume that there will not be a single additional US shale oil rig added to the market from July 2017 and all through to the end of 2018 we still expect that US crude oil production will grow by 0.5 mb/d y/y in 2017, 1.5 mb/d y/y in 2018 and by 1 mb/d y/y in 2019. However, as a consequence of the extension of the cuts all until March 2018 we are likely going to see a more supportive oil price and thus yet more US shale oil rigs being added to the market over the coming 9 months of cuts. In our view this is likely going to flip the global supply/demand balance for 2018 and 2019 into surplus.
Thus OPEC is increasingly painting itself into a corner. OPEC’s choice next year will be
1) Roll some cuts forward in both 2018 and 2019 (longer term structural battle) or
2) Put 1.8 mb/d of production cuts (OPEC & Co.) back into the market. Produce at will and let the price regulate the market yet again. I.e. the oil price needs to drop in order to push non-OPEC production lower in order to make room for OPEC & Co’s production revival.
It is often said that generals always fight the previous war meaning that they use tactics and strategy from the last war because that is what they know even if these are outdated. In a way this is what OPEC & Co are doing. In a shale oil world they should have med the cuts quick and dirty. It should definitely have been a short term intervention and not a long term structural battle. In the old days when non-OPEC production solely consisted of conventional oil production with a lead time from investments to production of some 5 years then gradual, enduring cuts did work. Now however keeping cuts going just leaves US shale oil producers all the time in the world to respond and revive. Rather than OPEC & Co cutting 1.8 mb/d for a full 5 quarters (2017 + Q1-18) they should rather have cut production by 3 mb/d for one quarter. That would have left little time for US shale oil players to ramp up investments and thus have limited the cumulative production impact on 2018 and 2019.
At yesterday’s meeting they should have decided massive cuts in Q3-17 and then no more. That would have been the right medicine for the market. Draw down the inventories in a flash. No lengthy time for US shale oil producers to revive and voila, inventories down to normal. A flat or backwardated crude oil forward curve where the mid-term WTI forward curve could be kept in check from there onwards.
It is still not too late for Saudi Arabia to follow this kind of strategy. They have basically promised what they are going to produce over the next 9 months. They could possibly do all of it in Q3-17. Rather than placing production at 10.06 mb/d for 9 months (a cut of 486 kb/d) they could instead produce 9.07 mb/d for the three months in Q3-17 which would mean a cut of 1.458 kb/d versus its October 2017 level. That would have drawn the inventories down by an additional 90 mb in Q3-17. At the same time Saudi Arabia should sell a comparable amount of volumes on a forward basis 2018 and 2019. This would help to prevent the medium term forward curve from rising. Thus again limiting the price signals and hedging opportunities for US shale oil producers.
Khalid Al-Falih has said that US shale oil producers are not the enemy. He welcomes their production revival. However, it still needs to be managed in the right way. At least as long as OPEC & Co is trying to manage the market. And the right way in our view is quick and dirty cuts. Do it all in one go rather than extended and do manage the price level of the mid-term forward crude oil prices.
JPM this morning cut its 2018 Brent crude oil price outlook to $45/b. That is great news for OPEC & Co because it will help to hold price expectations low for 2018 and 2019 and thus help to keep the mid-term forward crude prices in check and thus help to limit the positive price signals to US shale oil producers and thus limit further strong additions and activations of rigs.
As of now however the picture is for a lengthy nine months of additional production cuts and thus more US shale oil rigs being activated driving both 2018 and 2019 into surplus. As such there is increasing concern in the market for the exit from cuts. It is easy to take 1.8 mb/d off the market (1.2 mb/d for OPEC and 0.6 for Co.). With further revival of US shale oil it will be increasingly difficult to put the volumes back into the market again. An exit strategy was not discussed at the OPEC meeting. “We will cross that bridge when we get there” was Khalid Al-Falih’s comment. The market is worried however that come April 2018 then OPEC & Co moves back to “produce at will”. If that was the case following 5 quarters of US shale oil stimulating production cuts from OPEC & Co that would mean that the front month Brent crude oil price probably would have to move down to $35/b in order to slow down US shale oil production again.
With increasingly a surplus becoming the likely outlook for 2018 and 2019 (due to nine more months of cuts) the price outlook for these years increasingly becomes tied to OPEC & Co’s strategy of rolling cuts yet further down the road or not.
For now we are positive to oil prices for the rest of the year in 2017 where we expect OECD inventories at normal level at the end of 2017 with the Brent crude curve moving into backwardation with the front end contract standing at $60/b. We then expect the market price structure to be as follows. The WTI 18 month contract standing at $52.5/b. The Brent crude 18 month contract standing at a $2.5/b premium at $55/b and lastly the front month Brent crude oil contract having a $5/b premium backwardation the 18 months contract thus placing Brent crude front month contract at $60/b at year end 2017.
We are however increasingly concerned about the oil market balance and thus oil prices in 2018 and 2019. The fact that Algeria’s Energy Minister, Noureddine Bouterfa, was replaced in a minister re-shuffle yesterday is concerning. He was at the heart of last year’s negotiations. He was the oil diplomat which criss-crossed between OPEC and non-OPEC members to make the production cut deal last year happen. Thus losing him as oil minister is probably not a good thing with respect to further cuts beyond March 2018.
Global supply/demand oil market balance:
This is what OPEC hopes for:
This is however probably what they might get:
Kind regards
Bjarne Schieldrop
Chief analyst, Commodities
SEB Markets
Merchant Banking
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.
Diesel concerns drags Brent lower but OPEC+ will still get the price it wants in Q3
Londons roll som ett globalt nav inom råvaruhandeln
’wait and see’ mode
Also OPEC+ wants to get compensation for inflation
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