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Prepare for more turmoil, lower inventories and higher prices

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Brent crude is pulling back below the 90-line this morning trading as low as USD 88.78/b following a 4.2% gain last week. The pullback is blamed on news that Israel is pulling some troops out of Gaza. But we think this is much more of a technical move below the 90-line with preparations for further price gains ahead. The Israeli troop movements are a preparation for a final push into Rafah in Gaza to take out the last stronghold of Hamas there (FT article today). Iranian retaliation following the attack in Damascus last week also looks set to unfold in some way. Possibly by Hezbollah in Lebanon though instigated by Iran. Prepare for more turmoil, lower oil inventories and higher prices as the market continues to run a deficit.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Brent gained 4.2% last week with a solid close above the 90-line. Brent crude had a stellar week last week gaining 4.2%. Even following such a strong performance it made a gain on Friday of 0.6% with a close at USD 91.17/b. Friday also saw the highest trade of the week at USD 91.91/b.

Brent was propelled by positive PMI gains, geopolitics and falling US inventories. Oil was supported by a rang of factors last week. Both the US and China saw their manufacturing PMIs rise above the 50-line (50.3 and 50.8 resp.). The Eurozone manufacturing PMI rose to 46.1 from 45.7 while the composite index rose above the 50-line to 50.3 from 49.9. These PMI gains supported both oil and metals through growth recovery optimism. US oil inventories last Wednesday created less waves with a net draw of 2.2 m b in total crude and product inventories. It was still a very bullish reading in our view as inventories normally this time of year should have risen 3.8 m b. Thus driving US commercial oil inventories further away and below the normal level of inventories. Geopolitical focus flared up following the attack on Iran’s consulate in Syria where Iran’s top Islamic Revolutionary Guard Corps (IRGC) general in Syria along with five other IRGC officers were killed. Israel is assumed to be behind the attack but has not taken responsibility yet.

Back below 90 this morning in what seems like a geopolitical breather. But is more of a technical move. This morning Brent crude has pulled back and traded as low as USD 88.78/b while trading at USD 89.76/b. We commented on Friday that it is quite normal for Brent crude to pull back below big numbers after having broken them. Just to test out the level properly before heading higher.

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Israel is pulling some troops out of Gaza. Most likely it is preparing to attack Rafah (FT today)Price action to the downside this morning is blamed on some kind of reduced geopolitical premium as Israel is withdrawing some of its troops in Gaza. The reason why it is withdrawing some tropes however is to our understanding that Israel is preparing to attack Rafah, the southernmost part of Gaza bordering to Egypt where now close to one million Palestinians are living. It is the last strong-hold of Hamas and Israel looks bent on taking it out despite repeated warnings against it from the US. Human tragedy looks set to unfold in Rafah in not too long.

”Iran will respond to the Damascus strike”. The most likely flareup is Lebanon and Hezbollah. The geopolitical flare following the attack on Iran’s consulate in Syria last week has faded a little this morning. But this is in no way over. John Sawers, former chief of MI6, in an article in FT on Friday bluntly stated: ”Iran will respond to the Damascus strike”.  Iran still doesn’t want to be involved in direct military confrontation. The likely flareup will be Lebanon and Hezbollah which could force Israel into a two-front war. 

Rafah is located in the southernmost part of Gaza

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Gaza map
Source: https://www.un.org/unispal/document/auto-insert-200679/

Net long specs in Brent + WTI rose by 34 m b over the week to 2 April.

Net long specs in Brent + WTI rose by 34 m b over the week to 2 April.
Source: SEB graph and calculations, Data feed by Bloomberg

Saudi Arabia lifted its Official Selling Prices to Asia for most grades for May delivery

Saudi Arabia lifted its Official Selling Prices to Asia for most grades for May delivery
Source: SEB graph and calculations, Data feed by Bloomberg

Analys

German solar power prices are collapsing as market hits solar saturation

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German solar power producers got a price haircut of 87% over the past 10 days. German solar power producers have over the past 10 days received a volume weighted power price of only EUR 9.1/MWh. The average power price during non-solar-power-hours was in comparison EUR 70.6/MWh. Solar power producers thus got an 87% cut in the power price they get when they produce vs. the power price during non-solar-power-hours. This is what happens to power prices when the volume of unregulated power becomes equally big or bigger than demand: Prices collapse when unregulated power produces the most.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

Massive growth in solar power installations in Germany in 2023 is leading to destruction of solar hour prices and solar profitability. Germany installed a record 14,280 MW of solar power capacity According to ’PV Magazine International’. That is close to twice as much as in 2022. Total installed solar capacity reached 81.7 GW at the end of 2023 according to ’Renewables Now’. Average German demand load was in comparison 52.2 GW. So total solar capacity reached almost 30 GW above average demand. Solar power produces the most during summer when demand is lower. The overshoot is thus much larger than the 30 GW mentioned when it matters.

The collapse in solar-hour-power-prices implies a collapse in solar power producer earnings unless the earnings of the installations are secured with subsidies or by PPAs. It also means that there is a sharp reduction in the earnings potential for new solar power projects. The exponential growth in new installations of solar capacity we have seen to date is likely to come to an abrupt halt. There is however most likely still a large range of solar power projects under construction in Germany which will be finalized before growth in new capacity comes to a halt. The problem of solar power production curbs (you are not allowed to produce at all) and solar power price destruction is likely to escalate yet higher before new growth in supply comes to a halt. 

Focus will now shift from solar production capacity growth to grid improvements, batteries and adaptive demand. All consumers are of course happy for cheap power as long as they are able to consume it when it is cheap. At the moment they can’t. But the incentive to be inventive is now super high. The focus will now likely shift from solar power production growth to grids, batteries, adaptive demand and all possible ways to utilize ”free power”. This will over time exhaust the availability of ”free power” and drive solar-hour-power-prices back up. This again will then eventually open for renewed growth in solar power capacity growth.

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It is probably much worse down in the grid. What is worth noting is that these numbers are for all of Germany average. Solar power congestion is much worse in the local grids all around Germany along with local grid capacity constraints ect.

The problem of solar power is high concentration of production: 80% of German solar production was produced during 22.3% of the hours in the year in 2023. What is also worth mentioning is that solar power production is extremely concentrated in relatively few hours per year. It produces in the middle of the day and during summer. In 2023 German solar power produced 80% of its production in only 22.3% of the hours of the year. This basically implies that once solar power production reaches 22.3% of total power supply (without batteries), then solar-hour-power-prices will likely collapse. Solar power production reached 55 TWh in 2023. That’s a lot but it is still only 12% of total demand of 458 TWh in 2023. What it means is that the acute problem of solar-hour-power-price-destruction sets in much before the ”theoretical 22.3%” mentioned above.

On the 21 Feb 2024 we wrote the following note on this issue: ”The self-destructive force of unregulated solar power” where we highlighted these issues and warned that this will likely be a process of ”First gradually. Then suddenly”.

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German solar power capacity makes a big leap upwards in 2023 as the energy crisis hurt everybody. Demand went down. Now there is a large overcapacity in installed solar effect vs. demand load.

German solar power capacity makes a big leap upwards in 2023 as the energy crisis hurt everybody. Demand went down. Now there is a large overcapacity in installed solar effect vs. demand load.
Source: SEB calculations and graph, PV Magazine, Wikipedia, Blberg data on German power demand

German solar power producers got an 87% price haircut on average during last 10 days vs. those who produced during non-solar-power hours.

German solar power producers got an 87% price haircut on average during last 10 days vs. those who produced during non-solar-power hours.
Source: SEB calculations and graph, data by Blbrg

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.
Source:  SEB calculations and graph, data by Blbrg

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.

Volume weighted solar power prices vs. non-solar-hours. Bigger and bigger discount.
Source: SEB calculations and graph, data by Blbrg

Solar power production and German power prices over the past 10 days.

Solar power production and German power prices over the past 10 days.
Source: SEB calculations and graph, data by Blbrg

Solar power production and German power prices on 27 April 2024.

Solar power production and German power prices on 27 April 2024.
Source:  SEB calculations and graph, data by Blbrg
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Analys

Firm at $85

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This week, Brent Crude prices have strengthened by USD 1.2 per barrel since Monday’s opening. While macroeconomic concerns persist, market reactions have been subdued, with price fluctuations primarily driven by fundamental factors. Currently, the oil price stands at its weekly high of USD 84.4 per barrel, with Wednesday’s low recorded at USD 81.7 per barrel, indicating relatively normal price movements throughout the week.

Ole R. Hvalbye, Analyst Commodities, SEB
Ole R. Hvalbye, Analyst Commodities, SEB

The upward trajectory since Wednesday afternoon can be attributed to two main factors:

Firstly, Wednesday’s US inventory report, though mixed, conveyed a bullish sentiment to the market due to an overall decline in commercial inventories. The report from the US Department of Energy (DOE) revealed a draw in US crude inventories of 1.4 million barrels last week, surpassing consensus estimates of a 2.0-million-barrel draw –  the American Petroleum Institute’s (API) forecast of a 0.5-million-barrel build on Tuesday.

Additionally, a marginal improvement in refinery margins hints at healthier demand prospects leading up to the driving season. While commercial crude oil inventories (excluding Strategic Petroleum Reserve) decreased, standing approximately 3% below the five-year average for this period, total gasoline inventories saw a notable increase of 0.9 million barrels compared to the consensus forecast of a decrease of 1.1 million barrels. Distillate fuel inventories experienced a more moderate increase in line with expectations, rising by 0.6 million barrels but remaining approximately 7% below the five-year average. Overall, total inventories (crude + gasoline + distillate) showed a marginal increase of 0.1 million barrels, coupled with a 1% improvement in refinery utilization to 88.5% last week (see pages 11 and 18 attached).

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The substantial draw in commercial crude inventories, particularly compared to the typical seasonal build, has emerged as a key price driver (see page 12 attached).

Secondly, the third consecutive day of oil price gains can be attributed to renewed optimism regarding US rate cuts, supported by positive US jobs data suggesting potential Federal Reserve rate cuts this year. This optimism has boosted risk assets and weakened the dollar, rendering commodities more appealing to buyers.

In a broader context, crude oil prices have been moderating since early last month amidst easing tensions in the Middle East. Attention is also focused on OPEC+, with Russia, a key member, exceeding production targets ahead of the cartel’s upcoming meeting. Expectations are widespread for an extension of output cuts during the next meeting.

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Conversely, providing support to global crude prices is the Biden administration’s intention to increase the price ceiling for refilling US strategic petroleum reserves to as much as USD 79.99 per barrel.

With geopolitical tensions relatively subdued, but lingering, the market remains vigilant in analyzing data and fundamentals. Our outlook for oil prices at USD 85 per barrel for 2024 remains firm and attainable for the foreseeable future.

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Analys

Diesel concerns drags Brent lower but OPEC+ will still get the price it wants in Q3

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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.

Bjarne Schieldrop, Chief analyst commodities, SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

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.

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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.

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Change in US oil inventories was a bullish driver last week.
Source: SEB calculations and graph, Blbrg data, US EIA

Crude oil time-spreads strengthened last week

Crude oil time-spreads strengthened last week
Source:  SEB calculations and graph, Blbrg data

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.

ICE gasoil forward curve
Source: Blbrg

ARA gasoline crack has rallied towards while Gasoil crack has fallen back. Not a totally unusual pattern.

ARA gasoline crack has rallied towards while Gasoil crack has fallen back. Not a totally unusual pattern.
Source:  SEB calculations and graph, Blbrg data

Proxy ARA refining margin with 40% gasoil crack, 40% gasoline crack and 20% bunker oil crack.

Proxy ARA refining margin with 40% gasoil crack, 40% gasoline crack and 20% bunker oil crack.
Source:  SEB calculations and graph, Blbrg data

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.

ARA diesel cracks
Source:  SEB calculations and graph, Blbrg data

Net long specs fell back a little last week.

Net long specs fell back a little last week.
Source:  SEB calculations and graph, Blbrg data

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

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
Source:  SEB calculations and graph, Blbrg data
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