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Reloading the US ’oil-gun’ (SPR) will have to wait until next downturn

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Brent crude traded down 0.4% earlier this morning to USD 91.8/b but is unchanged at USD 92.2/b at the moment. Early softness was probably mostly about general market weakness than anything specific to oil as copper is down 0.7% while European equities are down 0.3%. No one knows the consequences of what a ground invasion of Gaza by Israel may bring except that it will be very, very bad for Palestinians, for Middle East politics for geopolitics and potentially destabilizing for global oil markets. As of yet the oil market seems to struggle with how to price the situation with fairly little risk premium priced in at the moment as far as we can see. Global financial markets however seems to have a clearer bearish take on this. Though rallying US rates and struggling Chinese property market may be part of that.

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

The US has drawn down its Strategic Petroleum Reserves (SPR) over the latest years to only 50% of capacity. Crude oil prices would probably have to rally to USD 150-200/b before the US would consider pushing another 100-200 m b from SPR into the commercial market. As such the fire-power of its SPR as a geopolitical oil pricing tool is now somewhat muted. The US would probably happily re-load its SPR but it is very difficult to do so while the global oil market is running a deficit. It will have to wait to the next oil market downturn. But that also implies that the next downturn will likely be fairly short-lived and also fairly shallow. Unless of course the US chooses to forgo the opportunity.  

The US has drawn down its Strategic Petroleum Reserves (SPR) to only 50% of capacity over the latest years. Most of the draw-down was in response to the crisis in Ukraine as it was invaded by Russia with loss of oil supply from Russia thereafter.

The US has however no problems with security of supply of crude oil. US refineries have preferences for different kinds of crude slates and as a result it still imports significant volumes of crude of different qualities. But overall it is a net exporter of hydrocarbon liquids. It doesn’t need all that big strategic reserves as a security of supply any more. Following the oil crisis in the early 70ies the OECD countries created the International Energy Agency where all its members aimed to have some 100 days of forward oil import coverage. With US oil production at steady decline since the 70ies the US reached a peak in net imports of 13.4 m b/d in 2006. As such it should have held an SPR of 1340 million barrels. It kept building its SPR which peaked at 727 m b in 2012. But since 2006 its net imports have been in sharp decline and today it has a net export of 2.9 m b/d.

Essentially the US doesn’t need such a sizable SPR any more to secure coverage of its daily consumption. As a result it started to draw down its SPR well before the Russian invasion of Ukraine in February 2022. But then of course it fell fast and is today at 351 m b or about 50% of capacity.

The US is the largest oil consumer in the world. As such it is highly vulnerable to the price level of oil. The US SPR today is much more of a geopolitical tool than a security of supply tool. It’s a tool to intervene in the global oil market. To intervene in the price setting of oil. The US SPR is now drawn down to 50% but it still holds a sizable amount of oil. But it is little in comparison to the firepower of OPEC. Saudi Arabia can lower its production by 1 m b/d for one year and it will have eradicated 365 million barrels in global oil inventories. And then it can the same the year after and then the year after that again.

The US has now fired one big bullet of SPR inventory draws. It really helped to balance the global oil market last year and prevented oil prices from going sky high. With 350 m b left in its SPR it can still do more if needed. But the situation would likely need to be way more critical before the US would consider pushing yet another 100-200 m b of oil from its SPR into the global commercial oil market. An oil price of USD 150-200/b would probably be needed before it would do so.

With new geopolitical realities the US probably will want to rebuild its SPR to higher levels as it is now an important geopolitical tool and an oil price management tool. But rebuilding the SPR now while the global oil market is running a deficit is a no-go as we see it.

An oil market downturn, a global recession, a global oil market surplus where OPEC no longer want to defend the oil price with reduced supply is needed for the US to be able to refill its SPR again unless it wants to drive the oil price significantly higher.

But this also implies that the next oil price downturn will likely be short-lived and shallow as the US will have to use that opportunity to rebuild its SPR. It’s kind off like reloading its geopolitical oil gun. If it instead decides to forgo such an opportunity then it will have to accept that its geopolitical maneuverability in the global oil market stays muted.

Net US oil imports in m b/d and US Strategic Petroleum Reserves (SPR) in million barrels. The US doesn’t need strategic petroleum reserves for the sake of security of supply any more. But it is a great geopolitical energy-tool to intervene in the price setting of oil in the global market place.

Net US oil imports in m b/d and US Strategic Petroleum Reserves (SPR) in million barrels
Source: SEB graph, EIA data from Blbrg

Analys

All eyes on OPEC V8 and their July quota decision on Saturday

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Tariffs or no tariffs played ping pong with Brent crude yesterday. Brent crude traded to a joyous high of USD 66.13/b yesterday as a US court rejected Trump’s tariffs. Though that ruling was later overturned again with Brent closing down 1.2% on the day to USD 64.15/b. 

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

US commercial oil inventories fell 0.7 mb last week versus a seasonal normal rise of 3-6 mb. US commercial crude and product stocks fell 0.7 mb last week which is fairly bullish since the seasonal normal is for a rise of  4.3 mb. US crude stocks fell 2.8 mb, Distillates fell 0.7 mb and Gasoline stocks fell 2.4 mb.

All eyes are now on OPEC V8 (Saudi Arabia, Iraq, Kuwait, UAE, Algeria, Russia, Oman, Kazakhstan) which will make a decision tomorrow on what to do with production for July. Overall they are in a process of placing 2.2 mb/d of cuts back into the market over a period stretching out to December 2026. Following an expected hike of 137 kb/d in April they surprised the market by lifting production targets by 411 kb/d for May and then an additional 411 kb/d again for June. It is widely expected that the group will decide to lift production targets by another 411 kb/d also for July. That is probably mostly priced in the market. As such it will probably not have all that much of a bearish bearish price impact on Monday if they do.

It is still a bit unclear what is going on and why they are lifting production so rapidly rather than at a very gradual pace towards the end of 2026. One argument is that the oil is needed in the market as Middle East demand rises sharply in summertime. Another is that the group is partially listening to Donald Trump which has called for more oil and a lower price. The last is that Saudi Arabia is angry with Kazakhstan which has produced 300 kb/d more than its quota with no indications that they will adhere to their quota.

So far we have heard no explicit signal from the group that they have abandoned the plan of measured increases with monthly assessments so that the 2.2 mb/d is fully back in the market by the end of 2026. If the V8 group continues to lift quotas by 411 kb/d every month they will have revived the production by the full 2.2 mb/d already in September this year. There are clearly some expectations in the market that this is indeed what they actually will do. But this is far from given. Thus any verbal wrapping around the decision for July quotas on Saturday will be very important and can have a significant impact on the oil price. So far they have been tightlipped beyond what they will do beyond the month in question and have said nothing about abandoning the ”gradually towards the end of 2026” plan. It is thus a good chance that they will ease back on the hikes come August, maybe do no changes for a couple of months or even cut the quotas back a little if needed.

Significant OPEC+ spare capacity will be placed back into the market over the coming 1-2 years. What we do know though is that OPEC+ as a whole as well as the V8 subgroup specifically have significant spare capacity at hand which will be placed back into the market over the coming year or two or three. Probably an increase of around 3.0 – 3.5 mb/d. There is only two ways to get it back into the market. The oil price must be sufficiently low so that 1) Demand growth is stronger and 2) US shale oil backs off. In combo allowing the spare capacity back into the market.

Low global inventories stands ready to soak up 200-300 mb of oil. What will cushion the downside for the oil price for a while over the coming year is that current, global oil inventories are low and stand ready to soak up surplus production to the tune of 200-300 mb.

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Analys

Brent steady at $65 ahead of OPEC+ and Iran outcomes

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Following the rebound on Wednesday last week – when Brent reached an intra-week high of USD 66.6 per barrel – crude oil prices have since trended lower. Since opening at USD 65.4 per barrel on Monday this week, prices have softened slightly and are currently trading around USD 64.7 per barrel.

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

This morning, oil prices are trading sideways to slightly positive, supported by signs of easing trade tensions between the U.S. and the EU. European equities climbed while long-term government bond yields declined after President Trump announced a pause in new tariffs yesterday, encouraging hopes of a transatlantic trade agreement.

The optimisms were further supported by reports indicating that the EU has agreed to fast-track trade negotiations with the U.S.

More significantly, crude prices appear to be consolidating around the USD 65 level as markets await the upcoming OPEC+ meeting. We expect the group to finalize its July output plans – driven by the eight key producers known as the “Voluntary Eight” – on May 31st, one day ahead of the original schedule.

We assign a high probability to another sizeable output increase of 411,000 barrels per day. However, this potential hike seems largely priced in already. While a minor price dip may occur on opening next week (Monday morning), we expect market reactions to remain relatively muted.

Meanwhile, the U.S. president expressed optimism following the latest round of nuclear talks with Iran in Rome, describing them as “very good.” Although such statements should be taken with caution, a positive outcome now appears more plausible. A successful agreement could eventually lead to the return of more Iranian barrels to the global market.

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Analys

A shift to surplus will likely drive Brent towards the 60-line and the high 50ies

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Brent sinks lower as OPEC+ looks likely to lift production in July by another 400 kb/d. Brent crude declined 0.7% yesterday to USD 64.44/b and traded in a range of USD 63.54 – 65.03/b. This morning Brent is down another 0.7% to USD 64/b along with expectations that OPEC+ will lift its production quota by another 411 kb/d in July.

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

Kazakhstan would be in breach even if the whole 2.2 mb/d of voluntary cuts are unwounded. The eight countries behind the 2.2 mb/d of voluntary cuts, the V8, have lifted their production quotas by close to 950 kb/d from April to June with unwinding starting in April. Over the coming week towards the end of May, the group will discuss what to do with quotas in July. Market expectations as well as indications from within the group is for another 411 kb/d hike also in July. Higher oil demand during summer both in the Middle East and globally is one reason for the hikes. Most of the additional production will not leave the Middle East but be consumed locally this summer. But Kazakhstan is also a major problem. The country produced 1.77 mb/d in April and 300 kb/d above its quota level. To maintain cohesion and credibility the group needs internal cooperation and harmony. Kazakhstan seems to have no plans to reduce production down to its quota. The alternative solution to reestablish internal harmony is to lift quotas up to where production is. The problem is that Kazakhstan only accounts for less than 5% of the overall production of V8. Thus even after unwinding all of the 2.2 mb/d, the quota of Kazakhstan would not rise much more than 100 kb/d. Far from the country’s overproduction of 300 kb/d in April.

A shift to surplus will likely drive Brent towards the 60-line and high 50ies. Losing front-end backwardation implies Brent crude down to the 60-line and high 50ies. Currently the Brent crude curve holds a front-end backwardation premium of USD 1.5/b versus the November price currently at USD 62.6/b. A result of an oil market which is still tight here and now. But if OPEC+ lifts production to a level where the market starts to run a surplus, then the front-end contract will flip from a USD 1.5/b premium vs. 4 months out to instead a comparable USD 1.5/b discount to 4 months out. That would bring the front-end contract down towards the 60-line and the high 50ies. This because a full out contango market usually also will drive the deferred contracts a bit lower as well. But this may not be all doom and gloom. A softer USD and a lower oil price is a powerful combo for global consumption. Global oil stocks are also low. This will help to cushion the downside.

Brent crude forward curve. Surplus and full contango would eradicate the front-end backwardation and drive Brent crude down towards the 60-line and high 50ies.

Brent crude forward curve. Surplus and full contango would eradicate the front-end backwardation and drive Brent crude down towards the 60-line and high 50ies.
Source: Bloomberg graph, SEB highlights
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