Author: Brynne Kelly 8/15/2021
The oil complex cooled off significantly last week. We highlighted the potential for this in our report dated 8/06 regarding seasonality.
What may not have hit the radar for many in the oil complex is the surge in natural gas and LNG prices. Global natural gas and LNG prices have made a remarkable move higher this month in anticipation of a tight winter season. Coupled with the recent ERCOT winter power grid debacle earlier this year, gas prices have soared over the last month.
The rally in spot liquefied natural gas (LNG) prices in recent weeks has been framed as being led by robust demand in Asia and in Europe as the northern hemisphere deals with hotter-than-usual temperatures and looks ahead to the winter 2021/2022 heating season.
A decade ago, the IEA declared that the world may be entering a “golden age” of natural gas demand growth due to historic expansion of low-cost supply. Indeed, between 2009 and 2020, global gas consumption surged by 30% as utilities and industries took advantage of booming output. This seems to be coming to a head as natural gas and LNG prices have been surging towards their highs over the last several weeks.
Meanwhile, the front of the oil complex is plagued by some very large and looming macro themes. Let's get those out of the way first since macro themes only take control of the wheel during periods when the market lacks conviction or is technically strung out - by challenging the amount of risk premium in the market (or lack thereof).
OPEC Production Cuts
Venezuelan Oil Sanctions
The impact of the Delta variant on demand
The fall of Afghanistan to the Taliban
Fall Refinery Maintenance
1. OPEC Production Cuts
The irony coming out of the White House regarding oil production last week was epic:
- White House: We will ask OPEC+ to increase oil output
- White House: We have not asked US oil producers to increase output
In IEA's monthly report, they noted that OPEC July output rose 604,000 bpd as Saudi Arabia tapers voluntary cuts. They kept 2021 demand growth forecast at 5.95 mbpd while lowering their expected demand for OPEC crude next year by 1.1 mbpd.
It's likely that White House rhetoric surrounding this has little impact on OPEC's trajectory. However, it does suggest that the administration is focused on price and may attempt to use other avenues that have the desired impact of lowering prices.
One of these avenues lies with Venezuela. Representatives of the Venezuelan government and the opposition began a round of talks on Friday in Mexico City aimed at overcoming Venezuela's acute political and economic crisis, which has caused millions to flee the Latin American nation.
Platts Analytics revised down its Venezuelan crude supply forecast by 70,000 b/d for September to end-2022, with production now capped at 600,000 b/d. An eventual fall to mid-2020 levels of 300,000 b/d would be unsurprising absent sanctions relief, it said.
The S&P Global Platts OPEC survey put June production at 550,000 b/d, up 10,000 b/d month on month. Venezuela pumped 2.4 million b/d in 2015, before sanctions, mismanagement and widespread power outages decimated its oil sector.
Analysts are skeptical they can break the country's stalemate and create conditions for eventual US sanctions relief.
**Some on twitter claimed the talks have resulted in a Memorandum of understanding signed in Mexico between representatives from Maduro’s government and the US, opening the possibility for some 1.500.000+ BPD (total) of additional crude oil supply in a matter of 3 months max.
3. Delta Variant
The bearish sentiment induced by surging COVID cases doomed WTI at the reopening Sunday night.
The IEA said on Thursday that global oil demand surged by 3.8 million barrels per day month-on-month in June, led by increased mobility in North America and Europe, but reversed course in July and is set to proceed more slowly for the rest of the year due to the spread of the Delta variant.
The events unfolding in Afghanistan over the weekend should drive Middle East risk premiums for crude oil higher. One cannot rule out significantly more conflict in the year ahead between Iran, Israel and the Taliban. Key highlights of the events so far:
Afghanistan's President Ashraf Ghani relinquished power to an interim government led by Taliban commander Mullah Abdul Ghani Baradar. "In order to avoid the bloodshed, I thought it was best to get out," Ghani said in a statement
Officials told Reuters and The Associated Press that President Ghani fled Afghanistan for Tajikistan and is expected to travel to a third country
The Pentagon authorized 1,000 additional troops to Afghanistan to help with the evacuation, boosting the overall number to 6,000, US officials said
The US Embassy in Kabul has suspended all operations and told Americans to shelter in place, saying it has received reports of gunfire at the international airport, according to The Associated Press
Nobody should bilaterally recognize the Taliban as the government of Afghanistan, British Prime Minister Boris Johnson said on Sunday, adding it was clear that there would be a new administration in the country very shortly. This was most likely aimed at China since it's been reported that China is prepared to recognize the Taliban as the legitimate ruler of Afghanistan if it succeeds in toppling the Western-backed government in Kabul, U.S. News has reported, a prospect that undercuts the Biden administration's remaining source of leverage over the insurgent network as it continues its startling campaign to regain control.
The high premiums that Oman crude oil enjoyed over Brent as OPEC+ cuts began to draw down global inventories has begun to fade in the front of the market. At a minimum, risk premiums for middle eastern crude oil such as Oman should increase relative to Brent and WTI. The secondary impact of this would be for the Brent/WTI spread to widen out.
5. Fall Refining Maintenance
Early spring and fall traditionally are busy periods for U.S. refinery maintenance, as operators gear up for summer driving demand and switch to making more heating oil and winter gasoline blends. The shoulder demand season is fast approaching and will require producers to either store excess barrels or cut production as refinery runs fade. If the market remains in backwardation, producers might just opt to pull-back on production rather than hold inventory barrels into a declining market.
This brings us back to natural gas and LNG. Earlier this year, Texas, the energy hub of the US, came to a grinding halt in February when the ERCOT power grid crumbled under the weight of cold weather. A state rich with energy production as far as the eye can see, was suddenly unable to continue operations without electricity, and the dominos began to fall one by one. Refinery outages ensued as a result of power outages. Texas oil and gas companies filed 174 notices of pollution releases above permitted levels between Feb. 11 and Feb. 18, four times the number the prior week, according to the Texas Commission on Environment Quality (TCEQ) data. Meaning that any fuel switching that could take place, was taking place.
We were fortunate at the time to be sitting on higher-than-normal refined product inventories. Refinery outages helped foster inventory drawdowns in distillate not only in the USGC but also along the US East Coast (PADD 1 and PADD 3 inventory levels shown below). Fast forward to the upcoming winter season and the picture is much different, especially in PADD 3 (purple line, US East Coast distillate inventories). And, let's not forget, the Nymex ULSD futures contract is based on delivery into New York Harbor.
Understanding the price relationship between two commodities that compete for the same uses can provide important information and clues to future price direction. Diverse infrastructures such as water supply, transportation, fuel and power stations are coupled together and depend on each other for functioning.
LNG prices and global natural gas prices have already begun to signal tight supplies. Yet, consumers are starting to balk at price levels. India's biggest gas importer Petronet LNG said on Saturday that some of its customers have deferred imports of spot liquefied natural gas (LNG) due to high prices. Perhaps trying to take the route the home builders did when lumber prices were peaking. Pouring their foundations but holding off on the purchase of lumber to build the actual structure until prices pulled back. Fortunately, prices did pull back.
Looking at the structure of the futures complex in the natural gas markets, Asian LNG and European natural gas futures are trading above US ULSD and US east coast natural gas futures through march of next year (pink and blue lines vs red and cyan lines below).
Typically, during peak winter season, the marginal clearing price for a unit of energy to produce heat is driven by Asian or European natural gas prices. Constrained markets like the northeast are forced to price US winter natural gas futures at or near the marginal unit (used to either heat homes directly or indirectly via the power grid) in order to attract molecules into the region.
New England locations such as Boston, as well as New York, lack sufficient pipeline capacity to import cheap shale gas production from the Appalachian region and are forced to supplement with LNG imports. Hence, the reason domestic natural gas futures in those regions are forced to battle it out with ULSD and LNG prices to find the lowest cost supplies to generate electricity in a cold winter (pink, blue, cyan and red lines below, in US$/Mmbtu heat content adjusted). At the moment, Asian LNG futures are the costliest on the board for the winter season.
UK and European natural gas prices are a proxy for LNG demand. Like some US New England markets, the UK is a net importer of natural gas in the winter so futures tend to price in expected seasonal spot market shortages quicker than US natural gas prices (since the US is a net exporter of LNG). In fact, over the last 2 months, UK natural gas prices (governed by global LNG prices) have surpassed Nymex ULSD prices and the spread between the two has gone negative (purple line below, ULSD prices are lower than LNG prices).
Inventory levels of both US distillate and US natural gas are significantly lower than they were this time last year which could expose some real operational issues should we have any supply disruptions due to severe weather conditions.
Regardless of the macro items mentioned earlier driving sentiment in the oil markets, the global natural gas market is signaling a tight supply/demand balance heading in to this winter. The cheap seat that has been natural gas over the last decade seems to be coming to a head in the US as the lack of US oil drilling in the Permian region is leading to less associated natural gas production.
Cold weather led to failures across the energy system this past winter, and this was exacerbated by failures in the ERCOT power grid. The loss of basic electricity services in Texas cascaded down to the production of energy, transportation systems, water distribution and the performance of telecommunications. Winter 2021/2022 markets across the board in natural gas are beginning to reflect this risk. Perhaps it's time for oil markets to take notice??
EIA Inventory Statistics Recap
The EIA reported a total petroleum inventory change of Zero for the week ending August 6, 2021, fairly inline with the 5-year average.
Year-to-date cumulative changes in inventory for 2021 are DOWN by 94.90 million barrels (vs down 94.90 million last week).
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to slightly below historical levels and should continue to draw as long as backwardation in the market persists.