The announcement of US-led SPR releases last week combined with the new Omicron variant muddy the waters for the upcoming OPEC meeting
Author: Brynne Kelly 11/28/2021
Oil markets were delivered a double blow last week beginning with the announcement of a US-led Strategic Petroleum release followed by the discovery of a risky new coronavirus strain called Omicron. WTI fell 13.06% on Friday, hitting lowest since September 1. This makes it the worst one-day move since April 2020. Similarly, Brent fell 11.55%.
Rather than dissect the ramifications of the new Omicron variant, we simply note how vulnerable we remain to the risk of sweeping regulations in response to the virus. After all, that was the fear that struck the market last Friday. The uneasiness that people have when they no longer understand the yard stick by which things are measured. The realization that there are no salient guidelines and that with each new development in the virus saga the global response becomes more bifurcated.
Prior to last week, narratives of winter supply shortages had paired nicely with the broader market inflation story. It was easy to craft a bullish outlook built on the sins of the last few years - that being the lack of capital investment in the oil complex.
Now however, the announcement of a US-led coordinated SPR release last week has not only put this bullish narrative on hold, but also put the upcoming OPEC meeting squarely in the crosshairs. Toward that end, Bloomberg reported over the weekend that OPEC is moving two technical meetings to later this week in order to give committees more time to evaluate the impact of the new Omicron coronavirus variant.
Old Meeting Schedule
29 Nov - JTC
30 Nov - JMMC
1 Dec - OPEC;
2 Dec - OPEC+.
New Meeting Schedule
1 Dec - JTC and OPEC
2 Dec - JMMC and OPEC+
To prepare for this it's good to reflect on the slight differences in motives behind what drives OPEC and what drove non-OPEC countries to take such an historical move and release supply from their own coffers.
OPEC+ ‘Declaration of Cooperation’ (DoC)
Covid production cuts and increases:
OPEC has always claimed to have an eye on long-term supply/demand fundamentals. Likening their approaches to that of 'turning the Titanic' rather than being 'lean and nimble'.
In accordance with its Statute, the mission of the Organization of the Petroleum Exporting Countries (OPEC) is to "coordinate and unify the petroleum policies of its Member Countries and ensure the stabilization of oil markets in order to secure an efficient, economic and regular supply of petroleum to consumers, a steady income to producers and a fair return on capital for those investing in the petroleum industry." That sounds like a nice goal, doesn't it?
Let's review OPEC+ actions since the pandemic. In April 2020, OPEC and non-OPEC oil producing countries participating in the ‘Declaration of Cooperation’ (DoC) announced voluntary productions adjustments commensurate with the huge oil stock surplus, to achieve the rebalancing and stabilization of the global oil market. In their July 18, 2021 meeting they then agreed to Increase overall production by 0.4 mb/d on a monthly basis starting August 2021 until phasing out the 5.8 mb/d (million barrels per day) production adjustment, and in December 2021 assess market developments and Participating Countries’ performance, and adjust the Reference Production baseline for certain members, effective 1st of May 2022 (see previous post for details).
Since then, global inventories have declined significantly from their historic peak in June 2020. At the end of September 2021 they had fallen by 938 mb, with all components witnessing stock draws.
OPEC nations rely on guidance from it's Joint Technical Committee (JTC). The JTC is a technical body of the Joint Market Monitoring Committee (JMMC) and both committees were established under the umbrella of the historic ‘Declaration of Cooperation’ (DoC) signed on 10 December 2016. The committees are mandated to review global oil market conditions and prospects, and monitor the conformity levels to the voluntary production adjustments adopted by the OPEC and non-OPEC Ministerial Meeting.
On top of that, each month OPEC publishes their Monthly Oil Market Report based on the research provided by the JTC. In their November 2021 Oil Market Report, OPEC reported that demand for OPEC crude in 2021 was revised slightly down by 0.1 mb/d from the previous month to stand at 27.6 mb/d, around 4.9 mb/d higher than in 2020. Demand for OPEC crude in 2022 was also revised slightly down by 0.1 mb/d from the previous month to stand at 28.7 mb/d, around 1.0 mb/d higher than in 2021.
Every meeting, they lay out their supply/demand forecast, acknowledge risks to the forecast and then agree to a course of action.
The measured approach being taken by OPEC+ has been influenced by expectation of lingering vulnerabilities to Covid-related slow-downs.
US-led SPR Release
On Saturday, President Biden tweeted:
"This week, we launched a major effort to moderate the price of oil — an effort that will span the globe in its reach and ultimately reach your corner gas station. It will take time, but before long you should see the price of gas drop where you fill up your tank."
The motivation is clear as day: Lower Prices.
In the weeks leading up to this, The Energy Information Administration’s Stephen Nally testified during a Senate Energy and Natural Resources hearing, emphasizing on multiple occasions that any release from the SPR would only provide “temporary” and “short-lived” impacts.
The market began to 'brace for impact' during all of the signaling over the past week. The possible release of oil reserves from top consumers globally dented sentiment and weighed on prices. The general expectation was that much of the US supply release would be in the form of 'loans' that need to be paid back. The market was right as in fact, out of the announced 50 million barrels to be released, 32 million of them are in the form of a loan. Meaning that barrels will be lent to winning bidders now (from 12/16/2021 - 4/30/2022) and required to be returned to the SPR - plus a premium - over a future scheduled time frame (can you blame Biden for wanting to 'capture' a little backwardation?).
Specifically, the details of the 'loan' terms are as follows.
The green highlights above indicate the most likely release schedule, by month, based on the stated Nominal Delivery Rate for each location of SPR reserves. Pay close attention to the far right column in the table above. The loan program will result in between 50k to 357k barrels per day of supply being added between December 16, 2021 and April 30, 2022. This is useful when comparing the OPEC+ production increase schedule of 400k barrels per day through September, 2022. Also of note is the various repayment 'Windows' and repayment 'Premiums' highlighted in various shades of pink above. The black outlines represent the latest date at which loan repayments could restart under each program and still have time to repay the loan in full.
In addition to the loan program, the US also announced it would pull forward 18 million barrels in calendar 2022 mandated sales to 2021 (however, there isn't much 'time' left in 2021).
OPEC's Move
The question now becomes: Will the US-led SPR release lead to a change in OPEC's supply/demand forecast to the point where they adjust their own output accordingly? At face value, that seems logical. But, is it?
Reducing output to accommodate the release of non-OPEC reserves would send some odd signals. On the one had, a reduction in output for OPEC would mean they would have to cede some market share to non-OPEC players while SPR volumes were being delivered. Additionally, it would suggest that OPEC believes in it's long-term supply/demand forecast and it's associated risks enough to back off accordingly. Meaning they don't believe the market needs nor can handle the excess supply (if by 'handle' one means 'prices'). On the other hand, if they decide to stay the course and continue with production increases they risk sending market prices even lower. It seemed the only stabilizing factor in oil markets on the Sunday night re-open was the risk that OPEC+ would counter with lower output. It then seems like a wasted effort overall.
Neither choice appears very favorable. Hopefully we see something more creative out of them next week!
Market Impact
The market has digested all of the above very negatively. Lofty expectations of winter supply shortages quickly fell by the wayside. Is this what we can now expect when the underlying narrative gets too bullish? Are we to believe that we have found the 'magic price level' that leads to government intervention by consuming nations? Curious that large oil producers are now being targeted as greedy price-gougers instead of the price-takers that they are.
The chart below shows the price action in WTI calendar strip futures over the last few years. Note the deviation of the term markets below the $50-$55 range before, during and after the initial shock of the pandemic. The 2020 pandemic selloff pulled term markets well below the long-term range. The re-open recovery rally pulled term markets well above the long-term range. This was largely driven by the expectation that future supply growth might be stunted due to lack of Capex going forward. As a result, the back of the market was more than willing to follow the rally in the front of the market.
At this point, oil markets have lost trust in normal supply/demand analysis. There is a potential price war developing between OPEC+ nations who have been towing the line (since their initial pre-covid mis-step) and countries that want a quick-fix to rising prices.
One of the drivers behind President Biden's SPR release was high gasoline prices. Hoping that a reduction in the price of their raw materials (aka crude oil) will lead to a reduction in output prices (aka, gasoline and other refined products) alone or via increased refinery output. And it's true, outright oil and refined product prices plummeted last week (WTI futures curve shift, left chart below). Equally true is that refining margins weakened (RB/WTI crack spread curve shift, right chart below).
This is curious for a couple of reasons. Normally, lowering input costs in the face of healthy demand results in higher processing margins. This was not the initial market reaction.
Lowering input costs 'should' have increased refining margins. The fact that they didn't either suggests the market hadn't had time to fully digest the news by the close of business on Friday, OR the excess SPR supply was seen as 'more than the market needs' overall.
Remember President Biden's statement over the weekend:
"This week, we launched a major effort to moderate the price of oil — an effort that will span the globe in its reach and ultimately reach your corner gas station. It will take time, but before long you should see the price of gas drop where you fill up your tank."
This statement doesn't seem to have much historical resonance. The one where high prices cure high prices (via demand destruction) and low prices cure low prices (via decreased production). What is the impact of curing high prices with government intervention? We will see.
Bottom Line
There is no denying that the fears of Q1 2022 supply shortages have been dampened by last week's SPR announcement along with the Omicron variant of the Covid virus reaching main street. However, in the game of supply, the decision by OPEC+ this week has the potential to put us right back where we started if they lower or pause their production increases.
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EIA Inventory Recap
Weekly Changes
The EIA reported a total petroleum inventory DRAW of 3.20 for the week ending November 19 2021 (vs a net DRAW of 6.90 last week).
YTD Changes
Year-to-date cumulative changes in inventory for 2021 are DOWN by 151.40 million barrels (vs down 148.2 million last week).
Inventory Levels
Commercial Inventory levels of Crude Oil (ex-SPR) compared to prior years are have gone from way above historical levels to surprisingly below historical levels and should continue to draw as long as backwardation in the market persists.
