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Low Inventory and Volatility

Another Drone Strike on Saudi Arabia Added to the Mix

Author: Brynne Kelly 3/20/2022

On Saturday September 14, 2019 the world awoke to breaking news that fires had erupted after Yemen Houthi rebels carried out a drone attack on the world's largest oil processing facility in Saudi Arabia. State energy producer Saudi Aramco lost about 5.7 million bpd of output after 10 unmanned aerial vehicles struck the world's biggest crude-processing facility in Abqaiq and the kingdom's second-biggest oil field in Khurais. The immediate impact was that WTI futures jumped from the mid-$50's to the low-$60's....

Fast forward to Sunday, March 20 2022. Saudi Arabian energy and water desalination facilities were attacked by Yemen's Iran-aligned Houthis missiles on Saturday night and Sunday morning. Missile strikes hit a petroleum products distribution terminal the Jizan region, a natural gas plant and a Yasref refinery plant in the Red Sea port of Yanbu. There has been a temporary reduction in the refinery at the Yasref facility, but will be compensated for from inventory according to statements from the official Saudi Press Agency.

It seems like 2022 is shaping up to be the year the world drains it's produced oil inventories. In fact, the IEA stated in it's monthly oil market report released on March 16 that January OECD industry stocks are the lowest since April 2014, covering 57.2 days of forward demand. We see evidence of that in US inventory levels. The US Department of Energy said on March 16 that it has awarded contracts for 30 million barrels of crude oil for sale from the country's Strategic Petroleum Reserve, following Russia's invasion of Ukraine. This is the second major release of barrels from the US Strategic Petroleum Reserves in the last 6 months. Last November, the US announced that it would release 50 million barrels from it's SPR as part of a global coordinated inventory release. Those barrels were released between December 16, 2021 and April 30, 2022.

To which, 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." We know how that turned out.....

Adding this second SPR release to the picture and we will see US Strategic oil reserves fall to levels not seen since the early 2000's.

At the moment, US oil inventories are lower than they were at this point in 2014, with production growth estimates out of the EIA suggesting, at best, US oil production will 'recover' to pre-pandemic levels. In its monthly report Friday, the IEA said that global oil markets are in an "emergency situation" that could get worse in the next few months as the potential loss of Russian oil exports "cannot be understated." This is hardly optimistic. Without a decline in demand it will be difficult to grow overall inventory levels from here.

One source of additional supply the market has come to rely on is from OPEC+ production increases. As a reminder, at the 19th OPEC and non-OPEC Ministerial Meeting (ONOMM) held via videoconference on Sunday, 18 July 2021 the group laid out their plan for the remainder of the Declaration of Cooperation (which ends December 2022).

Along with extending the existing agreement through the end of December 2022, in the July 2021 meeting the group provided clarity around two specific details. Specifically, they will:

  • 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 .

Additionally, they affirmed that they will continue to adhere to monthly meetings for the entire duration of the Declaration of Cooperation, to assess market conditions and decide on production level adjustments for the following month, endeavoring to end production adjustments by the end of September 2022, subject to market conditions.

And, in fact, they have stuck to this plan and have been consistently been increasing production by 0.4 mb/d. As it stands now, there are 6 months remaining on the production increase schedule to simply get back to pre-pandemic production levels. After that, it will be up to production growth to lead the way. But can we expect enough production growth to not only supply markets but also to pay back all the inventory that has been borrowed over the last several years?

In 2014, US production was just beginning it's shale revolution. This led to increased US inventory levels in the ensuing years through 2017 when lifting the US export ban finally began to alleviate the inventory backup. Between 2014 and 2020, the US increased it's domestic production by over 5 million barrels per day. And, as we know, the appetite to increase oil drilling and production in the US is not what it was in 2014. Regulatory and financing burdens have changed significantly, meaning that incremental production from here is costlier. Replacement costs have gone up and the supply curve has shifted horizontally left at every price point, aka a structural move thanks to years of underinvestment.

From a trading perspective, it’s becoming more difficult to deal in some of the world’s most important commodities as everything from geopolitical turmoil to exchange snafus prompt traders to rush for the exits, rapidly draining liquidity. Prices of materials like crude, gas, wheat and metals have become alarmingly erratic as a gulf emerges between buyers and sellers who are facing big financing strains. Markets have been roiled on fears about Russia’s invasion of Ukraine constraining commodities flows, though in many cases rallies were quickly followed by a drop in prices.

This volatility is particularly difficult to navigate because some moves appear to defy fundamentals, with hedge funds exiting long-term bullish bets just as supply looks the tightest in years. Combined open interest on main crude and refined product contracts have hit the lowest since 2015. Almost 1 billion barrels of contracts were liquidated in a period that saw Brent post 16 consecutive $5-a-barrel intraday swings — its longest such run ever.


The jump in crude prices and inflationary fallout has prompted leading oil importers to pressure producers to step up output. Over the weekend, Japan urged the United Arab Emirates to increase exports, saying it “would like the UAE to contribute to the stabilization of the global crude oil market”.

With the balance of WTI calendar 2022 futures hovering near $100/bbl (green line below) and inventory levels waning, it's no wonder governments around the world are trying to scrounge up alternatives. Belgium’s government announced it will work to extend the life of two nuclear reactors beyond their original shutdown date of 2025 to secure supply amid record-high energy prices.

One other potential supply gap looming out there comes from within Ukraine itself. Nearly 65% of Ukraine’s total energy demand is covered by domestic production. This high self-sufficiency is explained by nuclear energy production, as Ukraine is the world’s seventh-highest producer (83 terawatt hours [TWh] in 2019). Over half of the country’s electricity is produced with nuclear power. A total of 15 nuclear reactors run at four locations across the country. Many of which have come under Russian control. A loss of any of these units would be devastating to Europe as a whole.

There would be no immediate replacement for this amount of electricity generation. At best, emergency generators run on oil or gas could be set up, but really this would be a disaster were Ukraine to lose access to its nuclear power plants as a result of the Russian invasion.


Calendar spreads across the curve have been in extreme backwardation for some time with risk premiums heavily skewed towards the front of the market relative to the back. We see this in some of the butterfly spreads in the WTI markets (specifically: June/Sep/Dec, left chart below and Dec/June/Dec, right chart below).

As you can see, the premiums placed on front spreads continue to make new highs. Whereas historically this hasn't been the case. Is this a true break in historical patterns or is the market presenting an historical opportunity to sell spreads? Against a backdrop of low inventories, the Russian invasion of Ukraine and potential Middle East tensions, weathering the spikes to the upside in these spreads has been brutal for shorts.


Refining margins have surged since the start of the Russian invasion and are fast approaching their 2014 highs, as fuel prices soar.

With California gas prices topping $5 to $7 per gallon, California State Senator Ben Allen joined with consumer advocates last week to announce new legislation that will require oil refiners to disclose once a month the price they pay for crude oil and the profit margins they make on the gasoline they refine and sell. It's like looking for a needle in a haystack.

HO/WTI Calendar Strips:

RB/WTI Calendar Strips:

Strength in the crack spreads is supportive for crude prices. The higher crack spread encourages refiners to boost their crude purchases to refine the crude into gasoline. Yet, it appears as though governments are looking for villains in this price environment as we see with the legislation proposed by California, which sort of implies that refiners profiting from said market opportunity may be, what? Penalized? No wonder it's getting more and more difficult to find supply of any sort.

Bottom Line

The scale of economic sanctions imposed on Russia are unprecedented. It has been suggested this conflict could be remaking the world order, with Russia choosing territorial hegemony over global trade. Fears over Russia's huge fossil fuels export being interrupted has led to global oil and gas prices spiking. According to the EIA, Russian oil could fall by 2.5 million barrels per day starting from next month. Inventories are being drained and replacements appear hard to come by.


EIA Inventory Recap

Weekly Changes

The EIA reported a total petroleum inventory DRAW of 1.00 for the week ending March 11, 2022.

YTD Changes

YTD total petroleum EIA inventory changes show a DRAW of 13.50 through the week ending March 11, 2022.

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.


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