Schachter’s Eye on Energy: Massive Inventory Build Trumps OPEC+ Deal

Each week Josef Schachter will give you his insights into global events, price forecasts and the fundamentals of the energy sector. Josef offers a twice monthly Black Gold newsletter covering the general energy market and 31 energy and energy service companies with regular updates. He holds quarterly subscriber webinars and provides Action BUY and SELL Alerts for paid subscribers. Learn more and subscribe. 

OPEC+ Non-Deal: OPEC’s various meetings last week to formalize an agreement to cut a total of 20Mb/d to balance supply and demand and to raise crude prices has failed. They came up with a near 10M+b/d cutback and were working with the G20 to cut another 5Mb/d, and with the US production decline, see a total cut of 20Mb/d. They hoped this would result in firming the crude oil price over US$40/b for Brent. This has not materialized. OPEC had an issue of when the cuts would start and after wrangling over using actual April 2020 data from which the Saudi’s had lifted production from 9.7Mb/d to 12.3Mb/d, they finally decided to go back to October 2018 levels. Then the Saudi’s were producing 10.6Mb/d and Russia 11.5Mb/d (including 600Kb/d of condensate). The new deal goes from the October 2018 levels and removes Russian condensate from the quota numbers. So the proposed cut for the Saudi’s of 4.0Mb/d, from their 12.3Mb/d production level in April is really only down to 8.3Mb/d in May. This turns their cut into a real decrease of 2.3Mb/d (10.6Mb/d down to 8.3Mb/d). Russia supposedly cut back by 2Mb/d to 9.5Mb/d but this now allows them to also sell 600Kb/d+ of condensate on top of this for overall liquids sales of 10.1Mb/d (a real cut of only 1.4Mb/d). 

The same magical smoke and mirrors was done across the OPEC member board to get to the announced successful non-deal. Mexico was mandated to cut 400Kb/d and was finally only required to cut 100Kb/d, as the US declines in production of 800Kb/d from its 2020 high of 13.1Mb/d, was used to stop-gap Mexico’s additional cutback. So they have a deal which in the end cuts less than 6Mb/d of real barrels from OPEC, as well as up to 4Mb from non-OPEC (G20). With demand down by over 30Mb/d during March and April so far, the inventory glut continues and we will see storage fill in the coming weeks and crude oil prices will decline even further once storage is full up. 

The official OPEC cuts of 9.7Mb/d are for May and June 2020 and then they reduce to 7.7Mb/d from July to December 2020 and then to 5.8Mb/d from January 2021 to April 2022. This later amount of 5.8Mb/d of cutbacks if real and if held and there is no cheating, will be the window for crude prices to move back over the 2020 high of US$65.65/b.

EIA Weekly Data: Wednesday’s (April 15th) EIA data was again horrible with an overall commercial stock increase of 19.2Mb (versus last week’s rise of 15.2Mb and a forecast of 11.7Mb). The large build was due to a fall in demand of 4.4% or down by 640Kb/d to 13.8Mb/d as quarantining expanded across the US. Gasoline inventories rose by 4.9Mb. Worst hit was jet fuel usage which fell 39% or 463Kb/d from 755Kb/d in the prior week as more flights were cancelled. Since March 13th total product demand in the US has fallen by 8.1Mb/d or by 37%, from 21.9Mb/d to this week’s report of 13.8Mb/d. With quarantining continuing across the US we may see US demand fall to below 11.0Mb/d in the next few weeks. This would be a fall of 50% from the start of March. If the US is 20% of world demand of 100Mb/d, prior to the Covid-19 pandemic start, then overall world demand decline could be 5x the 8.1Mb/d  US decline or by 32Mb/d, just in the last two months. Any cutback by OPEC of 9.7Mb/d or 6.0Mb/d of real barrels won’t put a dent in the build as demand falls by 5x the real cut and once storage is full then game over! More cutbacks (and these must be real cutbacks) will be required until we see economies reopen and the virus under control. President Trump may be optimistically looking at a staged reopening starting in early May in parts of the US and it is likely from Prime Minister Trudeau that late May is likely the window for Canada to reopen. Parts of Europe are now trying to reopen in small tranches but they are watching to see if Covid cases pick up and they will reverse the openings. 

Overall crude stocks in the US rose by a whopping 27.2Mb on the week. US domestic production fell by 100Kb/d to 12.3Mb/d and is now down 800Kb/d from the peak at 13.1Mb/d. With massive budget cuts coming across the energy sector and rapid shale depletion it is likely US production could fall to 10.0Mb/d or lower, possibly by Q3/20, if crude prices stay below US$30/b for another month or so. Many oil companies are now shutting in high cost oil and low volume wells are the earliest ones to be shut-in. With demand faltering, refinery utilization fell from 75.6% last week to 69.1% this week. This compares to last year at this time of 87.7%. Storage is filling up in the US with Cushing seeing a build of 5.8Mb or by 12% to 55.0Mb. There may only be 15-20Mb left in this main storage hub. Exports rose by 603Kb/d or by 4.2Mb, on the week or storage would have risen more.

Baker Hughes Rig Data: Last week Friday the Baker Hughes rig survey showed a decline in the US rig count of 62 rigs to 602 rigs and down 41% from 1,022 rigs working a year ago. The Permian felt the largest loss with a rig loss of 35 rigs or down by 32% from a year earlier. We expect the US rig count to fall to 400 or less in the next month or so. With high depletion for new wells this supports the view that the US production could fall to 10.0Mb/d in Q3/20. Canada had a decline with 6 rigs ending work, and the count now is at 35 rigs working down 40% from 66 a year ago. With WCS below transportation costs, it is likely that 500Kb/d has been shut in already in Canada during Q2/20 and maybe a total of 1.0-1.4Mb/d before the end of Q3/20, if prices for WCS remain below operating and transportation costs. Breakup is coming and the rig count may be the lowest on record for the next few months.

Conclusion: Investors had been hopeful that OPEC would come up with a great cutback plan that lifts crude prices back over US$50/b for WTI and over US$55/b for Brent. This has not happened. The Saudi’s started this with a game plan to drive out high cost production around the world and they have signed up most of the large crude carrier fleet to move the inventory overhang to the consuming nations. The Saudi’s know there will be no real cutback by the Russians even though they agreed to past deals, but have failed to comply with prior deals. The Saudi’s started this price war and they are now pricing oil for Asian markets very low to regain market share lost to Russia. Prices to the US have been raised to ally President Trump’s ire and have priced Saudi crude out of the US market. 

WTI this week fell to US$19.56/b down nearly 20% from US$24.42/b last week. Our target remains below the low of US$19.48/b during March 30th, likely to the US$17-18/b level for WTI and the timeline is the coming weeks. The S&P TSX Energy index now at 59.75 is down 8% from 65 last week. We see it falling to the 32-36 level in the upcoming weeks as crude falls into the range of US$17-19/b. The recent bear market short covering rally over the last three weeks of 75% is now spent at the high of 69 and we see it falling over the coming weeks by around 50%. The short covering rally that took the S&P Energy Bullish Percent Index from 0% on March 9th to 92% last week is rolling over. We expect to see it fall below 5% again, as the overall stock markets plunge. One further negative for the sector is the overwhelming bullishness now by commodity speculators who as of last week were long 473Mb (up from 428Mb the prior week) while commercials (refiners and other crude users) were short 518Mb (up from 480Mb the prior week). Normally at true bottoms speculators have gone to minimal long positions or to being short and commercials see the cheap prices and move to net long. 

We got a BUY signal from the Energy Bullish Percent Index on March 13th and added eight new ideas to our Action Alert BUY list. We expect to see another below 5% BUY signal in the coming weeks as crude falls and the Dow Jones Industrials Index plunges below 18,000 (now 23,340). The overall stock market plunge will be likely as poor Q1/20 earnings, poor outlooks by companies, and slow arrival of stimulus funds all weigh on the stock markets. The longer the delay in getting adequate testing kits and the longer the delay in reopening the economy the lower the markets may go. 

We intend to send out an Action Alert to subscribers when the next BUY signal occurs and also send out Action Alert TOP PICKS recommendations on the best of the best ideas at that time. We expect to see this over the next month or so. 

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