Schachter’s Eye on Energy: The Market Is Focused On The OPEC Production Meeting. How Large A Production Increase Will Be Approved Will Depend On Their View On Iran’s Sanction Relief.

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 30 energy, energy service and pipeline & infrastructure companies with regular updates. We hold quarterly subscriber webinars and provide Action BUY and SELL Alerts for paid subscribers. Learn more. 

EIA Weekly Data: The EIA data on Wednesday June 30th was supportive of crude oil prices. The headline Commercial Crude Inventories data was bullish for crude as it fell 6.7Mb on the week (forecast was for a draw of 4.7Mb) to 452.3Mb. The reason for the miss was that Net Imports fell by 602Kb/d or by 4.2Mb on the week. Refinery Utilization rose 0.7% to 92.9% last week (last year was 75.5% and in 2019 was 94.2%). With the increase in refinery activity Gasoline Inventories rose by 1.5Mb.  

US Crude Production was steady at 11.1Mb/d last week. Over the coming months we see US crude production lifting to 11.5-12.0Mb/d as the increase in drilling activity and higher energy company cash flows are reinvested to stabilize production volumes which are still declining for many producers. Many companies are now talking about lifting their production guidance for the second half of this year. 

Total Product Demand rose by 152Kb/d to 20.9Mb/d. Demand now exceeds that of late June 2019 when consumption was 20.76Mb/d. Gasoline Demand dropped by 267Kb/d to 9.17Mb/d (9.49Mb/d consumed in late June 2019). Jet Fuel Consumption also fell with a decline of 149Kb/d to 1.43Mb/d (1.86Mb/d in late June 2019). Cushing Inventories fell last week by 1.4Mb to 40.3Mb compared to 45.6Mb last year.

Baker Hughes Rig Data: The data for the week ending June 25th showed the US rig count flat at 470 rigs (up nine rigs in the prior week). Of the 470 US rigs active, 372 were drilling for oil and 98 were focused on natural gas activity. This overall rig count is up 77% from 265 rigs working a year ago. 

Canada had a nine rig increase (up by 24 rigs in the prior week) to 126 rigs. Canadian activity is now up 9.7x from the low of 13 rigs last year. Of the Canadian increase there were eight more oil rigs working last week, for a total of 82 oil rigs working, up from just four last year. There are 44 rigs working on gas projects now, up from only nine last year. 

The increase in rig activity in both the US and Canada should continue to translate into rising production. Energy service stocks have recovered significantly from this activity recovery.

Conclusion:

In July, OPEC plans to lift production by 840Kb/d. OPEC’s meeting tomorrow will determine the increase planned for August. An agreement for an increase of 500Kb/d is expected but Russia is pushing for an increase of up to 1.0Mb/d. The final number to be decided will depend upon the timeline for a nuclear deal with Iran, with sanctions ending against their energy industry, and when they can bring back shut in production. It is now expected that a deal will be completed in July and Iran could increase production sometime in August. Iran has over 200Mb in storage waiting to be sold. Of this 80Mb is in floating storage offshore their probable customers. They want to quickly lift production to 4.0Mb/d from the 2.46Mb/d they produced in May 2021.

Bearish pressure on crude prices:

1. The new Covid variant ‘Delta” is spreading around the world and is replacing the prior B.1.1.7 variant. Now more than 50% of new cases are of this variant. It is also hitting more young people under 12 years of age. New lockdowns or restrictions have been imposed in the UK, Australia (nearly half of the country), Israel and Portugal. Spain  and Portugal have imposed travel restrictions on unvaccinated Britons on Monday which will hurt their recovering tourist industry. 
2. This Delta version has been found in over 60 countries including the US (49 of the 50 States) and Canada. Over 3.93M people have died from the pandemic of which the US has exceeded 604K deaths. The biggest single case load increases are occurring in Bangladesh, Brazil, Colombia, Oman and Zambia. 
3. Iran is in the final stage of talks to return to the 2015 UN nuclear deal and an accord is likely to be completed in July (the seventh and likely final round). Significant progress has been made and 1,040 sanctions on issues such as insurance, oil and shipping have been agreed to. China and India are expected to be the biggest buyers of this new crude supply. The US has signalled that things are progressing as they lifted sanctions on more than a dozen Iranian officials and energy firms. 
4. Rising crude and product prices may dampen worldwide demand. Overall the US is seeing an average of over US$3/gal with some places seeing price spikes to US$5/gal. Other gasoline stations have no supply availability and have closed. 

Bullish pressure on crude prices:

1. Rising vaccination levels of the adult population in the US to herd immunity level of 70% during July, is expected to provide a return to normal summer holidaying and energy consumption, as well as in Canada and the EU. Demand should rise by 1.5-2.0Mb/d during the summer travel months. 
2. Weather impacts (hurricane season) have started in the Gulf of Mexico which may necessitate shutting in some of the offshore production. 
3. High temperatures, crippling droughts and heatwaves across the US and Canada are cranking up demand for air conditioning and natural gas is a beneficiary of this increase in electricity demand. NYMEX natural gas prices have lifted to US$3.62/mcf. AECO prices are a marvelous C$4.10/mcf. 
4. There has been a lift in crude prices in the last few weeks as some commentators have said that the Iran deal may come much later than the August forecast as talks drag on.

CONCLUSION: We remain skeptical of the optimism about the projected 4-5Mb/d full recovery in energy demand to 100Mb/d before year-end. The tug of war between the normal summer holiday travel demand pick-up and the 3-4Mb/d increase in crude oil supplies this year remains the key determinant of future energy consumption and crude oil prices. We see demand picking up by around 2Mb/d before year-end which is less than the amount of production that will be brought on by OPEC (ex-Iran) alone. Between some OPEC cheating and Iran adding 1Mb/d+ beginning in August (if a deal is concluded), the additional product will be in excess of current demand and will build inventories. This would endanger the OPEC bullish scenario for crude prices.

WTI crude oil prices rose recently to US$74.45/b (highest since October 2018 – today US$73.22/b) and are now quite overbought. A decline below US$67/b should start the corrective phase we have been forecasting. The current enthusiasm by hedge fund futures traders and now MEME speculators for the sector, appears to be like that seen in late 2018. That’s when crude oil prices rose to US$76.90/b in September and three months later, had declined to US$42.36/b, down by 45%. The price of crude now is above the pre-pandemic price of early 2020, yet demand is 4-5Mb/d less and OPEC is ramping up production while still having over 8Mb/d of spare capacity. The current price level for crude does not make sense! It should be trading in the US$50/b area.

Energy Stock Market: The S&P/TSX Energy Index trades currently at 139 (down from 143 last week). A close below 132 should initiate the next sharp decline. An initial downside target after such a breach is down to the 100 area. General stock market weakness would be the catalyst for the energy sector to lose its current momentum and back off meaningfully.

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