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EIA Weekly Data: The EIA data on Wednesday July 14th was mostly bearish for crude oil prices as energy product demand declined and US crude production rose again. The headline Commercial Crude Inventories data showed a decline of 7.9Mb on the week (forecast was for a draw of 4.1Mb) to 437.6Mb. The main reason for the decline was the increase in exports of lighter crudes which have little demand from US refineries using heavier crudes. Last week exports rose by 1.397Mb/d or by 9.8Mb on the week. If not for this export increase US Commercial Stocks would have risen. Refinery Utilization fell 0.4% to 91.8% last week (last year was 78.1% and in 2019 was 94.4%). Gasoline Inventories rose by 1.0 and Distillate Fuel inventories rose by 3.7Mb.
US Crude Production growth was the bearish part of the report as the US industry added 100Kb/d last week to 11.4Mb/d of production, up 400Kb/d so far this month, and up 1.7Mb/d from the pandemic low. Over the coming months we see US crude production continuing to lift and getting close to the 12.0Mb/d level. The increase in drilling activity and higher energy company cash flows are causing a growth in reinvestment to stabilize production volumes which were declining for many producers. We expect the vast majority of energy companies to indicate a go-forward strategy of increased drilling activity with production growth in 2H/21 and much more growth in 2022 than in their prior forecasts.
Total Product Demand fell by 2.245Mb/d to 19.3Mb/d. Demand fell below mid-July 2019 when consumption was 20.3Mb/d. Gasoline Demand fell by 760Kb/d to 9.28Mb/d (9.21Mb/d consumed in mid-July 2019). Jet Fuel Consumption rose 186Kb/d to 1.56Mb/d (below the pre-pandemic level of 1.876Mb/d in mid-July 2019). Cushing Inventories fell last week by 1.7Mb to 38.1Mb compared to 48.7Mb last year.
Baker Hughes Rig Data: The data for the week ending July 7th showed the US rig count with a rise of four rigs to 479 rigs (up five rigs last week). Of the 479 US rigs active, 378 were drilling for oil and 101 were focused on natural gas activity. This overall rig count is up 86% from 258 rigs working a year ago. The US oil rig count is up 109% from 181 rigs last year. The natural gas rig count is up only 35% from last year’s 75 rigs.
Canada had a one rig increase (up by 10 rigs in the prior week) to 137 rigs. Canadian activity is now up 5.3x from the low of 26 rigs last year. Of the Canadian increase there was one more oil rig working last week for a total of 88 oil rigs working, up from just six last year. There are 48 rigs working on gas projects now, up from only 20 last year.
The increase in rig activity in both the US and Canada should continue to translate into rising production.
The next OPEC meeting may occur soon as the disputes from the last meeting seem to be getting close to resolution. There were three key issues that were outstanding.
- The Saudis wanted to see an increase of 400Kb/d in each of the remaining five months of the year which would add 2.0Mb/d into the year end. The UAE and Russia wanted to see the increase to be 500Kb/d per month or 2.5Mb/d before year end. Russia is currently producing 100Kb/d over its official quota and wants to raise production materially in the coming months. Russia and the UAE are pressuring OPEC to open the spigots to fill current demand and lower the price so that demand is not destroyed once the summer seasonal demand growth subsides. It looks like a deal for 500Kb/d is likely now that they and the UAE have resolved the base quota level. This will create a glut and pressure crude prices in 2H/21.
- The Saudis wanted to extend the deal to the end of 2022 from the current agreement to end in April 2022. The UAE and Russia had opposed this. It now looks like a deal into the end of 2022 is likely but with more volumes to be added over the additional time.
- The UAE wanted a higher quota level as they have been investing in new productive capacity and felt they were being penalized by those not reinvesting in their energy industry. The UAE produced 2.64Mb/d in June versus 3.1Mb/d in Q4/19 and its capacity of 3.8Mb/d. They are spending US$25B per year so that they can raise their productive capacity to 5.0Mb/d before the end of the decade. It appears according to Bloomberg reports today that the Saudis have agreed to lift the base quota for the UAE to 3.65Mb/d, or near their desired level of 3.8Mb/d, which will add 1.0Mb/d of additional production in the near term.
It appears that the proposed agreement by the Saudis and OPEC+ is a result of the pressure by the US, China and India, as the largest consuming nations, to force the members to an accommodation.
Bearish pressure on crude prices:
- The Delta Covid variant is spreading around the world and more countries are facing more lockdowns as this new variant takes hold and becomes the dominant version. This Delta version has now been found in over 100 countries and with cases rising in 69 of them. Over 4.0M people have died from the Covid pandemic of which the US has exceeded 607K deaths. The biggest single case load increases this week are occurring in Bangladesh, Colombia, Indonesia, Iran, Iraq, Malaysia, Russia, Singapore, South Africa, Tunisia and Zimbabwe. The US is experiencing a rise in caseloads and filling up of hospital ICU beds in States with low vaccination rates and where the young are getting the most severe reactions. Even New York City infections are rising in the unvaccinated.
- Iran is working to return to the 2015 UN nuclear deal and an accord is likely to be completed this month under the auspices of the newly elected President. Iran is cash strapped and their economy is imploding, facing rapidly rising inflation and shortages of food and medicine. It needs a deal if they are going to afford necessary imports.
- Rising crude and product prices may again dampen worldwide demand. Overall the US has an average cost over US$3/gal with many places seeing price spikes to US$5/gal.
- China lowered imports by 3% in Q2/21 as the Chinese government import quotas were shrunk and refineries went into maintenance cycles.
Bullish pressure on crude prices:
- Rising vaccination levels of the adult US population to herd immunity level has lifted summer travel both by air and land. Worldwide demand should rise by 1.5-2.0Mb/d during the summer travel months. This demand increase should last into early September and then we should see a seasonal slowdown of 1.5-2.0Mb/d of consumption and an inventory build to meet winter peak demand.
- Weather impacts (hurricane season has started early) may necessitate shutting in some of the offshore Gulf of Mexico offshore production.
- 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 are now at US$3.65/mcf. AECO prices are at C$3.64/mcf.
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 having picked 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, US production growth and Iran adding 1Mb/d+ beginning sometime in August (once a new nuclear deal is concluded and sanctions removed), the additional product will be in excess of current demand and will build global inventories. This would endanger the OPEC bullish scenario for crude prices.
WTI crude oil prices have fallen today by US$1.95/b to US$73.30/b and down US$3/b over the last week due to the EIA report and the likely revised OPEC deal. A decline below US$67/b for WTI should start the corrective phase we have been forecasting. The current enthusiasm by speculative forces including hedge fund futures traders, appears to be like that seen in late 2018 just before OPEC entered another market share war. That’s when crude oil prices were at 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 3-4Mb/d less and OPEC is ramping up production while still having nearly 9Mb/d of spare capacity.
Energy Stock Market: The S&P/TSX Energy Index trades currently at 133 (down 12 points from 145 in mid-June or down so far by over 8%). A close below 132 should initiate the next sharp decline. An initial downside target after such a breach is down to the 111 area. The current stock market weakness is likely an additional catalyst for the energy sector to lose its current momentum and back off meaningfully. A revised OPEC deal with more production, Iran launching a large increase in volumes once sanctions are removed, and rising US production are all likely to drive WTI crude below US$60/b and energy related stocks should fall sharply. August could be a very nasty month for the sector.
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