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Oil Producer Report

Crude Oil Trading Report: Growing producer queue to hedge

By February 8, 2019No Comments

Brent has been stuck in a compressed $60-63/bbl range since its rally from the late December abyss, historically a reliable indicator that a pop in volatility awaits. 

The narrow range is counterintuitive given the multitude of macro and oil-specific variables. However, consumers are buyers at $60/bbl Brent, while a wall of producer selling sits above, putting a floor and cap on prices.

Producers are lined-up and view a potential bounce in oil prices as an opportunity to sell. The queue grows with every passing week. Nothing short of a substantial catalyst is needed for Brent to break to the key technical level of $71.5 – $72.5/bbl. A foreign policy mis-step aimed at swapping Iranian for Venezuelan barrels could be just the failed outcome needed as a catalyst …

The supply side narrative remains constructive, while consensus demand growth expectations for 2019 remain, in our view, completely unrealistic. That being said, the usual barrel-counting feels absurd to us. The market seems to be sleepwalking while there are major game-changers developing given geopolitics and macro-economic stresses ahead.

*Contact us for detailed analysis on CTC’s Brent-linked hedging survey

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SUPPLY IMPROVEMENT

On the supply side, things arguably have improved: 1Q 2019 was always expected to be the weakest quarter with S/D balances building to the order of 0.5 to 1.0 mil bpd (dependent on OPEC compliance to announced cuts).

Refinery maintenance is indeed high again this year – with ~ 4mil bpd in Jan, at least 5 mil bpd in Feb and ~6.5 mil bpd in March of CDU capacity expected offline.

Libya, which had managed to push its production to ~ 1.1 mil bpd for several consecutive months, has its major El Sharara field closed since 9th Dec as tensions between UN-backed Tripoli forces and factions intensified.  That’s 315 kbpd out. As we write, UN-backed forces are regaining control but expectations that the field quickly resumes to full capacity is premature given the protests and history of outages.

Saudi has led the OPEC+ cuts, down ~800 kbpd from Nov highs. This has been factored in the market for several weeks.  They aim to increase spending and handouts, which are mathematically impossible without a massive fiscal deficit under current oil prices.  Saudi will need a Brent equivalent of $71+/bbl. Some analysis point to $80/bbl, which seems more accurate to us.

For now, Brent is in the low $60s/bbl and OPEC exports are down. The latest data from cargo-tracking company Kpler, shows OPEC exports down by over 1.3 mil bpd in January, at 24.52 mil bpd – the lowest since 2015.

OPEC EXPORTS - MONTHLY BY COUNTRY | SOURCE: KPLER

OPEC EXPORTS – MONTHLY BY COUNTRY | SOURCE: KPLER

GLOBAL OIL-ON-WATER DOWN

Lower OPEC production is having an impact on global oil. A look at both oil-in-transit and floating storage, shows levels are coming down from the December highs and back towards the early October level, implying that ~ 60 mil barrels have been sponged up. The surge higher in the trend has been halted, at least as it stands since January.

OIL ON WATER - IN-TRANSIT + FLOATING STORAGE | SOURCE: KPLER

OIL ON WATER – IN-TRANSIT + FLOATING STORAGE | SOURCE: KPLER

VENEZUELA – OUTCOME WILL DICTATE WHAT HAPPENS WITH IRAN WAIVERS

The US has imposed sanctions on Venezuela in an effort to push Maduro into capitulation and hand over power to Juan Guaido. The immediate impact on the oil market has been a narrowing of the light/heavy differential. Iran and Venezuela sanctions in combination with OPEC, Canadian production cuts and growing US shale production has created a tightness of heavy barrels versus a glut of light barrels.

Ultimately, the consequence of US sanctions on Venezuela production and oil prices depends on how long the power struggle takes to play out. A quick transition could be bearish for oil prices. Venezuela generates 90% of its revenues from oil exports. A quick win for any new government would be to boost  oil production and exports.  Venezuela could quickly increase production to 2.0mb/d after years of under-investment and neglect, by our estimates. Growth, thereafter, would take time and considerable reinvestment.

 

The US policy goal in Venezuela is regime change, and in relatively short order. Existing waivers on sanctioned Iran oil production are due for renewal in April/May. Rising Venezuela production would allow the US to back a “zero oil export policy” on Iran. In broad terms, Iran barrels would be replaced by like-for-like Venezuela barrels.

The bull case, therefore, assumes a drawn out regime change in Venezuela that coincides with the non-renewal of waivers on Iran. Sanctions on both Venezuela and Iran would strain OPEC spare capacity and likely lead to a geo-political premium in the market.

The US could use the SPR to dampen any immediate impact on oil markets. Adding light-to-medium barrels to the market would overhang benchmark crudes such as WTI and Brent, which would likely trickle down to lower pump prices, a priority of the Trump administration.

VENEZUELA EXPORTS DOWN & HEAVY BARRELS ARE BID UP | SOURCE: BLOOMBERG

VENEZUELA EXPORTS DOWN & HEAVY BARRELS ARE BID UP | SOURCE: BLOOMBERG

DEMAND EXPECTATIONS WILL DISAPPOINT

Consensus 2019 demand growth estimates – when averaging EIA, IEA & OPEC data – forecast 1.4 mil bpd.  Revisions lower are inevitable (possibly by 300 kbpd).

  • The US had ~450 kbpd demand growth in 2018, this was mostly on the back of “Trump tax cuts” and boost to US GDP in 1H 2018. Democrats now control the house, we see no tax relief in 2019 but rather legislative gridlocks and political battles just when the FED is “wobbly” on policy and sending mix messages to the market. Our readers need to think about those implications.
  • Polarization of politics to affect market in 2019: The EU looks to be undergoing a socio-economic upheaval. “Strong men” are elected, Brexit clouds, “gilets jaunes” movement, Italy’s debt and 4-consectutive months of declining German industrial output – it is hard to see this region as a pocket for demand growth.

 

  • China: We monitor electricity consumption and earnings from companies such as Caterpillar (CAT) as a bellwether for EM growth and specifically machinery sales in China. In-short, either China is slowing down fast or US-Trade war is having a notable negative impact.

Either way, given ~80% of oil demand growth comes from trucking/diesel consumption in China + India, expectations from that region are at risk to say the least.

Latest China crude import increases appear to be front-end loading ahead of the Lunar New Year and a response to the allocated export quotas rather than a sign of demand surging from end-users.  It is in essence, borrowed demand from 2Q 2019 (and explains Chinese bid for N. Sea and W. African grades recently).

2018 OIL DEMAND GROWTH DOMINATED BY US & CHINA | SOURCE MORGAN STANLEY

2018 OIL DEMAND GROWTH DOMINATED BY US & CHINA | SOURCE MORGAN STANLEY

WHAT WE ARE WATCHING

In oil we can point to major outages from “barrels at risk” regions such as Libya, Venezuela, Nigeria, Angola, KRG pipeline and updates on Kuwait neutral zone restart. These will need to be monitored. We can be sure, geopolitics will dominate, now in LATAM and also in the Middle East.

But our readers must be certain that 300 kbpd here and there is not going to dictate flat price direction when there are such “monster” macro events brewing. If the S&P500 retests the Dec lows, oil will trade $50/bbl or below.

Last year, the bulk of demand growth (70%+) came from two countries only: The US and China.  It is quasi-guaranteed that this will not repeat in 2019 and also makes US-China trade wars by far the most important variable to watch for oil.

In summary, a highly charged geopolitical environment, unpredictable policies from the US, protectionism and the onset of a significant sulphur spec change from the International Maritime Organization (IMO), makes the outlook for the oil market set to be choppy.

Hedging for producers will play an important role in managing volatility and in our view, will be a key performance differentiator amongst peers.

 


We provide unbiased market, derivative & risk-management advice. Contact us to discuss further implications and optimal hedging strategies contact@comtradingcorp.com

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