THE above chart shows the extent to which this year's
oil-price rally has been led by futures markets. What is significant, though,
is that futures activity seems to have plateaued.
Sure, futures activity could easily go the other way again, driving prices significantly above the $50/bbl level. But barring a decision by the US Federal Reserve to once again step away from interest rate rises and China further loosening the credit tap, it is hard to see why the speculators would want to go deeper into bull territory. The market remains heavily distorted by the speculators, and so first and foremost you must analyse futures activity before you then look at physical supply.
Right now, I would argue that the Fed looks set on raising interest rates again in June or July. And in China, credit growth contracted again in April. I believe this indicates that economic reforms are gathering pace again.
As for the real supply and demand of oil, you should have been asking yourselves two questions throughout this rally: Shortages? What Shortages?
I'll deal with the Fed, China, and today' crude supply position in more detail later on. First of all, though, here is some historical context behind the role that financial markets have played in determining the oil price over the last seven years.
China, Jobs and Economic Stimulus
I believe that that the 2009-2014 rally in crude prices was driven by the fall in the value of the US dollar, thanks to the Fed's ultra-low interest rate policies. This forced hedge funds and pension funds etc. to seek an alternative 'store of value'. This store of value was oil and other commodities.
What seemed to justify this alternative store of value was China's parallel decision to conduct the biggest economic stimulus programme in global economic history, which cushioned the country from the impact of the Global Financial Crisis. It was all about preserving jobs for the Chinese leadership of the time. They didn't care about anything else, including the long term fundamentals of supply and demand as overinvestment poured into manufacturing and real estate. To give you an idea of the scale of what I am talking about, China increased lending by $10 trillion in 2009, when its nominal GDP was only $5 trillion. Lending was an astonishing $18 trillion higher by 2013.The long term economic benefits of this extraordinary rise in credit didn't worry the financial speculators. Of course not. It is not their job be worried about the long term. But other people who should have known better, including CEOs of some chemicals companies, who started talking about a 'new paradigm' of a rising middle class in China who would very soon be as rich as the middle classes in the West. This not only justified and underpinned the rallies in oil and commodity prices - but crucially also added further momentum to the rallies.
As this paradigm became the new consensus, the shale-oil industry took off in the US - aided also by the availability of cheap financing thanks to the Fed's interest-rate policies. Petrochemicals projects in the US, and elsewhere, were also sanctioned on the theory that China - and emerging markets growth in general - had entered this new paradigm.
It all went very badly wrong from September 2014, when it became apparent that Chinese economic stimulus had, after all, been unsustainable. Crude markets belatedly woke up to the notion that China's stimulus had left behind vast domestic oversupply in manufacturing and real, estate, and so a serious bad debt problem. The scale of China's environment crisis, made much worse by this overinvestment, was also recognised.
What made people wake up to these long-standing realities was that China's new political leaders admitted the scale of the problems - and, more importantly, they reversed course. They started reducing credit growth, and so the Chinese bubble began to dramatically deflate. Credit growth began to decline from January 2014. And here is another extraordinary number: In 2015, growth in credit was no less than $4 trillion lower than in 2014.
Back To The Future: Q1 2016
After the January 2016 collapse in oil prices and equity markets, the US Federal Reserve got cold feet. It began to back away from further interest rate rises, on the belief that weak crude and equities etc. meant that US economy was in too perilous a condition to take that risk. This was the signal sent to the oil speculators: The dollar was going to be weaker for longer than they had expected, and so it was time to get back into crude as an alternative store of value. This also led to recovery in other commodity markets, including iron ore.
What once again added further momentum to the rally was China's decision to loosen credit, which grewby some 58% in Q1 over the first quarter of 2015. The detail didn't matter here. All that mattered to the crude-market speculators was the wider belief that China had, somehow, turned the corner. The renewed economic stimulus created the erroneous idea that China could spend its way out of trouble.
Now, though, thanks to stronger US GDP growth and continued robust jobs growth, Fed chairman Janet Yellen has indicated that two to three interest rate rises could, be on the cards later this year - with the first hike possibly in June or July.
And in China, credit growth fell in April. Total social financing plunged to 751 billion yuan during month compared with 2.34 trillion yuan in March.
Any sensible analyst would have told you that China's Q1 rise in lending was unsustainable - and that, of course, it was a drop in the ocean compared with the $4 trillion of credit withdrawn from the economy in 2015.
What told you it was unsustainable was that this represented another example of a victory for the short-term thinkers who in China, who prefer to prop-up immediate growth rather than deal with the longer-term issues. But you also had to bet that the reformers would reassert control - and, indeed, this has happened. In this particular instance, local governments temporarily gained the upper hand because of their struggle to cover their liabilities.
The end result - and may have already seen early signs of this in the above chart - could well be speculators switching back to the US dollar, as is strengthens - away from their alternative stores of value.
Actual Supply And Demand of Oil Itself
Last is not meant to be least. Of course, this matters. But in all the noise created by the speculators, the sound made by the data on physical production, storage and demand can sometimes be impossible to hear.
Take last year's oil-price rally as an example. Remember how we kept being told that the US rig count was falling? This took Brent from $45.19/bbl in mid-January to $69.63/bbl on 8 May.
Meanwhile, US shale oil producers continued to push the innovation envelope on cost reductions. Each rig in operation had also become much more productive. The practice of 'fracklogging' - storing oil in rocks ready to be fracked when prices recovered - also increased. And thanks to stronger futures prices, the shale oil industry was able to take out new hedges. This put them in the position to be able to sell at lower prices in the physical market because they had locked higher futures returns. Saudi Arabia also stuck with its market share strategy, whilst the global economy remained weak. This all led to the fall in oil prices during H2 2015.
The physical justification for today's rally is on even more shaky ground.
We were first told that there would be a production freeze agreement at the April Doha meeting. I never believed that this on the cards - and, of course, it didn't happen.
We did then, however, see a dramatic decline in production as a result of wild fires in Canada, attacks on Nigerian pipelines and more upheavals in Iraq. But I think that this was seized upon by markets whilst they overlooked some signs of long supply elsewhere. And, of course, this decline could well prove to be temporary.
Signs of long supply elsewhere includes oil in storage. Global oil stockpiles, including floating storage, have increased for the last ten consecutive quarters, according to this Hellenic Shipping News article, which adds:
It is estimated that almost 9% of the global VLCC fleet is currently booked for floating storage, which is a 40% increase in tankers by number since December. Reuters reported that at least 40 laden VLCCs anchored off Singapore as floating storage, storing estimated volumes of up to 47.7m bbl, thought to be the highest level in at least five years.
Crucially, also the contango is narrowing. Last week, the one-month arbitrage on Brent in floating storage was -$0.48/bbl, while the 12-month arbitrage was at -$6.11/bbl, implying there was no profit incentive to store oil on ship. Storage costs are a minimum of $0.74/bbl, and so there has to be a risk of destocking.
Iran is also raising production. By the summer its exports are expected to rise a further 200,000 bbl/day to reach 2.2m bbl/day the middle of this summer.
And nobody should be surprised over reports that the US rig count has stopped declining, with early signs that the rig count may actually increase.The US is the world's new 'swing producer'. The inventory of drilled but uncompleted US wells has been building, driven by companies with contracted drilling services. Ccompanies have merely postponed, rather than cancelled, completion of wells. This could add 400,000 bbl/day to supply.
Let's not forget yesterday's OPEC meeting. There was again, of course, no agreement to freeze, never mind cut, production.
As for demand, the summer lull season in the northern hemisphere, when many people take their holidays, is set to occur in August and July.
If this market turns, those who want to short oil have plenty of physical ammunition to support their positions.
John Richardson from ICIS
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After the OPEC+ club met on September 1st, and confirmed that it would be sticking to its plan of increasing its crude supply by 400,000 b/d a month through December, China made a rather unusual announcement. It announced that it was going to release some crude oil from its strategic petroleum reserves, selling it to domestic refiners that were grappling with crude’s heady price rise over 2021. The release of strategic oil reserves isn’t news in itself. What is news is that the usually secretive China did it and did it publicly.
And it did it to send a message to OPEC+: attempts to create artificial scarcity to maintain crude prices will not be tolerated. China has a right to feel that way. Even though great strides have been made to ease the effects of the Covid-19 pandemic worldwide, the virus is still exerting major effects on the global economy. Not least a massive ripple through the health of global supply chains that has seen the price of almost everything – plastics, semiconductors, agricultural commodity, lumber, steel – spike due to supply issues. In some cases, the prices of raw materials are at historic highs. Crude oil is still nowhere near its peak of above US$100/b, but it is high enough to be concerning, especially since it is happening within a major inflationary environment. And for a manufacturing-heavy economy like China, that matters. That matters a lot. So China’s National Food and Strategic Reserves announced that it would be releasing some of the country’s crude stocks to ‘better stabilise domestic market supply and demand, and effectively guarantee the country’s energy security’, a month after the country’s producer price inflation – ie. the cost of manufacturing – hit a 13-year high.
China made good on that promise, releasing 7.38 million barrels from its stockpile to domestic bidders on September 24 with more tranches expected. This was the first ever recorded release from China’s Strategic Petroleum Reserves (SPR), which began back in 2009 in serendipitous response to crude oil prices exceeding the US$100/b mark for the first time in 2008. But curiously, it may not have been the first ever release. So secretive is the SPR that China does not reveal the size of the reserve, although analysts have estimated it at some 300-400 million barrels with total capacity of 500 million barrels using satellite imaging. It has been speculated that batches of crude from the SPR have been released before on the quiet. But this is the first time China has gone public. Compared to the country’s overall oil consumption, 7.38 million barrels is small, almost tiny. And even if additional supplies are released, it will not make a major impact on China’s oil balances. But the message is what is important.
It is a message that China is not alone in sending. US President Joe Biden has already called on OPEC+ to accelerate its supply easing plans, given indications that the crude glut built up over 2020 has been all but erased. It is a notion that would be supported by some OPEC+ members – Russia, Mexico, the UAE – but so far, the discipline advocated by Saudi Arabia has held. The US too has attempted to release of its own crude reserve stocks – the largest in the world with a capacity of 727 million barrels – but this was also in response to the devastating impact of Hurricane Ida. India, China’s closest analogue to size and stage, has been complaining too. As a major oil importer and with a shakier economic situation, India is particularly sensitive to oil price swings. US$70/b is way above what New Delhi is comfortable with. But since India’s appeals to OPEC+ have fallen on deaf ears, it is attempting domestic directives instead. India’s state refiners have been ordered to reduce crude purchases from the Middle East, but with supply tight, there aren’t many other people to buy from. India has also been selling oil from its strategic reserve – officially stated to be for clearing space to lease storage capacity to refiners – although since India is more transparent about these announcements, the announcement isn’t as surprising.
Will it work? At least immediately, no. Crude prices did come under pressure in the wake of China’s announcement, but then recovered with Brent hitting US$75/b. But the fact that China timed the announcement of the September 24 auction to coincide with peak global trading time and with a lot of details (again an unusual move) shows that Beijing is serious about wielding its strategic reserves as weapons. If not to moderate crude prices, then to at least stabilise it. But this is a war of attrition. China may very well have a planned schedule to release more crude reserves over 2021 and 2022 if prices remain high, but its supplies are finite. And they will have to eventually be replenished, possibly at an even higher cost if the attempt to quell crude price inflation fails. Thus far, the details of the SPR release hint that this is a tentative dip in the pool: the volume of 7.38 million barrels was far lower than the 35-70 million barrels predicted by some market participants. And because successful bidders can lift the oil up to December 10, it seems unlikely that a second auction for 2021 is in concrete plans at this point.
But, at the very least, the message has been sent. Beijing has a tool that it can wield if crude prices get out of hand, and it is not afraid to use it. The first step might have been small, and it is a giant leap in what mechanics are available to influence crude prices. And as history has proven, China can be very quick to scale up and very single-minded in its approach. Over to you, OPEC+.
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In 2021, the makeup of renewables has also changed drastically. Technologies such as solar and wind are no longer novel, as is the idea of blending vegetable oils into road fuels or switching to electric-based vehicles. Such ideas are now entrenched and are not considered enough to shift the world into a carbon neutral future. The new wave of renewables focus on converting by-products from other carbon-intensive industries into usable fuels. Research into such technologies has been pioneered in universities and start-ups over the past two decades, but the impetus of global climate goals is now seeing an incredible amount of money being poured into them as oil & gas giants seek to rebalance their portfolios away from pure hydrocarbons with a goal of balancing their total carbon emissions in aggregate to zero.
Traditionally, the European players have led this drive. Which is unsurprising, since the EU has been the most driven in this acceleration. But even the US giants are following suit. In the past year, Chevron has poured an incredible amount of cash and effort in pioneering renewables. Its motives might be less than altruistic, shareholders across America have been particularly vocal about driving this transformation but the net results will be positive for all.
Chevron’s recent efforts have focused on biomethane, through a partnership with global waste solutions company Brightmark. The joint venture Brightmark RNG Holdings operations focused on convert cow manure to renewable natural gas, which are then converted into fuel for long-haul trucks, the very kind that criss-cross the vast highways of the US delivering goods from coast to coast. Launched in October 2020, the joint venture was extended and expanded in August, now encompassing 38 biomethane plants in seven US states, with first production set to begin later in 2021. The targeting of livestock waste is particularly crucial: methane emissions from farms is the second-largest contributor to climate change emissions globally. The technology to capture methane from manure (as well as landfills and other waste sites) has existed for years, but has only recently been commercialised to convert methane emissions from decomposition to useful products.
This is an arena that another supermajor – BP – has also made a recent significant investment in. BP signed a 15-year agreement with CleanBay Renewables to purchase the latter’s renewable natural gas (RNG) to be mixed and sold into select US state markets. Beginning with California, which has one of the strictest fuel standards in the US and provides incentives under the Low Carbon Fuel Standard to reduce carbon intensity – CleanBay’s RNG is derived not from cows, but from poultry. Chicken manure, feathers and bedding are all converted into RNG using anaerobic digesters, providing a carbon intensity that is said to be 95% less than the lifecycle greenhouse gas emissions of pure fossil fuels and non-conversion of poultry waste matter. BP also has an agreement with Gevo Inc in Iowa to purchase RNG produced from cow manure, also for sale in California.
But road fuels aren’t the only avenue for large-scale embracing of renewables. It could take to the air, literally. After all, the global commercial airline fleet currently stands at over 25,000 aircraft and is expected to grow to over 35,000 by 2030. All those planes will burn a lot of fuel. With the airline industry embracing the idea of AAF (or Alternative Aviation Fuels), developments into renewable jet fuels have been striking, from traditional bio-sources such as palm or soybean oil to advanced organic matter conversion from agricultural waste and manure. Chevron, again, has signed a landmark deal to advance the commercialisation. Together with Delta Airlines and Google, Chevron will be producing a batch of sustainable aviation fuel at its El Segundo refinery in California. Delta will then use the fuel, with Google providing a cloud-based framework to analyse the data. That data will then allow for a transparent analysis into carbon emissions from the use of sustainable aviation fuel, as benchmark for others to follow. The analysis should be able to confirm whether or not the International Air Transport Association (IATA)’s estimates that renewable jet fuel can reduce lifecycle carbon intensity by up to 80%. And to strengthen the measure, Delta has pledged to replace 10% of its jet fuel with sustainable aviation fuel by 2030.
In a parallel, but no less pioneering lane, France’s TotalEnergies has announced that it is developing a 100% renewable fuel for use in motorsports, using bioethanol sourced from residues produced by the French wine industry (among others) at its Feyzin refinery in Lyon. This, it believes, will reduce the racing sports’ carbon emissions by an immediate 65%. The fuel, named Excellium Racing 100, is set to debut at the next season of the FIA World Endurance Championship, which includes the iconic 24 Hours of Le Mans 2022 race.
But Chevron isn’t done yet. It is also falling back on the long-standing use of vegetable oils blended into US transport fuels by signing a wide-ranging agreement with commodity giant Bunge. Called a ‘farmer-to-fuelling station’ solution, Bunge’s soybean processing facilities in Louisiana and Illinois will be the source of meal and oil that will be converted by Chevron into diesel and jet fuel. With an investment of US$600 million, Chevron will assist Bunge in doubling the combined capacity of both plants by 2024, in line with anticipated increases in the US biofuels blending mandates.
Even ExxonMobil, one of the most reticent of the supermajors to embrace renewables wholesale, is getting in on the action. Its Imperial Oil subsidiary in Canada has announced plans to commercialise renewable diesel at a new facility near Edmonton using plant-based feedstock and hydrogen. The venture does only target the Canadian market – where political will to drive renewable adoption is far higher than in the US – but similar moves have already been adopted by other refiners for the US market, including major investments by Phillips 66 and Valero.
Ultimately, these recent moves are driven out of necessity. This is the way the industry is moving and anyone stubborn enough to ignore it will be left behind. Combined with other major investments driven by European supermajors over the past five years, this wider and wider adoption of renewable can only be better for the planet and, eventually, individual bottom lines. The renewables ball is rolling fast and is only gaining momentum.
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