Last week in world oil:
All of Saudi Arabia’s bluster can’t hide the fact that the tenuous OPEC agreement to cut production had hit a number of obstacles, with the latest being that Iraq wants exemption from the cuts, just as Nigeria, Libya and Iran do. That was enough to send oil prices lower today, though they remain just above the US$50/b level.
Mexico has approved Italy’s Eni to go ahead with test drilling at the Amoca 2 well, a shallow water field in the Gulf of Mexico. It is only the second well to be drilled in Mexico since reforms to open up its energy sector dissolved Pemex’s upstream monopoly. The first well was Amoca 1, also by Eni, part of an acreage that is estimated to hold some 800 million barrels of oil and 480 bcf of associated gas.
Announcements of asset sales by supermajors are common these days, particularly from Shell, seeking to pay for its acquisition of the BG Group. The latest involves some US$1.3 billion of non-core oil and gas properties in western Canada exchanging hands between Shell and Tourmaline Oil, including onshore land in the Gundy area of British Columbia and the Deep Basin area of Alberta that currently have a minor production output of 25 kb/d, with reasonable room for growth.
Higher prices spur more rigs, and the US operational oil rig count jumped by 11 last week, bringing the total to 443. Gas rigs also added 3 to their number, up to 108, as nimble onshore producers react to the positive price signals. The number of offshore rigs remains unchanged at 23.
There’s a problem looming in PDVSA and it threatens to spill over into the US Gulf. Beset with a huge amount of debt, the Venezuelan national oil company has been attempting to negotiate short-term measures to defer its debt, with the spectre of a default looming on the horizon. Already, Curacao appears to be abandoning PDVSA, seeking Chinese involvement in its refinery, while the woes are affecting PDVSA’s subsidiary Citgo in the USA and its Aruba refinery. A default would also wreck havoc with the US Gulf Coast refining system, dependent on Venezuela’s output that supplies a third of the crude processed along the Gulf Coast.
Qatargas has inked a deal with Petronas LNG UK to supply 1.1 million tons of LNG per year through 2023, extending a contract that was due to expire at the end of 2018. The deal is particularly important for Qatar, as it seeks to secure long-term supply agreements in the face of a looming global glut of gas supplies from Australia and the US, with Europe being a priority target. The LNG will be supplied from Qatargas 4, a joint venture between Qatar Petroleum and Shell, with the supplies delivered to the Dragon LNG terminal in Milford Haven in the UK. Qatargas is also looking at securing supply agreements in Rotterdam, which would be its gateway into western continental Europe.
The Chinese upstream sector is considered expensive, inefficient and now, declining. China’s crude output fell by 9.8% y-o-y in September, as low oil prices make imports cheaper while making the case that the country’s high-cost fields, like Daqing and Shengli, should be shut down. Crude output in August fell by 9.9%, the highest y-o-y decline on record, while September crude imports growth reached 18%.
Petrobras has finally reached a deal for its mothballed Nansei Seikyu refinery in Okinawa, agreeing to sell it to Japan’s Taiyo Oil for US$129.3 million as it continues on its asset sale spree to reduce its debt. The Okinawan refinery, an oddball choice that was acquired by Petrobras in 2007, has proven particularly difficult to sell, having its refining operations shut down last year due to the industry downturn.
With the downstream oil market in doldrums but the petrochemical industry still holding strong, Saudi Arabia is aiming to capitalise on that by focusing on a giant crude-to-chemicals project. Saudi Aramco and SABIC have formed a joint management team, together with a unnamed third party, to assess the viability of such a project that would cut out the middle link in petrochemical production, bypassing gasoline and diesel to go straight into chemicals. A preliminary study is expected in 2017, and is in line with the Kingdom’s stated desire to diversify its economy away from crude petroleum sales.
After the US$15 billion Inpex/Shell plan to boost output at the Masela natural gas field by 2.5 mtpa utilising a floating LNG facility was rejected by the Indonesian government in March, a new plan has been proposed to build an onshore LNG plant on the islands of Aru or Saumlaki. The anticipated start date of the giant gas field has been pushed into the late 2020s, and to recoup investment, Inpex is proposing a near quadrupling of output, to between 7.5-9.5 mtpa in total now. A decision on the new proposal is expected from the Indonesian government within the month.
Under pressure gas player Santos has sold its offshore natural gas assets in Victoria to Australia’s Cooper Energy for US$62 million. The sale marks the exit of Santos from offshore Victoria following the sale of its Kipper field for US$520 million in March. The assets include interests in the Casino-Henry gas project, as well as control of the Sole field and Orbost gas plant in Gippsland Basin.
In another sign that petrochemicals are booming, India’s Reliance has beaten forecasts by posting an 18% y-o-y increase in its Q2 profit, buoyed by its petrochemicals business. Reliance’s petrochemicals margins for Q216 were 15%, the highest in nearly four years, while its refining margins fell sharply due to weak product prices.
Meanwhile in the rig-making sector, Singapore’s Keppel Oil saw its quarterly profits fall by 38% on a weak offshore market. Cost-cutting measure and job cuts – more than 8,000 so far in 2016 – are continuing, and the company will also look at mothballing some facilities until 2020.
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Headline crude prices for the week beginning 23 March 2020 – Brent: US$27/b; WTI: US$23/b
Headlines of the week
Crude oil prices have fallen significantly since the beginning of 2020, largely driven by the economic contraction caused by the 2019 novel coronavirus disease (COVID19) and a sudden increase in crude oil supply following the suspension of agreed production cuts among the Organization of the Petroleum Exporting Countries (OPEC) and partner countries. With falling demand and increasing supply, the front-month price of the U.S. benchmark crude oil West Texas Intermediate (WTI) fell from a year-to-date high closing price of $63.27 per barrel (b) on January 6 to a year-to-date low of $20.37/b on March 18 (Figure 1), the lowest nominal crude oil price since February 2002.
WTI crude oil prices have also fallen significantly along the futures curve, which charts monthly price settlements for WTI crude oil delivery over the next several years. For example, the WTI price for December 2020 delivery declined from $56.90/b on January 2, 2020, to $32.21/b as of March 24. In addition to the sharp price decline, the shape of the futures curve has shifted from backwardation—when near-term futures prices are higher than longer-dated ones—to contango, when near-term futures prices are lower than longer-dated ones. The WTI 1st-13th spread (the difference between the WTI price in the nearest month and the price for WTI 13 months away) settled at -$10.34/b on March 18, the lowest since February 2016, exhibiting high contango. The shift from backwardation to contango reflects the significant increase in petroleum inventories. In its March 2020 Short-Term Energy Outlook (STEO), released on March 11, 2020, the U.S. Energy Information Administration (EIA) forecast that Organization for Economic Cooperation and Development (OECD) commercial petroleum inventories will rise to 2.9 billion barrels in March, an increase of 20 million barrels over the previous month and 68 million barrels over March 2019 (Figure 2). Since the release of the March STEO, changes in various oil market and macroeconomic indicators suggest that inventory builds are likely to be even greater than EIA’s March forecast.
Significant price volatility has accompanied both price declines and price increases. Since 1999, 69% of the time, daily WTI crude oil prices increased or decreased by less than 2% relative to the previous trading day. Daily oil price changes during March 2020 have exceeded 2% 13 times (76% of the month’s traded days) as of March 24. For example, the 10.1% decline on March 6 after the OPEC meeting was larger than 99.8% of the daily percentage price decreases since 1999. The 24.6% decline on March 9 and the 24.4% decline on March 18 were the largest and second largest percent declines, respectively, since at least 1999 (Figure 3).
On March 10, a series of government announcements indicated that emergency fiscal and monetary policy were likely to be forthcoming in various countries, which contributed to a 10.4% increase in the WTI price, the 12th-largest daily increase since 1999. During other highly volatile time periods, such as the 2008 financial crisis, both large price increases and decreases occurred in quick succession. During the 2008 financial crisis, the largest single-day increase—a 17.8% rise on September 22, 2008—was followed the next day by the largest single-day decrease, a 12.0% fall on September 23, 2008.
Market price volatility during the first quarter of 2020 has not been limited to oil markets (Figure 4). The recent volatility in oil markets has also coincided with increased volatility in equity markets because the products refined from crude oil are used in many parts of the economy and because the COVID-19-related economic slowdown affects a broad array of economic activities. This can be measured through implied volatility—an estimate of a security’s expected range of near-term price changes—which can be calculated using price movements of financial options and measured by the VIX index for the Standard and Poor’s (S&P) 500 index and the OVX index for WTI prices. Implied volatility for both the S&P 500 index and WTI are higher than the levels seen during the 2008 financial crisis, which peaked on November 20, 2008, at 80.9 and on December 11, 2008, at 100.4, respectively, compared with 61.7 for the VIX and 170.9 for the OVX as of March 24.
Comparing implied volatility for the S&P 500 index with WTI’s suggests that although recent volatility is not limited to oil markets, oil markets are likely more volatile than equity markets at this point. The oil market’s relative volatility is not, however, in and of itself unusual. Oil markets are almost always more volatile than equity markets because crude oil demand is price inelastic—whereby price changes have relatively little effect on the quantity of crude oil demanded—and because of the relative diversity of the companies constituting the S&P 500 index. But recent oil market volatility is still historically high, even in comparison to the volatility of the larger equity market. As denoted by the red line in the bottom of Figure 4, the difference between the OVX and VIX reached an all-time high of 124.1 on March 23, compared with an average difference of 16.8 between May 2007 (the date the OVX was launched) and March 24, 2020.
Markets currently appear to expect continued and increasing market volatility, and, by extension, increasing uncertainty in the pricing of crude oil. Oil’s current level of implied volatility—a forward-looking measure for the next 30 days—is also high relative to its historical, or realized, volatility. Historical volatility can influence the market’s expectations for future price uncertainty, which contributes to higher implied volatility. Some of this difference is a structural part of the market, and implied volatility typically exceeds historical volatility as sellers of options demand a volatility risk premium to compensate them for the risk of holding a volatile security. But as the yellow line in Figure 4 shows, the current implied volatility of WTI prices is still higher than normal. The difference between implied and historical volatility reached an all-time high of 44.7 on March 20, compared with an average difference of 2.3 between 2007 and March 2020. This trend could suggest that options (prices for which increase with volatility) are relatively expensive and, by extension, that demand for financial instruments to limit oil price exposure are relatively elevated.
Increased price correlation among several asset classes also suggests that similar economic factors are driving prices in a variety of markets. For example, both the correlation between changes in the price of WTI and changes in the S&P 500 and the correlation between WTI and other non-energy commodities (as measured by the S&P Commodity Index (GSCI)) increased significantly in March. Typically, when correlations between WTI and other asset classes increase, it suggests that expectations of future economic growth—rather than issues specific to crude oil markets— tend to be the primary drivers of price formation. In this case, price declines for oil, equities, and non-energy commodities all indicate that concerns over global economic growth are likely the primary force driving price formation (Figure 5).
U.S. average regular gasoline and diesel prices fall
The U.S. average regular gasoline retail price fell nearly 13 cents from the previous week to $2.12 per gallon on March 23, 50 cents lower than a year ago. The Midwest price fell more than 16 cents to $1.87 per gallon, the West Coast price fell nearly 15 cents to $2.88 per gallon, the East Coast and Gulf Coast prices each fell nearly 11 cents to $2.08 per gallon and $1.86 per gallon, respectively, and the Rocky Mountain price declined more than 8 cents to $2.24 per gallon.
The U.S. average diesel fuel price fell more than 7 cents from the previous week to $2.66 per gallon on March 23, 42 cents lower than a year ago. The Midwest price fell more than 9 cents to $2.50 per gallon, the West Coast price fell more than 7 cents to $3.25 per gallon, the East Coast and Gulf Coast prices each fell nearly 7 cents to $2.72 per gallon and $2.44 per gallon, respectively, and the Rocky Mountain price fell more than 6 cents to $2.68 per gallon.
Propane/propylene inventories decline
U.S. propane/propylene stocks decreased by 1.8 million barrels last week to 64.9 million barrels as of March 20, 2020, 15.5 million barrels (31.3%) greater than the five-year (2015-19) average inventory levels for this same time of year. Gulf Coast inventories decreased by 1.3 million barrels, East Coast inventories decreased by 0.3 million barrels, and Rocky Mountain/West Coast inventories decrease by 0.2 million barrels. Midwest inventories increased by 0.1 million barrels. Propylene non-fuel-use inventories represented 8.5% of total propane/propylene inventories.
Residential heating fuel prices decrease
As of March 23, 2020, residential heating oil prices averaged $2.45 per gallon, almost 15 cents per gallon below last week’s price and nearly 77 cents per gallon lower than last year’s price at this time. Wholesale heating oil prices averaged more than $1.11 per gallon, almost 14 cents per gallon below last week’s price and 98 cents per gallon lower than a year ago.
Residential propane prices averaged more than $1.91 per gallon, nearly 2 cents per gallon below last week’s price and almost 49 cents per gallon below last year’s price. Wholesale propane prices averaged more than $0.42 per gallon, more than 7 cents per gallon lower than last week’s price and almost 36 cents per gallon below last year’s price.
Headline crude prices for the week beginning 16 March 2020 – Brent: US$30/b; WTI: US$28/b
Headlines of the week