Two big bearish influences have yanked Brent and WTI down by $5-6/barrel from their 42-month peaks, but may be overturned by a supply shock as we approach the fourth quarter of this year. The price slide was triggered by a substantial boost in Saudi production in June and reinforced this week by reports of a rising tide in July not only from the kingdom, but joined by growing flows from Iraq, Kuwait, UAE, Algeria, Russia and Brazil. The countries are pumping at their highest levels since end-2016.
Within OPEC, the hikes more than offset the declines from Venezuela, Iran and Libya, to produce a net increase of around 340,000 b/d in July compared with June.
Incremental supply resulting from the OPEC/non-OPEC ministers’ agreement for a 1 million b/d boost in Vienna on June 23, meant to calm Brent down from the $80/barrel mark that had rattled several producer countries, may have come too soon.
Much would depend on how the second factor weighing on crude prices — mounting trade conflict between the US and China — pans out. Tensions spiked this week after the US said it was considering raising the proposed import tariff rate on $200 billion worth of goods from China from 10% to 25%.
China said it would have to retaliate “to defend the nation’s dignity”. The country might be running out of ammunition, though, as it buys much less from the US than what it sells to that country — an annual trade deficit of around $370 billion, which is at the heart of Donald Trump’s crusade.
China might compensate for that lack of leverage by continuing to shun US crude imports and rejecting Washington’s demands to curtail its business with Iran. And it might let the yuan depreciate against the US dollar, which makes Chinese exports more competitive, while discouraging imports, as they become relatively costlier.
The yuan has slumped by around 8.8% against the dollar since mid-April, accelerating its fall in recent weeks. The first round of tit-for-tat tariffs by the US and China on $34 billion worth of imports went into effect on July 6.
Data this week showed Chinese manufacturing activity grew at its slowest pace in eight months in July as new export orders contracted for the fourth month in a row, a fallout of the bitter trade dispute with the US. The full impact on China’s economy is not expected to be felt until early 2019. But it has begun to weigh on an oil market predisposed to bearishness due to the additional barrels flowing from the OPEC/non-OPEC producers who had been curtailing output since January 2017.
Fears of the trade war dampening Chinese oil demand — the second-largest in the world after the US — come on top of two successive monthly contractions in China’s crude imports, which saw June purchase volumes shrinking to the lowest level since December 2017. A marked slowdown in the appetite of the country’s independent refiners or so-called “teapots”, which have slashed operating rates due to shrinking margins after the government plugged some tax loopholes in March, is expected to sustain. These refiners hold 25-30% of China’s 15 million b/d refining capacity.
Meanwhile, US President Donald Trump this week dangled an ad hoc offer through the press to meet the Iranian leaders without pre-conditions, to which Secretary of State Mike Pompeo promptly added a list of conditions. Tehran, as expected, scoffed at the proposal. While the Iran-backed Houthi rebels in Yemen declared a two-week halt to attacking ships passing through the Bab el-Mandeb strait linked the Red Sea with the Arabian Sea after targeting two Saudi oil tankers in the choke point last week, Iran decided to flex its muscles by launching naval exercises in the Persian Gulf.
With the first round of US sanctions targeting Iran’s automobiles, gold and currency due to take effect on Monday (August 6), the Iranian rial has gone into a tailspin and there are reports of public protests erupting across the country again.
The oil market may remain complacent for a few more weeks. But it may be in for a rude shock once US sanctions against Iran’s oil sector begin to bite.
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In 2020, renewable energy sources (including wind, hydroelectric, solar, biomass, and geothermal energy) generated a record 834 billion kilowatthours (kWh) of electricity, or about 21% of all the electricity generated in the United States. Only natural gas (1,617 billion kWh) produced more electricity than renewables in the United States in 2020. Renewables surpassed both nuclear (790 billion kWh) and coal (774 billion kWh) for the first time on record. This outcome in 2020 was due mostly to significantly less coal use in U.S. electricity generation and steadily increased use of wind and solar.
In 2020, U.S. electricity generation from coal in all sectors declined 20% from 2019, while renewables, including small-scale solar, increased 9%. Wind, currently the most prevalent source of renewable electricity in the United States, grew 14% in 2020 from 2019. Utility-scale solar generation (from projects greater than 1 megawatt) increased 26%, and small-scale solar, such as grid-connected rooftop solar panels, increased 19%.
Coal-fired electricity generation in the United States peaked at 2,016 billion kWh in 2007 and much of that capacity has been replaced by or converted to natural gas-fired generation since then. Coal was the largest source of electricity in the United States until 2016, and 2020 was the first year that more electricity was generated by renewables and by nuclear power than by coal (according to our data series that dates back to 1949). Nuclear electric power declined 2% from 2019 to 2020 because several nuclear power plants retired and other nuclear plants experienced slightly more maintenance-related outages.
We expect coal-fired electricity generation to increase in the United States during 2021 as natural gas prices continue to rise and as coal becomes more economically competitive. Based on forecasts in our Short-Term Energy Outlook (STEO), we expect coal-fired electricity generation in all sectors in 2021 to increase 18% from 2020 levels before falling 2% in 2022. We expect U.S. renewable generation across all sectors to increase 7% in 2021 and 10% in 2022. As a result, we forecast coal will be the second-most prevalent electricity source in 2021, and renewables will be the second-most prevalent source in 2022. We expect nuclear electric power to decline 2% in 2021 and 3% in 2022 as operators retire several generators.
Source: U.S. Energy Information Administration, Monthly Energy Review and Short-Term Energy Outlook (STEO)
Note: This graph shows electricity net generation in all sectors (electric power, industrial, commercial, and residential) and includes both utility-scale and small-scale (customer-sited, less than 1 megawatt) solar.
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The tizzy that OPEC+ threw the world into in early July has been settled, with a confirmed pathway forward to restore production for the rest of 2021 and an extension of the deal further into 2022. The lone holdout from the early July meetings – the UAE – appears to have been satisfied with the concessions offered, paving the way for the crude oil producer group to begin increasing its crude oil production in monthly increments from August onwards. However, this deal comes at another difficult time; where the market had been fretting about a shortage of oil a month ago due to resurgent demand, a new blast of Covid-19 infections driven by the delta variant threatens to upend the equation once again. And so Brent crude futures settled below US$70/b for the first time since late May even as the argument at OPEC+ appeared to be settled.
How the argument settled? Well, on the surface, Riyadh and Moscow capitulated to Abu Dhabi’s demands that its baseline quota be adjusted in order to extend the deal. But since that demand would result in all other members asking for a similar adjustment, Saudi Arabia and Russia worked in a rise for all, and in the process, awarded themselves the largest increases.
The net result of this won’t be that apparent in the short- and mid-term. The original proposal at the early July meetings, backed by OPEC+’s technical committee was to raise crude production collectively by 400,000 b/d per month from August through December. The resulting 2 mmb/d increase in crude oil, it was predicted, would still lag behind expected gains in consumption, but would be sufficient to keep prices steady around the US$70/b range, especially when factoring in production increases from non-OPEC+ countries. The longer term view was that the supply deal needed to be extended from its initial expiration in April 2022, since global recovery was still ‘fragile’ and the bloc needed to exercise some control over supply to prevent ‘wild market fluctuations’. All members agreed to this, but the UAE had a caveat – that the extension must be accompanied by a review of its ‘unfair’ baseline quota.
The fix to this issue that was engineered by OPEC+’s twin giants Saudi Arabia and Russia was to raise quotas for all members from May 2022 through to the new expiration date for the supply deal in September 2022. So the UAE will see its baseline quota, the number by which its output compliance is calculated, rise by 330,000 b/d to 3.5 mmb/d. That’s a 10% increase, which will assuage Abu Dhabi’s itchiness to put the expensive crude output infrastructure it has invested billions in since 2016 to good use. But while the UAE’s hike was greater than some others, Saudi Arabia and Russia took the opportunity to award themselves (at least in terms of absolute numbers) by raising their own quotas by 500,000 b/d to 11.5 mmb/d each.
On the surface, that seems academic. Saudi Arabia has only pumped that much oil on a handful of occasions, while Russia’s true capacity is pegged at some 10.4 mmb/d. But the additional generous headroom offered by these larger numbers means that Riyadh and Moscow will have more leeway to react to market fluctuations in 2022, which at this point remains murky. Because while there is consensus that more crude oil will be needed in 2022, there is no consensus on what that number should be. The US EIA is predicting that OPEC+ should be pumping an additional 4 million barrels collectively from June 2021 levels in order to meet demand in the first half of 2022. However, OPEC itself is looking at a figure of some 3 mmb/d, forecasting a period of relative weakness that could possibly require a brief tightening of quotas if the new delta-driven Covid surge erupts into another series of crippling lockdowns. The IEA forecast is aligned with OPEC’s, with an even more cautious bent.
But at some point with the supply pathway from August to December set in stone, although OPEC+ has been careful to say that it may continue to make adjustments to this as the market develops, the issues of headline quota numbers fades away, while compliance rises to prominence. Because the success of the OPEC+ deal was not just based on its huge scale, but also the willingness of its 23 members to comply to their quotas. And that compliance, which has been the source of major frustrations in the past, has been surprisingly high throughout the pandemic. Even in May 2021, the average OPEC+ compliance was 85%. Only a handful of countries – Malaysia, Bahrain, Mexico and Equatorial Guinea – were estimated to have exceeded their quotas, and even then not by much. But compliance is easier to achieve in an environment where demand is weak. You can’t pump what you can’t sell after all. But as crude balances rapidly shift from glut to gluttony, the imperative to maintain compliance dissipates.
For now, OPEC+ has managed to placate the market with its ability to corral its members together to set some certainty for the immediate future of crude. Brent crude prices have now been restored above US$70/b, with WTI also climbing. The spat between Saudi Arabia and the UAE may have surprised and shocked market observers, but there is still unity in the club. However, that unity is set to be tested. By the end of 2021, the focus of the OPEC+ supply deal will have shifted from theoretical quotas to actual compliance. Abu Dhabi has managed to lift the tide for all OPEC+ members, offering them more room to manoeuvre in a recovering market, but discipline will not be uniform. And that’s when the fireworks will really begin.
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