The US-China trade war took a turn for the worse this week and could fester for months, potentially denting Chinese economic growth and oil demand well into 2019. That spectre controlled oil market sentiment almost to the exclusion of all other influences this week and had forced Brent to re-test recent support levels around $71/barrel on Friday.
Decisions by Washington and Beijing on August 7 and 8, to proceed with a second round of bilateral tariffs on $16 billion worth of annual imports starting from August 23, squashed any hopes of a return to negotiations. The Trump administration wants to narrow the $375-billion trade gap the US had with China as of 2017 and has threatened to impose duties on all $500 billion worth of its imports from the Asian giant. China is expected to run out of ammunition in its reciprocal retaliation much before that finish line, and yet, it is hard to see it backing off.
Chinese oil consumption is still centered around manufacturing despite the economy’s ongoing pivot to a services-led growth model, and there have been other signs of a demand slowdown, especially after the independent refiners or “teapots”, were hit hard by tightened tax regulations in March that had nothing to do with the tariffs dispute.
Crude imports by China, the largest in the world and a closely monitored proxy for its appetite, slipped two months in a row over May and June. Though there was a slight uptick in July imports to around 8.52 million b/d from a six-month nadir of 8.39 million b/d in June, market confidence in the country’s growth has been shaken.
Consensus expectations on US economic growth remain sanguine but it may be worth paying closer attention to its oil consumption data. Refined products supplied across the US, a proxy for consumption, averaged around 20.93 million b/d in the week to August 3, a slump of 1 million b/d from the corresponding week of 2017, according to the Energy Information Administration. Gasoline use, which accounts for nearly 45% of US oil demand, slid by 540,000 b/d from a week ago to around 9.35 million b/d, in the midst of the country’s peak summer driving demand season. However, four-week average figures, which smooths out volatility that may be more noise than signal, do not indicate any major downtrends.
In a curious last-minute twist in the trade war, China dropped US crude from its list of items that will attract 25% import duty from August 23 and included diesel, jet fuel, naphtha and propane, alongside a host of petrochemical products. The about-turn on crude could be aimed at alleviating pressure on Chinese refiners and holding it as a trump card for later use when Beijing’s leverage in terms of the value of remaining goods to tax withers.
China was the largest overseas buyer of US crude in May, averaging 427,000 b/d of imports, according to the latest monthly data from the EIA. Imports spiked to a record 553,000 b/d in June, according to Reuters. However, Chinese refiners began shunning US crude from July and may not risk resuming imports despite the commodity having been left off the latest tariff list, for fear that it may be reinstated any time. US LNG, which China had left alone but decided to threaten with a 25% import tariff on August 3, is a case in point.
The broader global economic fallout of a bitter fight between the world’s two largest economies defies prediction, but appears to have invited a general sense of gloom as far as oil demand is concerned. That may have been helped by bearishness closing in from the supply side as well. Growing flows from some of the OPEC/non-OPEC producers who have been ramping up in line with the ministerial agreement in Vienna on June 23 to boost collective output by up 1 million b/d have hit progressively the market since June (the Saudis had likely started ramping up that month, even before the Vienna deal).
A moderate-sized contango has entrenched itself at the front end of the Brent forward curve since mid-July, a market state that typically signals supply overshadowing demand. However, WTI, Dubai and Oman time spreads are in backwardation.
What's next for oil? We see no escape from the vortex of bearishness for the next few weeks, though we expect the OPEC/non-OPEC leadership to regroup to shore up prices if Brent breaches the key psychological level of $70/barrel. Looking beyond the next few weeks, the combination of Iran sanctions, moderating US oil production growth, and an exhausted OPEC/non-OPEC spare production capacity could hit the market with a perfect storm in Q4.
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Source: U.S. Energy Information Administration, Short-Term Energy Outlook
In April 2019, Venezuela's crude oil production averaged 830,000 barrels per day (b/d), down from 1.2 million b/d at the beginning of the year, according to EIA’s May 2019 Short-Term Energy Outlook. This average is the lowest level since January 2003, when a nationwide strike and civil unrest largely brought the operations of Venezuela's state oil company, Petróleos de Venezuela, S.A. (PdVSA), to a halt. Widespread power outages, mismanagement of the country's oil industry, and U.S. sanctions directed at Venezuela's energy sector and PdVSA have all contributed to the recent declines.
Source: U.S. Energy Information Administration, based on Baker Hughes
Venezuela’s oil production has decreased significantly over the last three years. Production declines accelerated in 2018, decreasing by an average of 33,000 b/d each month in 2018, and the rate of decline increased to an average of over 135,000 b/d per month in the first quarter of 2019. The number of active oil rigs—an indicator of future oil production—also fell from nearly 70 rigs in the first quarter of 2016 to 24 rigs in the first quarter of 2019. The declines in Venezuelan crude oil production will have limited effects on the United States, as U.S. imports of Venezuelan crude oil have decreased over the last several years. EIA estimates that U.S. crude oil imports from Venezuela in 2018 averaged 505,000 b/d and were the lowest since 1989.
EIA expects Venezuela's crude oil production to continue decreasing in 2019, and declines may accelerate as sanctions-related deadlines pass. These deadlines include provisions that third-party entities using the U.S. financial system stop transactions with PdVSA by April 28 and that U.S. companies, including oil service companies, involved in the oil sector must cease operations in Venezuela by July 27. Venezuela's chronic shortage of workers across the industry and the departure of U.S. oilfield service companies, among other factors, will contribute to a further decrease in production.
Additionally, U.S. sanctions, as outlined in the January 25, 2019 Executive Order 13857, immediately banned U.S. exports of petroleum products—including unfinished oils that are blended with Venezuela's heavy crude oil for processing—to Venezuela. The Executive Order also required payments for PdVSA-owned petroleum and petroleum products to be placed into an escrow account inaccessible by the company. Preliminary weekly estimates indicate a significant decline in U.S. crude oil imports from Venezuela in February and March, as without direct access to cash payments, PdVSA had little reason to export crude oil to the United States.
India, China, and some European countries continued to receive Venezuela's crude oil, according to data published by ClipperData Inc. Venezuela is likely keeping some crude oil cargoes intended for exports in floating storageuntil it finds buyers for the cargoes.
Source: U.S. Energy Information Administration, Short-Term Energy Outlook, and Clipper Data Inc.
A series of ongoing nationwide power outages in Venezuela that began on March 7 cut electricity to the country's oil-producing areas, likely damaging the reservoirs and associated infrastructure. In the Orinoco Oil Belt area, Venezuela produces extra-heavy crude oil that requires dilution with condensate or other light oils before the oil is sent by pipeline to domestic refineries or export terminals. Venezuela’s upgraders, complex processing units that upgrade the extra-heavy crude oil to help facilitate transport, were shut down in March during the power outages.
If Venezuelan crude or upgraded oil cannot flow as a result of a lack of power to the pumping infrastructure, heavier molecules sink and form a tar-like layer in the pipelines that can hinder the flow from resuming even after the power outages are resolved. However, according to tanker tracking data, Venezuela's main export terminal at Puerto José was apparently able to load crude oil onto vessels between power outages, possibly indicating that the loaded crude oil was taken from onshore storage. For this reason, EIA estimates that Venezuela's production fell at a faster rate than its exports.
EIA forecasts that Venezuela's crude oil production will continue to fall through at least the end of 2020, reflecting further declines in crude oil production capacity. Although EIA does not publish forecasts for individual OPEC countries, it does publish total OPEC crude oil and other liquids production. Further disruptions to Venezuela's production beyond what EIA currently assumes would change this forecast.
Headline crude prices for the week beginning 13 May 2019 – Brent: US$70/b; WTI: US$61/b
Headlines of the week
Midstream & Downstream
The world’s largest oil & gas companies have generally reported a mixed set of results in Q1 2019. Industry turmoil over new US sanctions on Venezuela, production woes in Canada and the ebb-and-flow between OPEC+’s supply deal and rising American production have created a shaky environment at the start of the year, with more ongoing as the oil world grapples with the removal of waivers on Iranian crude and Iran’s retaliation.
The results were particularly disappointing for ExxonMobil and Chevron, the two US supermajors. Both firms cited weak downstream performance as a drag on their financial performance, with ExxonMobil posting its first loss in its refining business since 2009. Chevron, too, reported a 65% drop in the refining and chemicals profit. Weak refining margins, particularly on gasoline, were blamed for the underperformance, exacerbating a set of weaker upstream numbers impaired by lower crude pricing even though production climbed. ExxonMobil was hit particularly hard, as its net profit fell below Chevron’s for the first time in nine years. Both supermajors did highlight growing output in the American Permian Basin as a future highlight, with ExxonMobil saying it was on track to produce 1 million barrels per day in the Permian by 2024. The Permian is also the focus of Chevron, which agreed to a US$33 billion takeover of Anadarko Petroleum (and its Permian Basin assets), only for the deal to be derailed by a rival bid from Occidental Petroleum with the backing of billionaire investor guru Warren Buffet. Chevron has now decided to opt out of the deal – a development that would put paid to Chevron’s ambitions to match or exceed ExxonMobil in shale.
Performance was better across the pond. Much better, in fact, for Royal Dutch Shell, which provided a positive end to a variable earnings season. Net profit for the Anglo-Dutch firm may have been down 2% y-o-y to US$5.3 billion, but that was still well ahead of even the highest analyst estimates of US$4.52 billion. Weaker refining margins and lower crude prices were cited as a slight drag on performance, but Shell’s acquisition of BG Group is paying dividends as strong natural gas performance contributed to the strong profits. Unlike ExxonMobil and Chevron, Shell has only dipped its toes in the Permian, preferring to maintain a strong global portfolio mixed between oil, gas and shale assets.
For the other European supermajors, BP and Total largely matched earning estimates. BP’s net profits of US$2.36 billion hit the target of analyst estimates. The addition of BHP Group’s US shale oil assets contributed to increased performance, while BP’s downstream performance was surprisingly resilient as its in-house supply and trading arm showed a strong performance – a business division that ExxonMobil lacks. France’s Total also hit the mark of expectations, with US$2.8 billion in net profit as lower crude prices offset the group’s record oil and gas output. Total’s upstream performance has been particularly notable – with start-ups in Angola, Brazil, the UK and Norway – with growth expected at 9% for the year.
All in all, the volatile environment over the first quarter of 2019 has seen some shift among the supermajors. Shell has eclipsed ExxonMobil once again – in both revenue and earnings – while Chevron’s failed bid for Anadarko won’t vault it up the rankings. Almost ten years after the Deepwater Horizon oil spill, BP is now reclaiming its place after being overtaken by Total over the past few years. With Q219 looking to be quite volatile as well, brace yourselves for an interesting earnings season.
Supermajor Financials: Q1 2019