Tightening Fundamentals Have Given Oil Prices Significant Upside

• Standard Chartered analysts conclude that crude prices are finally starting to catch up with the reality of a tightly supplied oil market.
• StanChart’s demand model projects a supply deficit of 2.81 million barrels per day in August.
• Excess gas inventories in Europe and the U.S. remain the biggest bearish catalyst that’s capping gas prices.

After remaining range-bound for much of the second quarter, oil prices have mounted a significant rally, with front-month Brent gaining over 10% since the beginning of the month to trade at $83.30 per barrel. This marks the first time the contract has settled above the key 200-day moving average in nearly a full year. According to commodity analysts at Standard Chartered, oil markets are finally waking up to the fact that fundamentals have tightened significantly. The analysts have predicted that a seasonal increase in demand combined with producer output restraint will create large supply deficits over the coming months.

StanChart’s demand model projects a supply deficit of 2.81 million barrels per day in August; 2.43mb/d in September and more than 2mb/d in November and December. The analysts have also projected that global inventories will fall by 310mb by end-2023 and another 94mb in the first quarter of 2024 thus keeping oil markets backwardated and pushing oil prices higher. According to the experts, Brent price will remain unchanged at USD 88/bbl for Q3 2024 but will climb to $93/bbl for Q4. Demand will hit an all-time high in August and then set fresh highs in December 2023 and again in February, March, June and August 2024. However, they have forecast that global oil demand will fall to a seasonal low of 99.33mb/d in January 2024, the only month in the current decade when demand is expected to plunge below 100mb/d.

Oil Inventories Fall, Gas Inventories Near Record Highs

Overall, crude and natural gas inventories have been moving in opposite directions, with crude inventories falling while those of natural gas have been increasing.

According to StanChart, total crude oil and oil product inventories fell by 7.58mb against the five-year average to stand 17.62mb below the average. Last week, crude oil inventories fell by 0.71mb to 457.42mb, with crude inventories at WTI’s pricing point in Cushing, Oklahoma, falling 2.89mb to 38.35mb. The main inventory tightness remains in gasoline and distillates.

Last week, gasoline inventories fell 1.07mb to 218.39mb, and are now 17.65mb (7.5%) below the five-year average, while distillate inventories are 19.59mb (14.2%) below the five-year average.

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In contrast, EU gas inventories stood at 96.76 billion cubic meters (bcm) on 16 July, 21.4bcm higher y/y and 18.65bcm above the five-year average. The build over the past week averaged 319 million cubic meters per day is 109% higher than the five-year average over the equivalent period. At this rate, Europe’s gas inventories will pass above 100 bcm on the 1th of August, and equal last year’s maximum as early as August. Inventories will then hit 100% of nameplate storage capacity in early September. According to the commodity analysts, EU gas inventories would be on course to finish the injection season just above 124 bcm if storage was not constrained. 

It’s clear that Europe’s gas buyer’s club has been a resounding success, with the continent’s gas stores nearly 80% full. Unfortunately, Europe’s purchases of U.S. LNG have also dwindled, with June’s volumes clocking in at 4.15 million metric tons, down from 5.63 million tons in May. 

Excess gas inventories in Europe and the U.S. remain the biggest bearish catalyst that’s capping gas prices, and it will take an extraordinarily black swan event for the situation to turn around. The big problem here is that not only are gas inventories rising but are doing so at a torrid clip. The deluge of gas has put nearby futures prices under immense pressure, with futures for gas delivered in October 2023 now trading at a discount of almost 12 euros per megawatt-hour to prices for April 2024. In contrast, they traded at a premium of more than 5 euros at the beginning of the year and a full 38 euros a year ago.

Asia and China Become Key U.S. Customers

But it’s not all doom and gloom for U.S. gas producers, with Asia and China picking up the slack left by Europe.

Asia's imports of U.S. LNG climbed to 1.34 million metric tons in June, up from 1.21 million in May, the most since February. Indeed, China and Asia are now the U.S. biggest LNG customers, a position Europe held last year when it purchased as much as 65% of U.S. output.

The United States' largest producer of LNG, Cheniere Energy (NYSE:LNG), has signed a long-term liquefied natural gas (LNG) sale and purchase agreement with China’s ENN Energy Holdings. 

ENN will purchase ~1.8M metric tons/year of LNG on a free-on-board basis at Henry Hub prices for a 20-year term, with deliveries to commence mid-2026 ramping up to 0.9 million tonne per annum (mtpa) in 2027. Last year, ENN signed a 13-year deal with Cheniere to purchase 900K metric tons/year, again based on Henry Hub prices.

The deal is subject to the completion of Cheniere’s Sabine Pass project, which is being developed to include up to three liquefaction trains with an expected total production capacity of ~20M tons/year of LNG. 

Currently, Sabine Pass has six fully operational liquefaction units aka ?“trains”, each capable of producing ~5 mtpa of LNG for an aggregate nominal production capacity of ~30 mtpa. Cheniere processes more than 4.7 billion cubic feet per day of natural gas into LNG. Sabine Pass has multiple pipeline connections to interstate and intrastate pipelines, and is located less than four nautical miles from the Gulf of Mexico thus providing easy access to seafaring vessels. 

Previously, Cheniere entered another long-term liquefied natural gas sale and purchase agreement with Norway’s national oil company Equinor ASA (NYSE:EQNR) that will see Equinor purchase 1.75M metric tons/year of LNG on a free-on-board basis for a purchase price indexed to the Henry Hub price, for a 15-year term.

By Alex Kimani for Oilprice.com

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