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Midweek Sector Update: Bearish Signs For Oil From Europe

Midweek Sector Update: Bearish Signs For Oil From Europe

Brazil’s Petrobras has slashed its capital spending program for the next five years, cutting it by 37 percent in an effort to stop the hemorrhaging of its balance sheet. Low oil prices and the kickback scandal have overwhelmed the company, already the world’s most indebted oil firm. Lower spending could help shore up the balance sheet, putting off expensive projects as it seeks to right the ship.

However, foregoing important investment on Petrobras’ presalt oil, off the coast of Rio de Janeiro, will lead to lower production levels down the line. The Brazilian company predicts that it will only produce 2.8 million barrels per day by 2020, a significant downward revision from the 4.2 million it predicted last year, and from even higher estimates in years past. The firm only has bad options: keep spending to boost output, or cut spending and watch output fall. With over $124 billion in debt, Petrobras has chosen the latter.

Each week we look at the level of crude oil located in U.S. storage tanks around the country, which offers a glimpse into the inner workings of production and consumption levels. After peaking earlier this spring, U.S. crude inventories have undergone successive weeks of drawdowns, indicating slowing production and higher demand from consumers. In Europe, however, the story is different. Crude storage is reaching a multi-year high at the trading hub of Amsterdam-Rotterdam-Antwerp, known as ARA. In fact, storage levels have spiked since the beginning of the year to 60.6 million barrels in June. European storage is growing so rapidly because a lot of oil coming from Africa is having trouble finding interested buyers, forcing it into storage. Related: New Safety Feature: A Smart Car Programmed To Let You Die?

Growing storage levels in the U.S. pushed down oil prices earlier this year, and the same could hold true for European storage. That points to a persistent glut in global oil markets, with production exceeding demand by around 2 million barrels per day according to IEA estimates. Even if some of that supply can get soaked up by extra demand, there is a lot of oil sitting idle in tanks right now. That means oil prices likely won’t jump in the near term because the markets will need to work through the excess sitting in storage first.

While inventories are drawing down in the U.S., a group of companies are proposing increased storage along the U.S. Gulf Coast. Magellan Midstream Partners and LBC Tank Terminals are proposing a $95 million oil storage facility near Houston. The facility would be able to hold around 700,000 barrels of crude and would be connected to existing distribution infrastructure. If it moves forward, the site could be completed by 2017. Magellan’s project would greatly expand storage along the Gulf Coast, helping refiners access and store product.

In another major construction project along the Gulf Coast, Cheniere Energy (NYSE: LNG) announced that it would take on $5.8 billion in new debt to build a fifth LNG train at its Sabine Pass facility in Louisiana. Lining up financing is a crucial step before construction can begin. Cheniere hopes to further expand by building a sixth LNG train, but has not secured financing for that yet. The company expects to liquefy and ship its first load of LNG later this year when its first train finishes construction, kicking off a new era in which the U.S. becomes a natural gas exporter. Related: U.S. Oil Glut An EIA Invention?

The U.S. Supreme Court ruled against the EPA on an important air pollution regulation on June 29. The court ruled that the EPA failed to consider the costs of the Mercury and Air Toxic Standards (MATS) rule, the nation’s first attempt to regulate toxic mercury emissions from power plants. The 5-4 decision was a rebuke to the Obama administration’s attempt to wring out air pollution from utilities, but it may have a more modest impact than the hype suggests. Utilities have already invested billions of dollars to comply with the rule, leaving few power plants around to benefit from the court’s decision. According to SNL Financial, only about 22 power plants might be affected.

Moreover, the court didn’t kill the rule, but merely sent it back to a lower court. At worst, the EPA could roll out a new rule that adequately addresses the court’s objections by including costs, although the process will take several more years. Bottom line is that the coal industry just got bit of relief, but it probably doesn’t significantly alter the terminal decline that appears inevitable at this point.

The decline of coal, along with a weak year for oil and agricultural commodities, are cutting into the profits of rail shippers. In recent years the rail industry has had extraordinarily successful outings, profiting off of the demand for crude. But with drilling slowing down amid a glut of oil, rail traffic has tumbled. And with utilities increasingly switching from coal to natural gas – which is not shipped by rail – rail demand has taken a hit there too. An index of the four largest rail shippers has fallen by 20 percent.

France is increasing its business and security relationship with Sunni-led countries in the Middle East, most notably Saudi Arabia, Qatar, Egypt, and Kuwait, according to a Reuters report. The development comes just as Iran appears tantalizingly close to a historic thaw in relations with the United States, its erstwhile rival. France has surprised many by taking a harder line with Iran than the U.S., demanding bigger concessions. Related: The Coming Financial Apocalypse For U.S. Shale

And as France’s skepticism of Iran has become apparent, so has its outreach to Iran’s enemies in the Middle East. France has stepped up military hardware sales to the Gulf Arab states, along with billion dollar sales of commercial airliners. France’s President even received an invitation from Saudi Arabia to attend a regional summit, a high honor. “We have common views with regard to the challenges in the region today with Syria, Yemen, Iraq, terrorism and of course Iran's nuclear programme, and there are very large commercial and military ties between our two countries. We hope to increase those,” Saudi Foreign Minister, Adel al-Jubeir, told Reuters in an interview.

Following up on a story we wrote about last week, the UK has rejected another proposed shale drilling project by Cuadrilla. The second permit that Cuadrilla hoped to receive was dismissed by the Lancashire Council, essentially putting an end to shale drilling in the UK for the time being. The UK is sitting on sizeable shale gas reserves, but with the public pressuring local governments, there is little chance for companies to tap those resources anytime soon.

The deadline for Iran negotiations is ostensibly set for today, June 30, but it appears that all sides will work past the deadline for a few days in order to try to clinch a deal. Iran sent high level officials on June 29 for a last minute push, but the talks will go past Tuesday’s deadline. Stay tuned.

Finally, in another story we discussed from last week that got a lot hotter in just a few days, the pending default by Greece caused a sell off across global markets on June 29. Both WTI and Brent lost around 2 percent as investors grew jittery. Greece is not a major producer or consumer of oil, but the threat of contagion is enough for major investors to question the longevity of the Bull Run that we have seen in markets in recent years. While oil prices will likely recover if and when the situation blows over, expect oil prices to remain soft amid the turmoil, at least through this week.

By Evan Kelly of Oilprice.com

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