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Oil Price Volatility Increases On OPEC Outages


Friday September 14, 2018

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

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Key Takeaways

- Crude inventories fell again, dropping below the 400-mb range for the first time since February 2015. The significant drawdown helped push up oil prices.
- However, gasoline inventories rose yet again, offsetting some of the crude draw.
- Refinery runs are still extremely high, but should come down in the weeks ahead. That could ease the pressure on crude stocks while leading to some drawdowns in gasoline inventories.

1. U.S. upstream capex rising quickly

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- U.S. upstream capex has been soaring since 2016, despite promises of capital discipline from a long line of shale executives.
- U.S. upstream capex has more than doubled from $40 billion in 2016 to $100 billion this year, according to Bank of America Merrill Lynch.
- “This increase in spending is most evident in the rig and frac spread counts, which have also nearly doubled over the same period,” BofAML said in a note. “[B]ut these data points are more meaningful when accounting for efficiency and productivity gains that producers have achieved over the same period.”
- Drilling times have declined by two-thirds in most shale basins, so fewer rigs are needed to produce ever more volumes of oil. The U.S. is arguably now the top oil producer in the world.

2. Oil price volatility rises

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- The CBOE Oil Volatility Index has climbed by more than 13 percent since mid-August. Oil prices have climbed along with it.
- There are numerous factors driving volatility in the oil sector, including currency turmoil, emerging market demand, the U.S.-China trade war, unclear production plans from Saudi Arabia, output losses in Iran and Venezuela, and rising U.S. production.
- “It will be essential to monitor the uncertainty in currency and financial markets,” OPEC said in its latest monthly report.
- The looming sanctions on Iran have cast a great deal of uncertainty over the oil market, with potential losses ranging from 0.5 mb/d to double or triple that amount.

3. Currency declines exacerbating oil prices

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- The strength of the U.S. dollar has contributing to the steep losses in a growing number of emerging markets.
- “The economic environment in some emerging markets is deteriorating,” the IEA warned in its latest Oil Market Report.
- The strength of the U.S. economy, including strong job growth and wage increases, puts more pressure on the Federal Reserve to stick to its interest rate hiking schedule.
- That could deal more losses to emerging market currencies. The weakening currencies means that crude oil in these countries is vastly more expensive than it used to be.
- In the chart above, the IEA indexed Brent prices to January 2014. Brent is actually down since then, but in a whole host of countries, oil is significantly more expensive when expressed in local currency.

4. Air travel in China and India soaring

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- Air passenger travel in China and India is skyrocketing, as these two major economies continue to grow.
- The IEA says that year-to-date air travel, measured in revenue passenger kilometers (RPKs), is up 13.5 percent in China and 20.5 percent in India.
- In July, RPK was up an astounding 18.3 percent in India compared to a year earlier. The IEA attributes the growth to increased airport connectivity and strong economic growth leading to the emergence of a booming middle class.
- The Indian government plans on rolling out 100 new airports by 2035, a truly mind-boggling expansion.
- China will also see astounding air traffic growth in the coming years. The number of passengers will grow from 500 million to 1.5 billion in China between now and 2036.
- China will become the largest aviation market by 2022, and will build 74 new airports by 2020.

5. Venezuela’s oil production continues to decline

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- Venezuela’s oil production continues to erode. Output fell by another 20,000 bpd in August, falling to 1.24 mb/d. Production now stands at half of the level of 2016.
- The pace of monthly declines has actually narrowed a bit. In early 2018, it was routine to see month-on-month losses in excess of 40,000 bpd.
- Still, the problems facing Venezuela’s PDVSA are overwhelming. “Skilled workers are leaving in droves, output from mature conventional oil fields is dropping swiftly and upgraders operated by foreign joint venture partners in the Orinoco heavy oil belt are breaking down and running below capacity,” the IEA said.
- There is a good chance Venezuela loses another 250,000 bpd by the end of the year, putting production at about 1 mb/d.

Heard on the Street

Oil market “tightening up”:

“We are entering a very crucial period for the oil market. The situation in Venezuela could deteriorate even faster, strife could return to Libya and the 53 days to 4 November will reveal more decisions taken by countries and companies with respect to Iranian oil purchases. It remains to be seen if other producers decide to increase their production. The price range for Brent of $70-$80/bbl in place since April could be tested. Things are tightening up.” – The International Energy Agency

U.S. becomes world’s largest oil producer:

“US crude oil production has rebounded sharply since bottoming in mid-2016, with output reaching a new record 10.67mn b/d in June and 11mn b/d in the latest weekly EIA survey. This represents a growth rate of 1.6mn b/d YoY, a pace that exceeds that of any month during the initial 2011-15 shale revolution. We expect oil production growth to average 1.4mn b/d YoY this year and 1mn b/d in 2019. As a result, we believe US crude oil output will exceed 12mn b/d by the end of 2019. With Russia pumping 11.2mn b/d at present, this milestone should turn America into the world's largest crude producer within the next few quarters.” – Bank of America Merrill Lynch

Shale drillers pivoting away from Permian:

“As a result of the strain that Permian producers are likely to face for the next 6-12 months, production from other basins, including the PRB, Niobrara, SCOOP/STACK, and Bakken, may see increased activity in the coming months.” – Barclays

6. Brazil’s oil production disappoints

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- Brazil was thought to be one of the largest contributors of non-OPEC supply in the medium-term, but results have been disappointing for the last few years.
- Brazil’s pre-salt is still a massive opportunity. In fact, pre-salt production has surpassed 1.5 million barrels per day.
- However, surging output from the Santos Basin, where lots of new money is flowing, has been offset by rapid declines in the aging Campos Basin.
- On net, Brazil’s output stood at 2.7 mb/d in July, down 60,000 bpd from a year ago. Entering 2018, the IEA had expected production to grow by 260,000 bpd, so Brazil’s disappointment has tightened the global supply picture relative to earlier expectations.
- However, that isn’t the end of the story. An estimated 7 new projects are coming online this year, followed by 2 more next year. Brazil could add somewhere around 1.35 mb/d of new supply when these projects reach full capacity.

7. WTI discount widens again

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- The discount for WTI relative to Brent has seesawed this year, widening and narrowing every few months. The discount increased in August to $6 per barrel, compared to $4.37 per barrel in July.
- Ongoing gains in U.S. production, plus infrastructure bottlenecks trapping oil (to some degree) within the U.S., has weighed on WTI.
- Also, Suncor Energy (NYSE: SU) restored some lost output from its Syncrude facility after several weeks of an outage.
- The spread should bolster U.S. exports in the weeks ahead, although, due to the aforementioned bottlenecks, there is a ceiling on the volume of exports that can leave U.S. shores.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.

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