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This Key Data Points At Strong U.S. Oil Demand

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Oversold Oil Markets Rally On Rumors Of OPEC Cut

Oversold Oil Markets Rally On Rumors Of OPEC Cut

Oil prices have seen a sharp rally over the last days and are back in the mid-30's while the national average gasoline prices in the U.S. have fallen over 15 cents per gallon since the start of the year.
Increasing U.S. crude inventories do not seem to have negatively impacted the oil markets this week.

Related: Continental Resources 2016 Guidance & Oil Price Impact

Oil prices surged this week on speculation that Russian and OPEC might work together to stabilize markets through coordinated production cuts. The latest developments are confusing due to conflicting statements from officials from both sides. Russia’s energy minister said that the country would consider a proposal of a 5 percent production cut, but would wait to discuss the option with OPEC in February. At the same time, top OPEC officials dismissed the speculation. Other Russian officials also downplayed the possibility of a production cut. The markets did not care – WTI and Brent surged to $34 per barrel by Friday, up nearly 10 percent for the week.

One worrying sign to keep an eye on: the fundamentals. The EIA reported a sharp uptick in crude oil inventories this week, breaking a new all-time high. U.S. oil in storage has now reached 494.9 million barrels, surpassing the previous record set in April 2015.

The Russian government is formulating plans to take in more money from its oil and gas industry by cancelling tax breaks. The industry is opposed to the measures, which they argue will lead to a steeper decline in Russia’s oil and gas production over the long-term. But the government is desperate to raise more revenue amid a serious recession. The de facto tax increases are not yet finalized.

Chevron (NYSE: CVX) was the first out of the majors to report fourth quarter earnings – and it wasn’t pretty. The oil major posted its first quarterly loss in more than 13 years, reporting a $588 million loss compared to a profit of $3.47 billion for the same quarter in 2014. Chevron’s exploration division reported the largest loss – $1.95 billion in the fourth quarter alone. But even its refining divisions were down as refining margins shrank towards the end of the year. The company’s output still managed to climb 4 percent in 2015, but it is now in the midst of a significant cost-cutting campaign. Chevron says it will spend $26.6 billion in 2016, or a 24 percent reduction from 2015. Related:Russian-OPEC Production Cut Remains A Long Shot

Refining giant Valero Energy (NYSE: VLO) also reported earnings for the fourth quarter. Earnings from its refining unit were flat, but due to charges and a decline in its ethanol business, the company reported a decline in overall earnings by 74 percent.

Saudi Arabia’s foreign exchange reserves continue to dwindle from low oil prices. In December alone, Saudi Arabia exhausted $19 billion from its cash reserve war chest, bringing the estimated total down to $608 billion. The oil kingdom lost $115 billion in 2015 alone. The Saudis are still sitting on one of the largest piles of cash in the world, and they could continue to burn through those reserves at the current rate, at least for a while, but persistent low oil prices only increase the pressure to eventually do something. For now, they are content to continue on the current course.

The long-term picture for Saudi Arabia is different. Reuters reported that the government is in talks with an army of consultants to figure out ways to diversify the economy beyond oil, looking into things like tourism, shipbuilding, information technology, etc. Of course, Saudi Arabia has long talked about economic diversification, but the massive budget hole is forcing a much harder look at reforms. In the short run, austerity and a dependency on oil is unavoidable. But Reuters reported that there is momentum towards real reform behind the scenes.

Nigeria is also facing mounting pressure on its currency, the naira. It is blocking certain imports in an effort to stem the losses on its foreign exchange. A competing priority – keeping the currency pegged at its current rate – is becoming more costly to defend, but the government is trying to prevent inflation. The import restrictions are stifling economic growth, and international investors, eyeing a possible devaluation, are slowing investments into Nigeria. Something will soon have to give and Nigeria is under growing pressure to abandon its currency peg. Related: Weak Economy Could Stifle Oil Price Rally

Everyone has been closely watching Iran to see how much oil it will return to the market. There has already been news that Greece could be the first European country to import Iranian crude. There were also deals between Iran and Italian oilfield service companies for pipeline work in Iran. But what will this mean for overall global supplies in the near-term? Best estimates at this point predict that Iran’s oil exports will jump to 1.5 million barrels per day in January and February, or an increase of 20 percent compared to 2015 averages. Much of the increase will come from the 40 million barrels of oil and condensates that Iran has sitting in floating storage in the Persian Gulf.

The Bank of Japan surprised the markets on Friday with its decision to pursue negative interest rates. Japan has struggled with extremely low inflation levels for years, and the central bank is now taking extraordinary measures to beat back deflation. The bank is already buying up $674 billion in assets each year in an effort to depress interest rates, spur economic activity, and induce a bit of inflation. But turmoil in global financial markets, especially from a slowdown in China, forced the central bank to go the route of negative interest rates. The yen dropped by more than 2 percent on the news.

What does that mean for energy? First, a weaker yen will depress Japan’s demand for imported products, including coal, gas, and oil. Japan is the largest importer of LNG in the world, so the negative interest rate policy is bad news for LNG prices. Then there is a second effect. The move will put pressure in the U.S. Federal Reserve to back off its plans to hike its own interest rates, over concerns that the dollar will strengthen too much. That could turn out to be a positive for oil prices, but much remains to be seen.

By Evan Kelly of Oilprice.com:

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