Thursday, March 7th, 2019

Oil Market Breakdown

The Bearish Risk Of Bullish News


Oil market bulls have had an easy two and a half months to start the year as prices have trended steadily higher. Working in concert, OPEC+ production cuts, central bank easing and progress on a US/China trade deal have basically eliminated downside risk and added a healthy amount of upside risk. We’ve been largely optimistic on all three themes and continue to believe they will positively impact prices through the balance of 2019. In short, we see continued OPEC+ cuts near current levels, continued dovish signaling from the US Fed and a US/China trade deal that Mr. Trump can use to get momentum in the 2020 elections.

Unfortunately, we also keep getting this nagging feeling these positive themes have been priced in to the market and 2019 could be the ultimate year of ‘buy the rumor, sell the news’ even if substantially bullish macroeconomic, geopolitical and fundamental upside headlines come to fruition. While we aren’t turning bearish on oil, we continue to believe that the easy money has already been made from the long side and observed tepid reactions to positive news on all three key fronts this week which make us think that there will need to be significant bullish surprises in order to push oil prices north of the $75 mark.

Perhaps the best example we’ve seen of this in the last few trading sessions has been the reaction to OPEC+ production data. OPEC+ production data for February revealed increased will from the Saudis to tighten the market alongside increase political strain in Venezuela and Nigeria. The cartel’s production fell to its lowest level in four years. Unimpressed, oil has moved completely sideways on the news looking more concerned with the restart of a recently shuttered Libyan oil field.

On the macro side, central banks continue to tip their hand to more dovish coordinated action particularly from the US Fed, European Central Bank, People’s Bank of China and the Bank of Japan. While low rates and money printing are obviously still positive for commodity prices, we think it’s unlikely that we’ll see the sort of ‘macro turbo fuel’ we and other market participants saw earlier this year for the simple reason that if every other central bank prints money alongside the US Fed we may not see significantly US Dollar weakness. It’s highly notable for oil traders that the US Dollar Index is still higher on the year despite a relentlessly dovish Fed. This is yet another signal that markets will have to ratchet the headlines up a notch to push oil meaningfully higher.

As for US/China, US Secretary of State Mike Pompeo told a newspaper on Monday “it’s never over ‘til it’s over, but they’ve made a lot of progress, and so I’m very hopeful that in the coming days and weeks, there’ll be a significant announcement.” Both sides are still lobbing harsh rhetoric towards one another in the press and continue to negotiate hard, but markets seem clear in pricing in the expectation that both sides will make a deal at some point this year. Unfortunately, US/China tensions and Brexit are weighing tremendously on markets even if they are resolved in a positive manner and this is showing up in global GDP data. This week the Paris-based Organization for Economic Cooperation and Development cut their 2019 global GDP growth forecast from 1.8% to just 1.0% after growing at 3.9% in 2018 (according to the IMF.) Stock markets have also looked underwhelmed as a potential deal has progressed with S&Ps touching a three-week low on Wednesday.

As we look ahead, it’s important to remember that continued OPEC+ cuts, central bank easing and a US/China trade deal may not be enough to push the market substantially higher as traders have already priced in a decent amount of optimism on all three fronts.

Quick Hits

Brent

Hedge

- Global crude prices moved sideways yet again this week with Brent treading water near $65/bbl while WTI was flatlined near $56/bbl.

- Bloomberg’s OPEC production estimates for February have been released seeing the cartel’s output at 30.5m bpd representing a 560k bpd decline from January and a four-year low. Saudi output fell 100k bpd to 10.1m bpd, Venezuelan output fell 160k bpd to 1.07mbpd, Nigeria output fell 30k bpd to 1.76m bpd, Iranian output fell 90k bpd to 2.65m bpd and Iraqi production fell 70k bpd 4.62m bpd.

- Saudi leadership is signaling they remain committed to leading OPEC+ production cuts into the second half of 2019. Energy Minister Khalid Al-Falih commented last week that “all of the outlooks that I have seen tell us that we will continue, we’ll need to continue, to moderate production in the second half of the year.”

- On a more bearish note, Libya’s NOC lifted the force majeure placed on its 300k bpd Sharara field this week and expects to resume exports this weekend after a three-month stoppage.

- Emerging markets showed strain over the last week. India reported 4Q’18 GDP growth of 6.6% for its worst mark in five quarters. Factory activity shrank in China for a third straight month.

- Hedge funds continue to buy oil but current positioning is by no means historically aggressive. Money managers currently hold a net long in ICE Brent futures and options of 291k contracts and have accumulated a net long in NYMEX WTI futures and options of 130k contracts. Despite eight straight weeks of net buying fund net length is down by 54% from last spring in ICE Brent while length in NYMEX WTI is lower by 70%.

- Bloomberg reports that the US/China trade spat has led to a complete stoppage of Chinese imports of U.S. crude oil. In January ’18 China imported 2 million metric tons of U.S. crude. In January ’19 that number was 0.

- U.S. and Chinese trade officials continue to signal that progress is being made towards a trade deal but barriers to a pact remain.

- Equity markets continued to diverge this week with European and Shanghai shares moving higher while U.S. shares softened.

DOE Wrap Up

crude

gasoline

- U.S. crude output was flat w/w at 12.1m bpd. Production has averaged 11.9m bpd in 2019 after averaging 10.8m bpd in 2018 and 9.3m bpd in 2017.

- U.S. crude stocks increased 7m bbls w/w to 453m bbls. Overall crude stocks are +7% y/y.

- A spike in crude oil imports was largely responsible for the increase in inventories. U.S. refiners and traders imported 7m bpd representing a 1m bpd increase w/w. Crude imports have averaged 7.4m bpd over the last six months.

- U.S. crude exports fell to 2.8m bpd last week and have averaged 2.4m bpd over the last six months.

- Cushing crude oil inventories increased 873k bbls w/w to 47.5m bbls representing a 15-month high. WTI spreads have continued to fall further into contango as Cushing stocks have filled up over the last three months.

- The U.S. currently has 28.6 days of supply of crude oil which is +2 days y/y.

- U.S. refiner demand jumped 100k bpd to 15.99m bpd. Overall inputs are lower y/y by 110k bpd over the last four weeks.

- Good news for U.S. refiners- crack margins continue to improve with the WTI 321 crack moving to $22/bbl this week. The RBOB / WTI crack is currently $19/bbl while the Heating Oil / WTI crack is offering $28/bbl. In Europe the gasoil / brent crack is trading $17/bbl.

- U.S. gasoline stocks fell 4.2m bbls w/w/ to 251m bbls and are flat y/y over the last four weeks.

- U.S. gasoline demand + exports printed 9.97m bpd last week and is averaging 9.71m bpd so far in 2019 which is flat y/y.

- U.S. distillate stocks fell 2.4m bbls to 136m bbls and are -0.5% y/ over the last four-week period.

Inside Intelligence

Global Intelligence Report – 7th March 2019


Sources

- Deputy aid to Turkish Foreign Ministry

- High-level official in Turkish Energy Ministry

- High-level diplomatic, intelligence and banking sector sources in UAE

BREAKING: We are about to witness the next UAE/Saudi-led attack on Qatar, which has the potential to shake markets. Our network of high-level sources in the region say that the UAE is now spinning a story to its regional allies that it has proof that Qatar is supporting terrorists using its financial infrastructure. They are trying to bring down Qatar National Bank, which claims to have been hacked in 2016. The UAE story is that they found names on the QNB database that support the allegation that Qatar is financing terrorism. In other words, the UAE hacked into QNB.

Investors: Why You Should Bet on Cypriot Oil & Gas, Despite Turkish Threats

Turkey appears to be throwing down the gauntlet in terms of oil exploration and its conflict with Cyprus. But things are not always as they appear. Turkey has just announced, very publicly, that it will launch oil and gas exploration off the coast of Cyprus. To wit: The Turkey foreign minister, Mevlut Cavusoglu, said drilling will start in this area in the “coming days”—and it is a direct challenge to the Greek Cypriots, and, indeed, Exxon, which has recently started exploring in this area of the eastern Mediterranean. The Turkish foreign minister said two drilling ships would be deployed around Cyprus. The message was this, with no need to read between the lines: “Let those who come to the region from far away, and their companies, see that nothing can be done in that region without us. Nothing at all can be done in the Mediterranean without Turkey, we will not allow that,” the foreign minister said.

But Turkey’s threats—while not empty entirely—are not exactly genuine. This is an election year, and Turkey’s oil exploration rhetoric should be viewed partly in the context of these elections. Make no mistake, though, there is some substance to the threat that goes beyond mere populism.

Turkish President Recep Tayyip Erdogan, Foreign Minister Mevlut Cavusoglu and Energy Minister Fatih Donmez have repeatedly hailed drilling operations in the Mediterranean in recent weeks. Fatih, a ship that is currently drilling off the coast of Antalya, will soon be joined by Yavuz, according to Turkish officials.

As the March 31 local elections approach, the two ships' activities are more or less vessels of nationalism for the Turkish public. They are also intended to pump up optimism about the future of the economy. In recent years, before each election, Turkey's ruling party applied the same two tactics: 1) Appealing to nationalist voters with jingoistic policies and 2) Releasing fake news stories through state-run media that hail the discovery or possible discovery of energy reserves, anywhere from southeastern Turkey to the northwest.

We have access to the foreign ministry and the energy ministry in Turkey. And while they will not outright admit that this sudden renewal of pomp and circumstance over drilling off Cyprus is about election point scoring, it is clear in lengthy talks with them that populism is the key element. A top aide of the deputy foreign ministry and a senior bureaucrat at the Energy Ministry have conceded as much. Once the elections are over, this rhetoric will suddenly be dialed down. Consider the second drilling ship—the Yavuz: Our source within the Turkish Energy Ministry admitted that it is going to be withdrawn to the Black Sea for Turkey exploration there. So it may have made it to the Mediterranean in a show of populist force against the Greek Cypriots and Western drillers, but that was more of a parade-like detour on its way back to the Black Sea.

Our source in the Turkish Foreign Ministry likewise confirmed that there was "no big game plan" for now regarding the activities of the two ships. But he also made it clear that the end game here is to stop the Cypriots by being as disruptive as possible. "Regardless of these activities, one of our red lines is to stop Greek Cypriot from exploiting the island's reserves alone by sidelining the Turkish Cypriots. We will continue to oppose it," he said.

So, what can Turkey do to disrupt Cyprus’ oil and gas exploration? Behind being simply a hindrance and making a big deal about it vocally, it is not clear what the Turks can do. After all, even its foremost ally, Qatar, is participating in Greek Cypriot drilling—and that is the most important thing to remember. All of the noise coming out of Turkey serves two purposes: 1) political populism ahead of elections; 2) getting the UN’s attention for a mandated negotiation.

The timing of the government’s latest threat is significant in another way, too: On the same day last week, ExxonMobil announced a natural gas discovery off the southwest coast of Cyprus—calling it the biggest find off Cyprus so far; and one of the biggest discoveries in the world in the past couple of years. The stakes have never been higher: Exxon says the preliminary data suggests 5-8 trillion cubic feet of natural gas in place. It also follows a world-class discovery. But, again, Qatar Petroleum is Exxon’s partner in this, so that makes things a bit tricky for Turkey.

Regardless, energy is an urgent issue for Turkey, and last year’s currency crisis made it even more urgent. It also explains the need for the appearance of economic optimism ahead of elections. Turkey will need billions of dollars to stabilize its economy in the coming months and years, and large oil or gas discoveries, whether in the Black Sea or the Mediterranean or on the land, would be extremely beneficial.

But Turkish officials aren’t nearly as optimistic as their public statements would have them seem. According to our source in the Energy Ministry: "Drilling only recently started and we don't know whether it will be feasible to extract it even if we discover oil and gas reserves thousands of meters deep. It's too early," he said.

The bottom line is this: Turkey cannot stop this, and it can only go so far in even trying to hinder or threaten Exxon’s drilling off Cyprus. Qatar is far too important an ally for Turkey, who has definitively gone on the offensive against Saudi Crown Prince MBS. Without Qatar, Turkey has no Middle East allies outside of Iran. For investors, it should not make sense to bet against Exxon over Cypriot oil based on threats emanating from Turkey. Exxon knows this, and partnering with Qatar Petroleum was its human shield. Cypriot oil and gas will be huge.

Global Oil & Gas Playbook

Deals, Mergers & Acquisitions

- Warburg Pincus, KKR, and two independent energy producers are among the suitors for BP’s shale assets worth $7 billion that the company is selling to streamline its onshore U.S. operations after the $10.5-billion acquisition of BHP Billiton’s shale portfolio in the country. BP plans to sell a total $10 billion worth of assets in the U.S. over the next two years.

- Japan’s Inpex has become the latest newcomer to the U.S. shale patch after a subsidiary of the energy major, Inpex Americas, acquired a number of exploration and production assets in the Eagle Ford play from GulfTex Energy. The buyer did not disclose the size of the deal but said it will help expand its oil and gas operations and boost production of oil and gas.

Tenders, Auctions & Contracts

- Occidental Petroleum has inked a production sharing agreement with Oman for the operation of Block 72. The deal is worth $59 million and will be carried out in two phases covering exploration before production begins. Occidental has been present in Oman for three decades and operates three oil fields there.

- TechnicFMC has scored a contract for the front-end engineering design of BP’s floating production, storage and offloading vessel it will station at the Greater Tortue Ahmeyim offshore gas field spanning across the border between Mauritania and Senegal. The value of the contract is between $496 million and $1 billion, the Italian company said. The FLNG project will have an annual capacity of 2.5 million tons of liquefied natural gas.

- Essar Oil has become the first company granted a license for both conventional and unconventional gas exploration in India under a new, laxer regulation regime. Essar will explore for shale gas in West Bengal, in a coal bed methane block it holds the rights to. Previously, energy companies could explore for either conventional oil and gas, or shale oil and gas and coal bed methane.

Discovery & Development

- BP has started production from the Angelin natural gas field offshore Trinidad. This is the third gas project BP embarks on in Trinidad and Tobago in the last three years and also the third new project to begin production since the start of the year. The Angelin platform has a daily production capacity of 600 million cu ft of gas. Trinidad and Tobago are a major part of BP’s plans to boost its average daily production by 800,000 bpd of oil equivalent by 2020, accounting for a fifth of the increase.

- Bahrain is in talks with U.S. energy companies for assistance in the development of what the sultanate proclaimed the largest oil discovery in about a century. The offshore deposit is unconventional and may contain up to 80 billion barrels of oil, of which 5-15% recoverable. The government hopes it could attract a partner with expertise from U.S. shale oil extraction by the end of the year.

- The Queensland government has approved the first large-scale LNG project in several years as gas supply for the local market tightens on the back of booming exports. The $7.14-billion Surat gas project is a joint venture between Shell and PetroChina and will bring 5 trillion cu ft of natural gas into markets, both local and international. Production should start next year, using infrastructure from a nearby Shell project, QGC.

- Total has announced it will end drilling operations at an offshore project in French Guyana after failing to strike commercial amounts of oil or gas. The company had planned five drilling sessions at the deposit but only if the first one produced promising results, which it apparently did not.

Company News

- Petrobras booked its first annual profit in five years in 2018, at $6.83 billion. The result missed analyst expectations but suggested the Brazilian energy giant is on the mend after a corruption scandal and the 2014 oil price crisis shook its foundations. The company is not yet trouble-free, with a still substantial debt load that it plans to relieve through asset sales.

- Petrofac reported $106.54 million in 2018 pre-tax profits, up more than twofold on the year, thanks to a strong order book, the company said. The value of this book stood at $9.53 billion at the end of 2019.

- Tellurian reported LNG sales revenues of $5.9 million for 2018, its second year as a public company. It also booked natural gas sales revenues of $4.4 million.

- Encana swung into a profit in the fourth quarter of 2018, at $1.03 billion versus a negative result of $229 million a year earlier. The result was boosted by a $941-million one-off gain.

Politics, Geopolitics & Conflict

- Tension between India and Pakistan flared up last week when a suicide bomber attack against Indian troops led to air strikes from India.

- Venezuelan opposition leader Juan Guaido has announced he will return to Venezuela after violating a Maduro-imposed travel ban. How the incumbent in the president’s office will react may determine the outcome of the political crisis in the country. In the meantime, Maduro has managed to move another 8 tons of the country’s gold out of the Central Bank in a desperate effort to raise cash while sanctions strangle him. We don’t yet know where this gold went, though it has gone previously to Turkey and the UAE.

- Algeria is undergoing something akin to an ‘Arab Spring’ over President Bouteflika’s announcement that he would run for a fifth term, despite massive protests calling on him to step down. He’s barely alive at this point, but determined to hold on to power despite his 82 years and a stroke that has largely incapacitated him. This time around, the Algerian regime may not be able to buy its way out of an Arab Spring with generous subsidies funded by energy wealth.

- The Saudis has scored an easy few points with Washington (while Senators are still pushing for something more over the Khashoggi murder) by stripping the son of Osama bin Laden of citizenship as the U.S. offers $1 million for information on his whereabouts. Earlier this month, Hamza bin Laden released a video in what is seen as the ‘revival’ of Al-Qaeda, calling for attacks on Western targets and threatening to target Americans abroad. Other recent bones thrown to the American public by the Crown Prince include the flashy appointment of a female ambassador the U.S. (at the same time that it is rounding up female activists at home). The Crown Prince also met with Kushner for the first time since the Khashoggi murder, and Kushner is the link between the Crown Prince and Washington (via MBS’ ‘creators’ in the UAE).

- There is now, once again, talk that Libya will hold elections by the end of the year. Last week, the prime minister of Libya’s internationally recognized (tongue-in cheek) government, Fayez al-Serraj, met with powerhouse General Haftar (who controls the Libyan national army). We do not yet have any details on those talks, but the LNA is making a massive push for control and could very well make a run on Tripoli this year. Timing elections for the end of the year gives Haftar enough time to secure control.

Executive Report

The Battle For The World’s Top Oil Benchmark


Many countries would like to have their own crude grades as international benchmarks that others would price their volumes against, however, only very few countries can boast of such a thing. Brent is the leading world benchmark, the first one to get all the letters in what we should call hereafter MAST (movability, availability, scope and transparency). It was moveable across the planet due to its seaborne location and easy access to export infrastructure, it was available because the governments of United Kingdom and Norway guaranteed their non-interference in the companies’ system of operation, it was plentiful because North Sea production was one of the dominant forces in European production growth and it was transparent because relevant companies thought having a retraceable baseline was too noble a cause not to share information about concluded deals.

Throughout the last decades Brent has undergone lots of changes – from being used as a single-source benchmark, it has grown to include first Oseberg and Forties in 2002, then Ekofisk in 2007 and Troll in 2018, all the while battling difficult structural issues such as irrevocable production declines and dropping numbers of reported trade deals in BFOE physical cargoes. Thus, both the scope and transparency elements suffered heavily amidst reoccurring calls for a thorough reform of the benchmarking system. They were, it has to be said, completely legitimate as the whole BFOE basket went from 55.33 million tons of production in 1996 (then UK accounted for 27 percent) to a mere 14.5 million tons by the year 2018 (with Britain just 12 percent).

production

Source: Norsk Petroleum, UK Oil and Gas Authority.

As one looks at the declining rates of production on the five fields that currently make up the Brent basket, it is reasonable to ask if Johan Sverdrup could solve the lack of traded crude. Johan Sverdrup is the most significant project on the Norwegian continental shelf currently, destined to reach a production plateau of 660kbpd – a quarter of Norway’s total output by that time in the mid-2020s. Even though some have anticipated the inclusion of Sverdrup in the Brent basket, it looks increasingly unlikely that this would be the path forward for the next couple of years. Firstly, this would make Brent a predominantly Norwegian pool, minimizing any British impact on it. Secondly and perhaps even more importantly, Sverdrup is a medium quality crude, with a 28 degree API and 0.8 percent Sulphur content, which would heavily skew the mainly light sweet North Sea basket.

north sea
Source: ICE.

The case for a prudent assessment reform is fortified by changes in the regional distribution of demand for North Sea grades. Forties is a fitting example – it has always enjoyed high levels of interest in the Asia Pacific region, however, if in 2017 the leading buyer of the crude was South Korea which took in roughly 35 percent of all cargoes, last year (i.e. 2018) witnessed a drastic shift towards China, which now takes in more than 55 percent of all Forties on the market. This creates a potential situation in which the opening of an arbitrage window and robust Chinese demand might skew the oil prices.

Thus, against the background of falling production, decreasing number of trades reported, substantial arbitrage windows that skew the demand picture and the incompatibility of upcoming projects, it is evident that something has to be changed. Last week’s International Petroleum Week in London provided a fitting opportunity for both S&P Global Platts and Argus Media, the world’s leading crude price assessors, to present their vision of what Brent ought to look like in the future to remain relevant. The core basis of both companies’ methodology will remain the same – up until now, it was always the cheapest of Brent, Forties, Oseberg, Ekofisk and Troll on a FOB basis that set the Dated Brent. This premise will remain the same in the future, too, however, the ways forward are quite different.

Argus has already launched its New North Sea Dated on February 15, the crux of which revolves around the inclusion of six non-European crudes to the Brent basket on a delivered Rotterdam basis. Argus has tried to keep the crudes somewhat similar in quality to Brent – Azeri BTC, Saharan Blend, Qua Iboe, Bonny Light, Escravos and WTI are light sweet grades, too. All six new crude types are to be adjusted for freight and timing, with the lowest-priced setting the New North Sea Dated. There remain fears that the inclusion of WTI into the basket would ultimately push prices down and so far the amount of statistical data to judge the validity of this claim remains insufficient to know for sure. Yet it is absolutely certain that the New North Sea Dated would trade lower than the conventional one.

Platts has also envisaged some changes to its Dated Brent price, albeit less revolutionary than Argus and without the inclusion of non-European grades into the basket. From October 2019, Platts will take into account any CIF Rotterdam offers for the Brent basket of crudes, adjusting it for freight and sailing time. Platts points out that the delivered Rotterdam prices will not form part of the benchmark and will be relevant only when a particular cargo is traded around. With a gradually increasing freight adjustment factor to the deliveries, Platts intends not to include cargoes that are traded from onshore storage – meaning Rotterdam storage – and that only offshore storage at the crude grade’s loading points’ would be taken into account.

The lack of revolutionary zeal on Platts’ part is due to the fact that it is their assessment which forms the basis of North Sea Dated trading, Argus’ is largely irrelevant therefore they can allow themselves ambitious experiments with the inclusion of grades that might be supplied to Europe, yet are far from becoming its staple diet. The UK-registered firm understands this, hence Argus’ intention to promote WTI Houston as the world’s leading benchmark, i.e. the one which should be used universally and which is under Argus’ control. Further complicating matters, Argus has been sold to US capital recently and the rumor goes that it is influenced by US elites to peg much of the crude world’s trade to a US basis.

WTI Houston is without a doubt a very promising ambition, however refiners and traders alike are too conservative in this respect to move along a murky path, the end of which is far from being obvious. Thus, the future of benchmark price assessments remains open – on the one hand Platts is working to make a wider concept out of it, as well as to make it more liquid, without solving the underlying issue of physical volumes gradually disappearing from the markets. Argus is pushing forward to use WTI Houston across all the globe, an assessment that would be theirs, yet the market participants’ readiness for this is still under question, especially in Europe. It should be a very interesting battle of benchmarks in the future.

Industry Outlook

Oil For Power: Bucking A Long-Term Trend


Oil demand for power generation has been in long-term decline since 1990 as countries have gradually displaced oil with cheaper feedstocks, primarily coal and natural gas. Since 1990, this process has freed up some 2 million b/d of oil for other uses. However, oil for power still accounts for just over 4 million b/d of demand or 4-5% of global oil consumption.

There are two reasons why oil-for-power use will buck its long-term trend in both 2019 and 2020, even though the secular forces pushing it slowly towards obscurity are now more powerful than ever before.

Iran sanctions

Iran’s use of oil for power generation is likely to rise sharply this year as a result of the re-imposition of US sanctions on the country’s crude exports from November 5 last year. Iran’s crude exports were estimated at between 1.1-1.3 million b/d in January and February, according to industry sources, down from 2.5 million b/d in April 2018 just before Washington withdrew from the 2015 Iran nuclear deal.

Iran’s internal response to sanctions in the past has been to increase oil burn for power generation, maximise refinery throughput and use petrochemical plant to produce oil products such as gasoline. In 2010, Iran’s oil use in power generation was about 225,000 b/d, but, by 2013, at the height of the earlier sanctions period, this had more than doubled to 471,000 b/d.

Since then its ability to export both gas and electricity to Iraq has increased. Tehran has every incentive to maximise oil burn at home to sustain the revenues gas and electricity exports provide. Power blackouts were also cited as a key grievance behind violent protests in the oil producing Basra region in Iraq last year. Given the failings of its own gas and electricity grids, Baghdad is equally keen to see these imports continue.

The US is thus engaged in multiple balancing acts when it comes to sanctions.

Although US officials have reiterated their desire to reduce Iranian crude exports to zero as they consider the extension and possible tightening of waivers from April, it is also a major supportive factor for crude oil prices. Higher oil prices hit the pockets of US consumers at a time of economic fragility just as presidential elections loom on the horizon.

Equally, forcing a reduction in gas and electricity imports from Iran to Iraq risks stoking social and political discontent within Iraq, which is also a major oil exporter.

US sanctions on Iran take barrels off the international market, but are also likely to see Iranian oil for power generation double from just over 150,000 b/d in 2017 to around 300,000 b/d or more in 2019 and 2020.

Sulphur rules

The second factor likely to push oil-for-power use higher in the next two years is the International Maritime Organisation’s 0.5% cap on sulphur in bunker fuels, which comes into effect from January 1 2020. A lack of conversion capacity worldwide is expected to see a temporary surplus of as much as 500,000 b/d of High Sulphur Fuel Oil (HSFO) as shipping turns to lower sulphur fuels.

While many countries which still burn significant amounts of oil for power - for example South Korea and Japan - will be blocked from taking this cheap feedstock by domestic air pollution regulations, others - particularly in the former Soviet Union and Middle East - do not face such restrictions. Cheap HSFO will temporarily displace other feedstocks in areas such as power generation, refinery own use and cement production.

Secular decline

2019 and 2020 are, however, likely to be the exceptions that prove the rule, although how long the US’s current sanctions regime lasts and how tightly it is applied are key uncertainties.

Oil’s demise as a source of power generation will continue in the longer term, owing to the rise of both gas/LNG supply and distributed renewable generation.

The largest use of oil for power is in the Middle East, most notably Saudi Arabia, but Saudi Arabia saw a peak in oil-for-power generation in 2015, while for the region as a whole the high point was in 2013, driven by sanctions-induced Iranian consumption. Gas in power generation in the Middle East has been rising steadily, displacing oil and allowing oil producers to sustain oil exports.

The region generated 840 TWh of electricity from gas in 2017 up 7.7% from 2016 and a jump of almost 50% from 2013, displacing predominantly direct crude burn and HSFO use.

Saudi Arabia, Kuwait and the UAE all have large gas expansion programs. By 2030, Saudi Arabia plans to add 93 Bcm a year of new gas supply, Abu Dhabi 31 Bcm and Kuwait 29 Bcm as all three start to more intensively develop non-associated gas reserves. This gas will be used to support oil field production, for power generation, in refineries and as petrochemical feedstock.

On the power generation side, growing gas use will be supported by the development of 5.6 GW of nuclear capacity in the UAE and large amounts of solar capacity. New solar projects announced across the Middle East and North Africa region exceeded 12 GW last year. Current plans suggest as much as 25 GW of solar capacity could be built in the Middle East by 2030.

Gas is also making serious inroads into other key oil-for-power markets. Mexico can expect to see oil demand for power generation fall as increasingly large amounts of US shale gas flood across its northern border. In Pakistan, oil use in power generation tripled between 2004-2014, but the country can now import LNG and is developing its LNG-to-power supply chain. Egypt has already curtailed its oil use in power generation as a result of developing its East Mediterranean gas reserves. Oil-for-power use in these markets will become an emergency back-up option.

Remote usage

However, oil in power generation faces other threats, namely distributed renewables and small-scale LNG as an alternative to off-grid diesel generation in remote areas. Renewable energy sources and batteries are competitive against diesel in island settings, while small-scale LNG infrastructure is expanding in the Caribbean. Both renewables and small-scale LNG can offer competition to diesel in large archipelagos such as Indonesia and the Philippines.

Micro-renewables are increasingly seen as a cheaper and more effective way of achieving universal electricity access targets in developing economies. Diesel remains expensive, but renewables can deliver small amounts of power for critical needs at much lower capital cost than the build out of electricity and gas grid infrastructure, delivering in terms of both capital and operating costs. Micro solar is proving popular in countries like Nigeria and Kenya where the alternative would be a small diesel generator. Electrification is progressing on a different path than before.

Given the rise in gas supply, both pipeline and LNG, oil-for-power use will eventually resume its steady long-term downward trend. After an increase in 2019 and 2020, a major downward adjustment could occur if there is a change in US policy on Iran after the 2020 presidential elections, at precisely the same time that the impacts of the IMO’s sulphur cap are being resolved.

Numbers Report

U.S. Crude Inventories Rise Despite Strong Product Demand


The correlation between the OPEC/OPEC+ production cuts and rising US production has been the theme of the oil market for the past several months and most likely will be further on. This week has been no different, creating a peculiar set of counteracting trends that first push prices up, then pull them down – OPEC producing the lowest volume in 4 years was easily undone by two US oil majors, Chevron and ExxonMobil revealing their ambitious plans to ramp up Permian output even higher than it is already, with US crude stocks most likely rebounding back from last week’s decline.

market

Early signs (see Point 4) point to the possibility of a breakthrough in US-China trade talks, yet if the history of the last four months is anything to go by, do not bet your money on it yet. As of Wednesday end of day, Brent traded 65.7-66 USD per barrel, whilst WTI oscillated around the 56 USD per barrel mark.

1. US Crude Stocks Rise While Gasoline and Distillate Inventories Draw

crude

- The market once again saw a stock buildup for the week ended March 01 (API reported 7.3MMBBl w-o-w – EIA 7.1 million bpd.
- US crude exports dropped to 3.4mbpd from last week’s 3.6mbpd, with imports falling along at a much steeper rate to 5.6mbpd, some 1.6mbpd down from the week ended February 15.
- After weeks of incremental decreases, the refinery utilization rate started its move upwards with a 1.2 percent hike to 87.1 percent, on the back of 179kbpd of additional crude being refined.
- Motor gasoline stocks have dropped for the fourth week in a row by 4.2MMbbl to 250.7MMbbl in total, which, however, is still more than 4MMbbl above the 5-year average.
- Distillate inventories have edged lower, too, albeit insignificantly by 2.4MMbbl to 136MMbbl, some 4MMbbl below the 5-year average rate.

2. Saudi Aramco Raises All Its Asia-Bound April OSPs

Saudi

Aramco

OSPs

- The Saudi national oil company Saudi Aramco has mandated an across-the-board increase of all its April-loading grades destined for Asia Pacific.
- Arab Light and Extra Light witnessed the steepest increase, rising 50 cents month-on-month to $1.45 and $1.20 premiums over the Oman/Dubai average.
- Interestingly, Saudi Aramco cut its Mediterranean prices, with FOB Ras Tanura prices dropping a hefty $80-90 cents month-on-month, whilst FOB Sidi Kerir OSPs were down by some $60-70 cents compared to March.
- This sweeping reduction is largely Saudi Aramco’s reaction to Europe’s leading medium sour crude Urals weakening against Dated Brent, swinging back into discount territory after it traded much of January at a premium to Brent.
- Saudi Aramco April-loading OSPs for Northwest Europe were cut, too, however to a smaller extent than the Mediterranean ones, by $30-40 cents per barrel.
- Saudi Aramco rolled over its Arab Light, Medium and Heavy US-bound prices for the third consecutive month, only hiking the Arab Extra Light OSP by $30 cents to a 4.8 premium vs ASCI.

3. China Cuts VAT, Impacting Energy Profitability

- To buttress its slowing economy, Chinese authorities intend to cut value added tax (VAT) for the manufactoring sector from the current 16 percent rate to 13 percent.
- Resulting in refiners having to pay less tax on the crude they purchase, eventually bringing about savings around 1 USD per barrel on gasoline/diesel sales.
- The effect will be even more palpable with imported gasoline, diesel and fuel oil supplies, which are currently subject to a 1 percent import duty (as opposed to crude), and even more so for bitumen, lubricants and aromatics, whose import duties are even higher.
- Analysts predict the VAT cut will not produce that much of an explosion on the Chinese domestic market as the nation still experiences motor fuel oversupply, which will influence profitability more than tax rate changes.
- Pipeline gas and LNG, which are currently subject to a 10 percent VAT rate, will see it fall 1 percent.

4. US Exports First Cargo of 2019 to China

Exports

- After China stopped buying American crude starting December 2019, shipping data suggest a thaw in relations might not be that far away.
- MT Maran Artemis has finished loading at the Southtex Lightering Zone on February 28 and is now on its way to Qingdao where it should arrive by mid-April.
- This marks the first occasion this year that a US crude-laden vessel is loaded and dispatched to China.
- Interestingly, the loading took place three days after US President Donald Trump’s decision to postpone the tariff hike on Chinese goods that was initially planned for March 01.
- Compared to the 53 million and 67 million barrels of US crude supplied to China in 2017 and 2018, this year’s one cargo (1.2 million barrels) indicates 2019 numbers will most probably lag significantly behind.

5. El Sharara Force Majeure Lifted

Libya

(Click to enlarge)

- The Libyan national oil company NOC lifted the 300kbpd El Sharara field’s force majeure status on Monday, stating production would start within hours and that it would be just a matter of days until the field gets back to its pre-shutdown production capacity.
- This is more than welcome news for Libya’s oil sector in general, which without El Sharara and El Feel volumes dropped to 0.89mbpd in January-February 2019 from its multi-year high of 1.16mbpd in October 2018.
- NOC estimates that shutdown and restart costs, equipment theft and missed-opportunity losses during the 3 past months amount to a hefty $1.8 billion, corroborating the necessity to create their own armed forces.
- It remains to be seen to what extent did General Haftar’s Libyan National Army retain its presence around El Sharara, however, all members of the operating company Akakus Oil received written confirmations from LNA guaranteeing the safety of operation.

6. ExxonMobil Announces Cyprus Gas Find

Cyprus

- ExxonMobil announced a new gas discovery in Cyprus’ offshore zone, spudding its Glaucus-I wildcat well in Block 10 to a total depth of 4200m.
- Having encountered 133 metres of an excellent gas-bearing reservoir, the Glaucus is estimated contain 5-8 TCf of gas, confirming assumptions that fields in Blocks 10 and 11 have a similar structure that Egypt’s giant field Zohr, located just a couple dozen miles from there.
- Somewhat taming the drillers’ ardour, in early February ExxonMobil and its JV partner Qatar Petroleum have spudded the Delphynus-I wildcat some 10 miles to the south of Glaucus and found no commercial volumes of natural gas.
- With Cypriot offshore drilling in full swing, Turkey has stated it would start drilling in the maritime zone northwest of Cyprus, the demarcation of which is still pending.
- Turkey’s foreign minister Mevlut Cavusoglu promised to spud the first well as soon as April, however Turkey’s national upstream company TPAO retorted it can only start operations from summer.

7. PDVSA Gas Head Jailed

- Further tightening the screws within the Venezuelan state oil company PDVSA in another tour de force of law enforcement zeal, the Venezuelan military intelligence unit Sebin detained the president of the PDVSA gas division, Rosa Mota.
- With the military searching for scapegoats to blame the current dilapidated condition on, Mota made headway with the offshore Dragon field being developed jointly by Royal Dutch Shell, PDVSA and Trinidad’s NGC.
- Interestingly, Mota was detained when PDVSA CEO Manuel Quevedo was out of the country, travelling to Riyadh in Saudi Arabia for an OPEC-IEA workshop.
- Even though 90 percent of Venezuela’s gas is associated and is mostly reinjected or flared, gas production did not witness a drop as radical as that of crude, with output standing at 3.6 BCfd as of early 2018.

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