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The Energy Report for Friday, August 9, 2019

The Saudi Put

Saudi Arabia and their OPEC and non-OPEC co-conspirators vow to do whatever it takes to stop the drop in the price of oil. That may get harder as the International Energy Agency (IEA) warns about the rising risk to global oil demand growth and a fragile oil market. The main risk is the U.S.-China trade war they say, but looking at Chinese export data, one might wonder what all the fear is about. Some economic data does seem to be flashing warning signs, but global loosening of monetary policy should spark oil demand just when OPEC starts to cut back on more output. This could offset some of the normal demand softness into shoulder season and even some of the new supply that should come online as pipeline capacity gets increased in the U.S. later this year.

Rumors of the Saudi plan to stop the oil price slide are staring to leak out. Bloomberg reports that Saudi Arabia is to keep oil exports below 7.0 million barrels a day next month, as OPEC countries allocate less oil than demanded by customers, according to Saudi officials. There are cuts in allocations applied to all regions according to Bloomberg. They also say that Saudi oil production will be lower in September. The funny thing is that despite all the fears of a crash in oil demand, Saudi officials say nominations show strong demand for oil in all regions. Bloomberg says that the Saudi’s “could have satisfied Sept. demand and produced about 10.3 million barrels a day because demand is much higher, but decided to keep production, exports flat and cut customer requests by 700,000 barrels a day in effort to maintain market stability.”

Yet the International Energy Agency, known for their major underestimations of global demand, are warning of another global demand slowdown. Of course, at the same time they admit that global oil inventories have been tightening mainly due to OPEC production cuts. The IEA says, “There have been concerns about the health of the global economy expressed in recent editions of this Report and shown by reduced expectations for oil demand growth. Now, the situation is becoming even more uncertain: the US-China trade dispute remains unresolved and in September new tariffs are due to be imposed. Tension between the two has increased further this week, reflected in heavy falls for stock and commodity markets. Oil prices have been caught up in the retreat, falling to below $57/bbl earlier this week. In this Report, we considered the International Monetary Fund’s recent downgrading of the economic outlook: they reduced by 0.1 percentage points for both 2019 and 2020 their forecast for global GDP growth to 3.2% and 3.5%, respectively.”

The IEA continued, “Oil demand growth estimates have already been cut back sharply: in 1H19, we saw an increase of only 0.6 mb/d, with China the sole source of significant growth at 0.5 mb/d. Two other major markets, India and the United States, both saw demand rise by only 0.1 mb/d. For the OECD as a whole, demand has fallen for three successive quarters. In this Report, growth estimates for 2019 and 2020 have been revised down by 0.1 mb/d to 1.1 mb/d and 1.3 mb/d, respectively. There have been minor upward revisions to baseline data for 2018 and 2019 but our total number for 2019 demand is unchanged at 100.4 mb/d, incorporating a modest upgrade to our estimate for 1Q19 offset by a decrease for 3Q19. The outlook is fragile with a greater likelihood of a downward revision than an upward one.”

“In the meantime, the short- term market balance has been tightened slightly by the reduction in supply from OPEC countries. Production fell in July by 0.2 mb/d, and it was backed up by additional cuts of 0.1 mb/d by the ten non-OPEC countries included in the OPEC+ agreement. In a clear sign of its determination to support market re-balancing, Saudi Arabia’s production was 0.7 mb/d lower than the level allowed by the output agreement. If the July level of OPEC crude oil production at 29.7 mb/d is maintained through 2019, the implied stock draw in 2H19 is 0.7 mb/d, helped also by a slower rate of non-OPEC production growth. However, this is a temporary phenomenon because our outlook for very strong non-OPEC production growth next year is unaltered at 2.2 mb/d. Under our current assumptions, in 2020, the oil market will be well supplied.” Of course, we know from the past that the IEA‘s assumptions change quite frequently.

In the meantime, growing concerns about natural gas flaring could raise another challenge to the U.S. shale production outlook. In their quest to produce, oil drillers are producing an extraordinary amount of associated natural gas and because there is no pipeline capacity and production is exceeding demand, in many cases it is getting flared or burned off. Bloomberg News reported, “An unusual split vote by Texas regulators over the flaring of natural gas shows that the days of giving a free pass to the controversial practice in the Lone Star state may be numbered. The chairman of the Texas Railroad Commission, which oversees the oil and gas industry in the state, dissented during a recent hearing over a flaring permit. Wayne Christian said there’s too much gas being burned off out of convenience rather than necessity, and he’s concerned about the “frequency and ease” with which companies are being allowed to continue with the practice. While his comments didn’t alter commission policy, they indicate a change may be coming. Texas is widely regarded as the most oil-and-gas-friendly state, and the commission has never turned down a request to burn excess gas. But the volume now being flared — more than residential gas demand for the whole of Texas — has attracted criticism for both its wastefulness and the carbon-dioxide emissions that come with it.”

Oil traders have been awaiting new pipelines and have been pricing in the potential impact from new supply. Reuters news reports that, “The operators of two new pipelines in West Texas shale fields are offering discounted prices to attract shippers accustomed to high fees to move oil to export hubs, according to the pipeline companies and federal filings. These bargain rates, in one case half the initial published rate, will aid strapped oil producers that once had to sell their oil for about $10 less per barrel because of transport constraints to move their oil from the largest shale oil field in the country. But pipeline companies, which have in the past year raced to add new capacity to flow oil from the Permian Basin to the refining and export hub on U.S. Gulf Coast, will face pressure to cut rates in coming weeks, said oil traders and analysts. The two operators – EPIC Midstream and Plains All American (PAA.N) – are opening lines that combined will in coming months be able to carry about 1.6 million barrels of oil per day (bpd) from West Texas to the Gulf Coast. A third line, the 900,000-bpd line being developed by Phillips 66 (PSX.N), will open later this year that will boost total capacity to flow oil from the region by two-thirds. “There’s no way another 2.5 million bpd are waiting to get sent to Corpus Christi (Texas),” said Sandy Fielden, an analyst at Morningstar. “Clearly, there’s going to be too much capacity … There will be buying up of barrels in Midland like it’s going out of style.”

The Energy Information Administration reported that, “Estimated operating margins for corn-based fuel ethanol plants in the Midwest decreased to multiyear lows in 2019, averaging about 3.5 cents per gallon (gal) through the first half of the year. Ethanol margins were at or near zero during June and July because of rising corn prices and high ethanol inventory levels. Lower operating margins mean some ethanol plants may cut or even pause production until conditions improve.”

Bottom line for oil and products is the fact that there is too much economic doom and gloom. While there has been some slowing, oil demand is not that bad. Economic data out of China on exports might be a sign that we may already be reversing the recent softness in the market. Now with OPEC cutting back more and global supply tightening, we are pricing in too much of a slowdown. Be an oil bear-market contrarian.

The EIA says that working gas in storage was 2,689 Bcf as of Friday, August 2, 2019. This represents a net increase of 55 Bcf from the previous week. Stocks were 343 Bcf higher than last year at this time, and 111 Bcf below the five-year average of 2,800 Bcf. At 2,689 Bcf, total working gas is within the five-year historical range. The number was slightly supportive but natural gas is having a hard time rallying even as demand is at record highs. Mainly because production is even higher.

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Phil Flynn
The PRICE Futures Group
Senior Market Analyst & Author of The Energy Report
Contributor to FOX Business Network

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