Prices are Showing a Return to Fundamentals
Global crude oil inventories, tracked by Kayrros through satellite imaging, are behaving in a way that closely resembles the pattern observed last year, where global inventories started to fall in June with the rate of draws slowing in August.
It will be key to watch what happens in September. Last year, the draws reaccelerated after the summer through to the beginning of the following year, in a move that removed 200 MMb from global inventories. The market was rebalancing last year as a consequence of OPEC/non-OPEC supply cuts. If the same draws repeat this year, inventories would be dropping to a much lower level. Although OPEC has pledged to reverse its cuts, the renewal of sanctions on Iranian oil exports could offset that.
After a sentiment-driven pricing regime observed since June 2018, prices are drifting back to fundamentals. The slump in Brent prices diverged from fundamentals in early July, but flat prices are now returning to a level consistent with low crude inventories and the declining spare crude production capacity. Brent time spreads are returning to backwardation but have more to go to reflect fundamentals.
Anticipation of the outcome of the OPEC meeting on June 22 led the move to a sentiment-driven price regime. This was followed in June and July by headlines on the trade war between the US and China, Trump’s tweets on Iran, and large daily moves on crude prices that triggered stops and changes to flows of money from investors. These factors kept the market in a sentiment regime, away from fundamentals, until now.
The fundamental negative relationship between crude flat price and crude inventories holds historically. However, this correlation approaches zero when the market moves mainly with geopolitical events and tensions, and the anticipation of their effects. This was historically observed around the key dates of the OPEC/non-OPEC cut agreement and was seen again in June 2018 as the markets awaited and reacted to the June 22 OPEC decision.
In the US, crude inventories were flat this summer in a season of typical draws. This is partially linked to a strong increase in US production. The June 2018 EIA Petroleum Supply Monthly reported a surprise jump in US crude production, led by growth of 165 kb/d in Texas, which comes after relatively weak growth in the Permian basin in April and May 2018.
The prompt WTI Midland contract is currently at its weakest point against WTI in Cushing, both historically and against the current forward curve, which is in contango and narrows continuously and significantly until the end of the year.
Times of excess supply in the Permian basin coincide with periods of low price differentials for WTI Midland vs WTI Cushing, with excess supply defined as production minus 95% of pipeline capacity out of the basin. However, no meaningful new pipeline capacity out of the Permian Basin is expected to come online until Q2 2019 with the Permian to Corpus and Sunrise pipelines. Because of this, we see a disconnect between the WTI Midland to Cushing spread forward curve and the reality of crude export capacity out of the Permian basin.
Quote of the Week
"I think it is good for all of us, for the global economy, importers but also for the exporters, not to see higher prices than we have today." - Faith Birol, Executive Director of the IEA
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Despite political turmoil and protests in Iraq, the country has been exporting record levels of oil: Oil Price reported that Iraq “sent out 3.583 million bpd of oil last month, beating the July record of 3.543 million bpd,” taken from Iraq’s oil ministry data.
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Article by Kayrros