OPEC in the Eye of the Hurricane

Weekly EIA Report – 8-9-17 OPEC in the Eye of the Hurricane

See our OPEC Deal Tracker at the end of the newsletter for our ongoing analysis of the OPEC cuts.

Many bullish commentators hoped Harvey would succeed where OPEC failed in boosting prices. Now that the storm has subsided and that Irma looks to be avoiding the Oil infrastructure, it is time to take stock of the situation. The aftermath of a Hurricane is never a pretty sight: Wind damage, floods, storm surges, torrential rain and flying trees do not make for an orderly scene. When the time comes to assess the damage, it can be hard to recognise what should be where. Cars are swept at sea, boats are swept aground, buildings are left in ruins and sometimes, you find all three jumbled together. Yet, to allow for rapid rescue and reconstruction, getting a clear picture of the situation is vital. This also applies to the US oil market. We must quickly understand what damage, if any, has been caused by Harvey and if it will have a long-lasting effect on the supply-demand balance. So, as we keep an eye on Irma, let’s see if the Texas’ predicament will end up being OPEC’s gain. 

As we had predicted, refining is the most troublesome and immediate issue. According to the EIA, the outage is considerable at 3.25 million barrels, almost exactly twice as large as when Hurricane Katrina hit New Orleans in 2005. Of course, the refinery concentration in Texas is bigger, but this time, refineries were better prepared, had ample warning and could shut down in advance. As a result, they were mostly undamaged. Most are now working to restart, motivated as they are by exceptionally high refining margins. We must be careful, however, that the gasoline season has ended and some refiners may have already programmed maintenance time, so some companies may bring the work forward and delay a restart until it is done. Generally, however, we expect refining activity to be back to normal within a couple of weeks.

Nevertheless, this being the tail end of the gasoline season and a week before the futures contract expiry, we had expected it would lead to panic buying. We also recommended selling the October gasoline margin the day after expiry, since we believed the move to be exaggerated. Proof of the market’s over-reaction could be found in the latest EIA report. Even though gasoline output fell almost 1.1 million barrels a day, production was still 9.517 million barrels a day and imports added another 475,000 barrels a day. This easily covered domestic demand which fell to 9.163 million barrels a day and implies a daily surplus of 829,000 barrels. Hence the only way gasoline stocks could drop 3,2 million barrels is through continuing exports of 1.286 million barrels a day. So, you should ask yourself the question, if the US can close almost 20% of its refining capacity, still comfortably cover domestic demand, be a net exporter of gasoline, and maintain stocks almost exactly on par with 2016, which was mercifully hurricane free, should you really be so excited about the end of this driving season? We didn’t think so either!

We had the same game-plan on the heating oil margin as we did on gasoline. When the numbers came out, they showed the two products replicated the same pattern: Production and imports remain ample enough to cover domestic demand, and the country remains a net exporter. Yet the heating oil margin has actually moved up slightly since we sold it. This is partly because the distillate season is looming on the horizon while the gasoline season recedes in your rear-view mirror. It may also be because stocks in that product are not as comfortable as they were last year. Nevertheless, we think the situation is also exaggerated, and will soon start to moderate.

On the other side of the refining equation, crude is suffering from the outages, but the drop in input is mitigated by decreases in production and imports of 783,000 and 822,000 barrels a day respectively. So, the stock increase was almost cut in half, but should still worry anyone of a bullish persuasion. Production will return, and vessels which could not discharge during the storm are currently doing so. So as refineries restart, crude prices will be supported relative to products, but they will likely still suffer in absolute terms.

There is one other segment of the market which barely gets mentioned at the moment: Demand. While evacuations use up a lot of fuel, the net effect of the floods and severe weather in Texas was to curtail demand. Flights were cancelled and unless they owned a boat or a monster truck, most people had to stay at home for the duration. We expect Harvey to durably impact demand in the Lone Star State. Similarly, if Irma moves up the entire length of Florida, it will have a similar effect there. And Irma may be the final piece of the jigsaw puzzle. If it drifts further west over the week-end, it could head into the oil patch or force more refineries on the Gulf coast to shut down, impacting supply rather than demand.

Overall, we believe there is a very high probability Irma will remain over Florida as it moves North. In so doing, it will move up the length of the state, impacting infrastructure, agriculture and tourism in a negative way. This will severely and durably curtail demand. In the meantime, we see the refining situation returning gradually to normal with a gasoline season that was a dismal failure. Not only did it fail to produce the promised soaring demand, US gasoline consumption so far in 2017 has been 1.85% below 2016 and total product demand is barely up 0.16% thanks to diesel consumption.

Rather than help OPEC in its goal to achieve higher prices, the 2017 hurricane season may have made the situation worse. Lacklustre demand numbers will likely turn dismal and the storms have demonstrated that the US oil industry is now much more resilient and prepared for natural catastrophe than it ever was. As things settle down weather wise, we expect the entire oil complex to do the same. We can only conclude that the hurricanes will generate a storm surge of unrefined crude which will compound the tenacious flood generated by excess production. Look to next Tuesday’s OPEC report to confirm that the Cartel is no closer to achieving any of its objectives.

US crude stocks increased 4.58 million barrels last week, and are likely to keep growing for the next couple of weeks as refineries restart. However, maintenance season could start at any moment and some refiners may take advantage of outages to start early. So, while we look to crude’s value improving relative to products, we feel crude prices will suffer. The Jan-Feb spread may have moved into positive territory, but we feel this should reverse once the hurricane frenzy dissipates.

US Commercial Crude Stocks (Source: EIA)

(High/Low/Average Range over five years in thousand-barrel increments)

Distillate stocks fell 1.396 million barrels, which is not much considering the size of the outages. We are still short the October margin from US$ 26 and are slightly out of the money, but we expect things to move our way next week.

Distillate Stocks (Source: EIA)

(High/Low/Average Range over five years in thousand-barrel increments)

All the panic was for nothing, as gasoline stocks fell a mere 3.199 million barrels and are almost at the same level as last year. Demand has been bad all year and is likely to get worse. We are also still short the October margin from US$ 26 and are comfortably in the money around US$ 21.5. Look out below, this will keep going.

Gasoline Stocks (Source EIA)

(High/Low/Average Range over five years in thousand-barrel increments)

US refining went from record breaking to the five-year low in one week as Hurricane Harvey forced many to shut down. We expect high margins to entice refiners to return relatively rapidly. As little, if any long-term damage has been reported.

US Refining (Source: EIA)

(High/Low/Average Range over five years in thousand-barrel increments)

THE OPEC DEAL TRACKER

(Please note that other than our future predictions for exempt nations and shale, we only use official numbers from OPEC and the EIA. Only official numbers can modify our estimates.)

With its August report, OPEC has again increased demand growth for the fourth quarter, but has left Q3 untouched. We think this is over-optimistic, and it doesn’t change the overall situation. Production in July reached 32.87 million barrels with exempt nations adding 721,000 barrels and compliance falling to 88.76%. Since October 2016, US output has risen 1,080,000 barrels, something which OPEC and most commentators had not expected at all. Taken together, these three factors now add up to more than 1.9 million barrels, neutralising and even overtaking the OPEC cut. We do not believe OPEC or the hurricane season can rescue 2017, and expect the cartel’s production to remain at or above 32.8 million barrels. Hence, the situation will be as follows:

(Source: OPEC/EIA)

THIS WEEK:

-         While Harvey has led to some production shutdowns, we expect US production to continue growing in 2017.

-         Exempt nations Libya, Iran and Iraq are 721,000 barrels over their October 2016 levels

-         At current rates, we now expect an average daily surplus of 240,000 barrels in 2017

-         As we had predicted, there was no deficit in Q1 or Q2

-         Despite hurricane activity, US Oil Production will likely be near 10 million barrels a day by the end of the year

Magma’s Assumptions:

-         Iran, Libya and Nigeria will together add 100,000 barrels a day each remaining quarter

-         Shale will add 150,000 barrels a day each remaining quarter

OPEC’s Ideal outcome:

In accordance with OPEC’s June report, even with compliance near 100%, production is at 32.87 million barrels. Even if we assume OPEC manages to get this number back to 32.5 million barrels, the “perfect outcome” with no further interference from shale or exempt nations looks like this:

(Source: OPEC)

Having increased demand, the best OPEC can hope for is a 30,000 barrel a day deficit, which is very far from anything you could call success.