Getting Serious

It may be time for the oil trade to get serious. This is a market that has seen significant price declines on slowing growth fears as well as the so-called Saudi oil production recovery. Yet once again, the U.S. Energy Information Administration data does not fit the bearish narrative and in fact, it is getting to a point where low inventories of product and strong demand are getting serious.

For example, with all of the talk about slowing demand, one might think with record U.S. oil production, we would be awash in crude oil. Well if you look at the data from the Energy Information Administration (EIA), the opposite is true. After yesterday’s surprise 1.7-million-barrel crude draw, which was correctly predicted by the late whisper number, that actually puts oil supply at 433.2 million barrels, just barely at the five-year average. I say just barely because yesterday's crude draw would have been much larger if it were not for a just under one million-barrel release from the Strategic Petroleum Reserve and an upward crude adjustment of 700,00 barrels a day.

This also raises the question of why the EIA is reporting that U.S. crude production is stuck at a record 12.6 million for 3 weeks in a row. We think that U.S. crude production will have to be adjusted downward. Lower rig counts and shale bankruptcies are taking its toll as many shale producers are figuring out that if you are losing money on every barrel, you can not make up for it in volume.  

This tight crude market comes at a time when it is obvious that U.S. crude refineries will have to significantly ramp up production in the coming weeks to meet very strong U.S. oil demand. Refinery oil demand spiked by 429,000 barrels as refiners start to exit the maintenance season. The EIA reported that refinery runs jumped to 85.2% of their operable capacity last week and will have to improve that in the coming weeks which should have us pencil in big draws in the coming weeks.

We should also mention that U.S. crude exports surged to 3.68 million barrels a day as the world clamors for U.S. light crude to replace the lost light barrels from Saudi Arabia.

Distillate fuel production increased last week, averaging 4.8 million barrels per day. Even the bad data that we are getting out of Europe’s manufacturing sector, like Germany, does not to have slowed oil demand growth as much as many had predicted.

Then there is the diesel dilemma. The EIA reported another disturbing 2.7 million distillate draw driving distillate supply 12% below the five-year average. This should raise concerns right at the kick-off to the International Maritime Organization IMO 2020 that will implement the new regulation for a 0.50% global sulfur cap for marine fuels. The problem is that it is going to be very difficult for refiners to meet that demand especially if we have a cold winter.

Gasoline is not out of the woods either and actually performed better than the ultra-low sulfur contract. Strong gasoline demand and refiners having to focus more on diesel may boost gasoline by default. The EIA said, "Total motor gasoline inventories decreased by 3.1 million barrels last week and are about 2% above the five-year average for this time of year."

Yet demand is smoking and not fitting the slow down narrative. The EIA says demand based on total products supplied over the last four-week period averaged 21.1 million barrels per day, up by 3.4% from the same period last year. Of that, gasoline demand averaged 9.4 million barrels per day, up by 2.3% from the same period last year. Distillate fuel product supplied averaged 4.1 million barrels per day over the past four weeks, up by 0.8% from the same period last year. Jet fuel product supplied was up 5.8% compared with the same four-week period last year. Hedgers should be hedged as upside supplies risk or rising. 

LNG is the fuel of the century as it is the most stable fuel to meet demand and reduce greenhouse gas emissions. In China, they are desperately trying to increase supply to meet explosive demand. The EIA writes that China is adding incentives in the country to try to boost their domestic production. The EIA writes that “Rapid growth in China’s natural gas consumption has outpaced growth in its domestic natural gas production in recent years. China’s natural gas imports, both by pipeline and as liquefied natural gas (LNG), accounted for nearly half (45%) of China’s natural gas supply in 2018, an increase from 15% in 2010. To increase domestic production of natural gas, the Chinese government has introduced incentives for several forms of natural gas production."

Natural gas production has recently grown in China largely because of increased development in low-permeability formations in the form of tight gas, shale gas, and to a lesser extent, coalbed methane. In September 2018, the Chinese State Council set a target of 19.4 billion cubic feet per day (Bcf/d) for domestic natural gas production in 2020. In 2018, China’s domestic natural gas production averaged 15.0 Bcf/d.

In June 2019, the Chinese government introduced a subsidy program that established new incentives for production of natural gas from tight formations and extended existing subsidies for production from shale and coalbed methane resources. This subsidy is scheduled to be in effect through 2023. In addition to the changes in the subsidy program, the government allowed foreign companies to operate independently in the country’s oil and natural gas upstream sector. Production of tight gas, shale gas, and coalbed methane collectively accounted for 41% of China’s total domestic natural gas production in 2018. China has been developing tight gas from low-permeability formations since the 1970s, especially in the Ordos and Sichuan Basins. Tight gas production was negligible until 2010 when companies initiated an active drilling program that helped lower the drilling cost per vertical well and improve well productivity.

Shale gas development in China has focused on the Sichuan Basin: China National Petroleum Corporation’s (CNPC) subsidiary PetroChina operates two fields in the southern part of the basin and the China Petroleum and Chemical Corporation (Sinopec) operates one field in the eastern part of the basin. PetroChina and Sinopec have respectively committed to producing 1.16 Bcf/d and 0.97 Bcf/d of shale gas by 2020, which, if realized, would collectively double the country’s 2018 shale gas production level.