Category Archives: oil

6/5/20: The Glut of Oil: Strategic Reserves

The Giant Glut of Oil continues (see my analysis of oil markets fundamentals here:

China strategic oil reserves have also surged. U.S. oil reserves are now nearing total capacity of 630 million barrels, and China's reserves are estimated to be about 90% of the total capacity of 550 million barrels. Japan's reserves similar (capacity of ca 500 million barrels). Australia is using leased U.S. strategic reserves capacity to pump its own stockpiles, with its domestic storage capacity already full. 

20/4/20: Oil

The madness of Oil (see an explainer below):

As I said a few minutes back: at this rate, within a couple of days, it will make sense to start re-injecting the stuff back into the wells, as opposed to storing it.

An explainer:

Quite a number of folks - including journalists - have confused the above data and the 'reported' price of oil today for the actual price of oil. It is not as simple as that. Actual price of oil did not fall below zero, though for some grades it has been below zero before and is still staying there now. So what all of this really means?

Q1: Is price of oil below zero? The answer is "it depends on what price of oil one takes". Let me explain.

First, there are several major grades of oil. The two most popular are:

  • Brent North Sea Crude (commonly known as Brent Crude). Brent originates in Brent oil fields and other sites in the North Sea. Brent is a benchmark price for African, European, and Middle Eastern crude oil producers, covering, roughly two-thirds of the world's crude oil production.
  • West Texas Intermediate (commonly known as WTI) and this is a benchmark oil for North America.
  • Urals grade oil is Russian oil
  • Fateh grade oil or Dubai Fateh is the most important crude oil benchmark for Asia
  • Iran Heavy and Iran Light are benchmarks for Iranian oil.

The percentage of sulfur in crude oil varies across the grades and fields of extraction, and this percentage basically determines the amount of processing required to refine oil into energy products. "Sweet crude" is a term that refers to crude oil that has less than 1% sulfur: Brent at 0.37% and WTI at 0.24%. And both Brent and WTI are "sweet". So, "sweet" oils carry a market premium, as refineries can process these at lower cost. 

Fateh sulphur content is around 2%, Urals at 1.35%, and other grades are described here: Higher sulphur content oil trades at a discount on WTI - or used to, roughly, prior to 2008 GFC. Since GFC, U.S. supply of WTI oil has been growing more robustly than Brent supply, so the relationship reversed (see chart below).

Now, notice the above table also shows "Port of Sale". This is an important feature of trading and pricing of oil and it matters in today's oil price determination too. Bear with me.

So, let's focus on WTI and Brent. 
  • Brent is traded at a discount on WTI because it is harder to process
  • WTI is traded in the futures markets - with contracts signed and priced today for future delivery. The NYMEX (New York Mercantile Exchange) division of the CME (Chicago Mercantile Exchange) trades futures contracts of WTI. Physical delivery for WTI futures occurs in Cushing, Oklahoma. Futures are contracts that must be delivered in physical delivery if held to maturity. In other words, futures are NOT options. Options can be left to expire and the bearer does not have to take a delivery of the commodity on which the option is written. With futures, if you bough June 2020 delivery of oil contract for 1,000 barrels at, say $22, and you hold it to expiration (at the end of May 2020), you will have to take physical delivery of 1,000 barrels of oil in Cushing, OK, no matter what. 
  • Brent crude oil futures trade on the Intercontinental Exchange (ICE), and are traded with delivery internationally. In other words, Brent futures contracts are deliverable to specific country, not to one location globally, as is the case with WTI.
So, now, what happens if your hold a contract for oil, deliverable in May 2020, at 8:00 am EST today? You have two actions you can take. Today happens to be the day when May 2020 contracts mature for WTI. You can: (1) let contract mature and take delivery of oil in Cushing, OK in May, paying the price of the contract - say $22 per barrel. Or (2) you can sell the contract today, before it matures, to someone else who will then face a choice of (1) or (2) herself. 

If you opt for (1), you will need somewhere to store 1,000 barrels and a transport from Cushing, OK to wherever that storage facility is. Both cost money. And, worse, the former is not available, since we are experiencing a glut of oil. You can pay to store your oil on board transport - e.g. on board a tanker sitting in the Gulf of Mexico, or on-board railroad cars. This is hellishly expensive, even if you own the said tanker or railroad cars. So you will not do this. Worse, yet, there is so much crude out there in storage already, that short-of-demand refineries are not buying oil today. Which means you will be paying high costs of storing this stuff for weeks to come.

If you opt for (2), you need a buyer of the contract that can do (1). And these are not available, because everyone is short storage and everyone is facing a market with no buyers for this stuff for weeks. 

So you dump your May futures contracts at a negative price just to get rid of the obligation to take physical delivery of oil in May. And this is exactly what happened today with May futures (charts above) for WTI.

Now, the same did not happen today in the Brent markets. Why? Because Brent, as noted above, is deliverable across a number of countries, not just Cushing, OK. Which means you can shift location of delivery to find a more-likely-available storage facility for it, or a more-ready-to-buy refinery. In chart 2 above, top red line did not fall as much today - these are Brent futures for May contracts.

Here is the spot price of oil for Brent and WTI:

And here it is over the last year:

Today's prices are not in the chart. So here they are:

Observe negative prices on some lower quality (high sulphur - ugly) stuff in the above. These are down to the lack of refineries willing to take low quality crude when there is a glut of higher quality key stuff available. And note that Brent is nowhere near $0 today. 

Blend of WTI and Brent is another way to look at oil prices. And here is a table from the CME showing different month contracts for the blend:

Yes, may delivery is ugly. June and on, however, is well above $20 per barrel. 

13/11/16: Oil Prices: Still in the Whirlpool of Uncertainty

This is an unedited, longer, version of my article for the Sunday Business Post covering my outlook for oil prices.

Traditionally, crude oil acts as a hedge and a safe haven against currencies and bond markets volatility. Not surprisingly, during the upheaval of the U.S. Presidential election this week, when dollar went into a temporary tailspin, equity markets sharply contracted and bonds prices fell, all eyes turned to the risk management staples: gold, oil and, on a more exotic side of trades, Bitcoin. Gold and Bitcoin did not surprise, staunchly resisting markets sell-offs and gaining in value. But oil prices tanked. The old, historically well-established correlation did not apply. Instead of rising, U.S. oil futures fell in the immediate aftermath of Donald Trump’s surprise victory, and then, in line with the stock markets, futures rose. Within the day, U.S. crude futures prices were back at USD45.27 a barrel on the New York Mercantile Exchange, while Brent rose back USD46.36 marker. More broadly, the S&P 500 Energy Sector Index rose 1.5 percent within 12 hours of the election results announcement.

This breakdown in historical patterns of correlations between crude and financial assets prices underlines the simple reality of the continuous oil markets slump: we are in the new normal of systemically low oil valuations underpinned by the very same driving forces that precipitated the crude price collapse from over USD100 per barrel to their mid-to-high 40’s today. These forces are three-fold, comprising reduced demand for energy, reduced demand for oil as a source of energy, and increased supply of oil.

Prices and Stocks

Currently, oil prices are rebounding from the eight-week lows, but prices remain sensitive to any signals of changes in demand and supply. The reason for this is the excess stockpile of oil stored in tankers, ground facilities and at refineries. Most recent U.S. federal data showed oil stockpiles swelling well ahead of the markets expectations, as producers continue to pump oil unabated.

U.S.-held inventories of oil were at 2.43 million barrels at the beginning of November, based on the data from the U.S. Energy Information Administration. American Petroleum Institute puts total stocks of oil in storage and production at 4.4 million barrels - more than 1 million barrels in excess of the seasonally-adjusted forecast for demand. And at the end of October, the U.S. posted a 34-year record in weekly increases in crude and gasoline stocks - at 14.4 million barrels.

The U.S. is no exception to the trend. OPEC recently revised its outlook for oil price recovery for the next three years based on the cartel’s expectation that current levels of production will remain in place for longer than anyone anticipated. Per OPEC latest forecast, we won’t see oil hitting USD60 per barrel until 2020. Only twelve months ago, OPEC forecast for 2020 was USD80 per barrel.

Similar forecasts revisions were produced a month ago by the IMF. In its World Economic Outlook forecast, the IMF revised its outlook for 2016 crude prices from USD50.54 per barrel forecast in October 2015 to USD 42.96 per barrel. 2017 full year price forecast moved from USD55.42 in October 2015 to USD50.64 in October 2016. If in 2015 the IMF was predicting oil prices to hit USD60 marker by mid-2018, today the Fund is projecting oil prices remaining below USD58 per barrel through 2021.

Both, the OPEC and the IMF forecast lower global economic in 2016 and 2017. The IMF outlook is based on world GDP expanding by just 3.08 percent in 2016 and 3.4 percent in 2017, well below post-Crisis average of 3.85 percent and pre-crisis average of 4.94 percent. OPEC forecast for oil prices is based on similarly pessimistic growth outlook for 3.4 percent average growth over the next six years, down from 3.6 percent forecast issued in October 2015.

Alternative Energy: Rising Substitutes

As demand for energy in general remains weak, alternative sources of energy are starting to take a larger bite out of the total energy consumption. Solar power capacity has almost tripled in the U.S. over the last 3 years. Renewables share of the U.S. power supply rose from around 4 percent of total power generation in 2013 to 8 percent this year, on its way to exceed 9 percent in 2017. Solar energy supply is now growing at a rate of almost 40 per annum, spurred on by the Federal solar tax credits, extended by the Congress in early 2016. In Germany, following the Government adoption of Energiewende policies — a strategy that aims to move energy supply away from oil and uranium — renewables now provide almost 30 percent of electricity, on average. And Gwermany’s upper chamber of parliament, the Bundesrat, has passed a resolution calling on the EU to create a system of harmonised taxation and vehicle duties that can ensure that only emission-free cars will be registered in Europe by 2030. On the other side of the spectrum, in the OPEC member states and Russia, renewables energy production is currently standing at below 5 percent of total energy demand. While the number is relatively low, it is rising fast and countries from Saudi Arabia to United Arab Emirates to Russia - all have significant ambitions in terms of lifting non-oil based energy output. In Abu-Dhabi, a recently approved solar energy project will deliver electricity at a cost below coal-fired power plants, at 2.42 US cents per kilowatt-hour, setting world record for the cheapest solar energy supply. Dubai plans to get 25 percent of its energy needs from renewables by 2030. The target is to reach 75 percent by 2050. Even Iran is opening up to use of renewables, with wind and solar investments in 2016-2017 pipeline amounting to close to USD12 billion. In Jordan, just one wind farm - a 38-turbine strong Tafila - is supplying 3 percent of country electricity, since production began in 2015.

All-in, globally, estimated 7 percent of oil demand decline over the last 5 years is accounted for by energy sources substitution. The key drivers for this trend are new environmental agreements, putting more emphasis on alternative energy generation, local environmental pressures (especially in China), and the desire to shift oil production to export markets, away from domestic consumption. Another incentive is to use clean power to reduce domestic subsidies to fossil fuels. According to the IMF report published earlier this year, Middle East, North Africa and Central Asia account for almost one half of the total worldwide energy subsidies. Since the onset of the oil price shock, UAE, Egypt, Oman and Saudi Arabia have been cutting back on fossil fuels subsidies and bringing retail prices for energy closer to market standards.

The second order effect of the above changes in energy composition mix is that moving away from subsidised fossil fuels improves markets transparency and reduces corruption. It also compensates for declines in oil prices in terms of exports earnings.

Drilling at These Prices?

As slower global growth and increasing substitution away from fossil fuels are suppressing demand for oil, supply of the ‘black gold’ is showing no signs of abating. Per latest OPEC statement, oil producers, especially in North America, surprised markets analysts by failing to curb production volumes in response to weak prices.  OPEC members have been running production volumes near historical records through out the 3Q 2016. And in the U.S., the Energy Department raised its production forecasts for both 2016 and 2017. However, U.S. crude output this year is unlikely to match the 2015 levels - the highest on record since 1972. All in, the Energy Department now estimates that 2016 average daily production will be around 8.8 million barrel per day (bpd), which is lower than 9.5 million bpd delivered in 2015, but more than forecast for 2016 back in September. Likewise, for 2017, the Energy Department revised its September forecast from 8.57 million bpd to just over 8.7 million bpd in October. Through the second and third quarters of 2016, North American drillers actually increased drilling activity as prices improved relative to late 2015. The number of active oil rigs operating in the U.S. is now up by more than 130 compared to May counts and the rate of new rigs additions is remaining high, rising to 2 percent last week alone.

Russia and Iran

A combination of stagnant or even declining demand, and expanding production means that the only change in the flat trend in oil prices over the next 6-12 months can come only from a policy shock on the supply side. For OPEC, Iran and Russia such a shock is unlikely to happen. Majority of oil exporting economies have either fully (as in the case of Russia and Iran) or partially (as in the case of Saudi Arabia) adjusted their economic policy frameworks to reflect low price of energy environment.

I asked, recently, Konstantin Bochkarev of Forex-BKS, who is one of the leading financial markets analysts working in the Russian markets for a comment on the current state of play in Russian economic policies in relation to oil prices. In his view, “It looks like the worst is over for the Russian economy in terms of adaptations to low oil prices, Western sanctions, geopolitical risks and other challenges of last two years. Sub-50-55 USD oil or even $40 is the new reality and it doesn’t scare any more. On the other hand low efficiency of the economic policy in Russia (due to a lot of constraints like the lack of reforms and the will to change anything before the President election in 2018) means that there’s rather huge cap for the Russian GDP growth which can be limited by 1%-1.5% at 40-55 USD oil.” Overall, “the «crisis policy» which was rather successful during this recession and led to the stabilization of the macroeconomic situations. The recapitalization of the Russian banking system, free float of the Russian ruble, higher interest rates, the transparency of the CBR policy and rather tight budget policy. All these measures finally led to 6% inflation by the end of 2016, rather sufficient decrease in volatility of the Russian ruble and less correlation with oil prices.” And moving away from the petroleum-dominated economy has had even deeper impact. Per Bochkarev, “Oil can’t solve all your problems any more whether it’s 40$ or 100$, because changing social and business environment, external and internal challenges demand something more than budget without deficit or stable cash flow. Still low oil prices can accelerate changes in the Russian economy and society and lead to some necessary reforms or unpopular measures.”

In a sense, Russian experience shows the direction that many oil exporting economies are heading in the age of low oil prices: the direction of accelerated fiscal and monetary responses and gradual structural economic reforms. In some areas, Russia took its medicine first and in a larger dose, but other big producers, including Iran and Saudi Arabia, as well as UAE are also traveling down the same path.

As an aside, it is worth noting that Iranian production is growing ahead of expectations. Per Bloomberg report:  “Output at the fields west of the Karoun River, near Iran’s border with Iraq, rose to about 250,000 barrels per day from 65,000 barrels in 2013, the Oil Ministry’s news service Shana reported Sunday, citing President Hassan Rouhani at a ceremony to formally open the project. Iran had expected to reach that output target by the end of the year, Mohsen Ghamsari, director for international affairs at the National Iranian Oil Co., said in September.” (

Since the easing of the sanctions, starting with end of January 2016, Iran’s output rose from just around 2.82 million bpd to ca 3.65 million bpd.

Russian producers are also hardly feeling a pinch. According to Bochkarev, “Tax system plays a much more important role in the Russian oil companies production decisions than the rise or fall in oil prices. Whether oil is $40 or $100 per barrel majors are generating generally the same financial results. Besides almost oil majors are stable even at $30 oil. The decreases in oil prices are easily compensated by the fall in the ruble exchange rate. So cost control or cost cutting plays much more important role in other sectors of the Russian economy.”

Still, Russia and Iran might be heading into a direct competition in the European markets, where geopolitics and legacy contracts are changing the playing field away from simple price competition. This new - since January 2016 - competitive dynamic may be a longer term, rather than a current issue, however, according to Bochkarev. “It doesn’t look like that Iranian oil is huge challenge for Russian majors next several years. Numerous consumers who stopped buying the oil from Iran due to sanctions made some changes to their refinery or productions lines and equipment. So Iran has to offer some kind of bonus or lower oil prices to make them return to its oil. Probably it’s much easier for Iran to deal with China, India and other countries in Asia in order to find export markets for its oil. Iran can try to restore market share in Europe but the other hand of such policy can be lower oil prices or necessary discounts. LNG Imports from the US as well as the bigger role of Qatar and Iran in the future are already evident in European markets. The unique status of Gazprom is probably now a matter of the past but the more competitive market can finally make Gazprom more competitive.”

Trump Cards

Which means that economic policies shocks that can alter the current flat growth trend for oil prices are unlikely to come from the OPEC+ countries. Instead, the key to the near-term future variation in oil price trend will most likely come from the U.S. The markets are still assessing the full impact of Mr. Trump’s victory on his foreign and energy policies - the two key areas that are likely to alter the supply side of oil equation, as well as his economic policies that might influence the demand side and inflation. Starting with the latter, if - as promised during the election - the new White House Administration deploys a significant infrastructure and spending stimulus across the U.S. economy, we can expect both the demand for oil to firm up, clearing out some, but not all of the excess supply currently available in the markets. A stimulus to the U.S. growth is also likely to trigger higher inflation. With oil generally being a historical hedge against inflationary pressures, the likely outcome of improved growth performance across the U.S. will be a rise in oil prices from the current range of mid-40s to mid-50s and upper-50s, slightly above the IMF forecasts for 2017 and well ahead of the current market prices.

On the other hand, President-elect has promised to shift Federal supports away from alternative energy toward ‘clean coal’, oil and gas sectors. If he gets his way, the impact will be more American oil flowing to exports and higher excess supply, with lower prices. Mr. Trump’s election is likely to see the Republicans-controlled Congress moving to approve more export-driven pipelines, reducing the cost of oil transport from shale oil rich regions, such as Ohio and Pennsylvania, as well as North Dakota, and increasing incentives to boost production levels. Beyond stimulating production of the U.S. oil, Trump Administration is also likely to green light Keystone XL pipeline that will connect Canadian oil sands to exports terminals in the Gulf of Mexico. This will further expand supply of cheaper oil in the global markets.

Combining the two factors, it appears that the current IMF and OPEC outlook for 2017 for oil prices may be rather optimistic.

Barring a significant surge in global (as opposed to the U.S. alone) growth, and absent supportive cuts to production by the OPEC and other major producing countries, in all likelihood we will see oil prices drifting toward USD52-55 per barrel range toward the second half of 2017. Until then, any significant repricing of oil from USD47-48 per barrel price levels up will be a speculative bet on strong economic growth uptick in the U.S.

15/4/16: Of Breakeven Price of Oil: Russia v ROW

There has been much confusion in recent months as to the 'break-even' price of oil for Russian and other producers. In particular, some analysts have, in the past, claimed that Russian production is bust at oil prices below USD40pb, USD30pb and so on.

This ignores the effects of Ruble valuations on oil production costs. Devalued Ruble results in lower U.S. Dollar break-even pricing of oil production for Russian producers.

It also ignores the capital cost of production (which is not only denominated in Rubles, with exception of smaller share of Dollar and Euro-denominated debt, but is also partially offset by the cross-holdings of Russian corporate debt by affiliated banks and investment funds). It generally ignores capital structuring of various producers, including the values of tax shields and leverage ratios involved.

Third factor driving oil break-even price for Russian (and other) producers is ability to switch some of production across the fields, pursuing lower cost, less mature fields where extraction costs might be lower. This is independent of type of field referenced (conventional vs unconventional oils).

Russian Energy Ministry recently stated that Russian oil production break-even price of Brent for Russian producers is around USD 2 pb, which reflects (more likely than not) top quality fields for conventional oil. Russian shale reserves break-even at USD20 pb. In contrast, Rosneft estimates break-even at USD2.7 pb (February 2016 estimate) down from USD4.0 pb (September 2015 estimate).

Here is a chart mapping international comparatives in terms of break-even prices that more closely resembles the above statements:

Here is another chart (from November 2015) showing more crude averaging, with breakdown between notional capital costs (not separating capital costs that are soft leverage - cross-owned - from hard leverage - carrying hard claims on EBIT):

Another point of contention with the above figures is that they use Brent grade pricing as a benchmark, whereby Russian oil is priced at Urals grade, while U.S. prices oil at WTI (see here: All three benchmarks are moving targets relative to each other, but adjusting for two factors:

  • Historical Brent-Urals spread at around 3.5-4 USD pb and
  • Ongoing increase in Urals-like supply of Iranian oil
we can relatively safely say that Russian break-even production point is probably closer to USD7.5-10 pb Brent benchmark than to USD20pb or USD30pb.

Another interesting aspect of the charts above is related to the first chart, which shows clearly that Russian state extracts more in revenues, relative to production costs, from each barrel of oil than the U.S. unconventional oil rate of revenue extraction. Now, you might think that higher burden of taxation (extraction) is bad, except, of course, when it comes to the economic effects of the curse of oil. In normal economic setting, a country producing natural resources should aim to capture more of natural resources revenues into reserve funds to reduce its economic concentration on the extractive sectors. So Russia appears to be doing this. Which, assuming (a tall assumption, of course) Russia can increase efficiency of its fiscal spending, means that Russia can more effectively divert oil-related cash flows toward internal investment and development.

During the boom years, it failed to do so (see here: although it was not unique amongst oil producers in its failure. 

Note: WSJ just published some figures on the same topic, which largely align with my analysis above:

Update: Bloomberg summarises impact of low oil prices on U.S. banks' balancesheets:

Update 2: Meanwhile, Daily Reckoning posted this handy chart showing the futility of forecasting oil prices with 'expert' models