U.S. Frac Spreads increase, but consumables remain soft
Oil and Gas Demand issues accelerate globally; all eyes on consumption
Coronavirus Update: We need another month to evaluate
Libya, Russia and Nigeria Output Updates
rebounded throughout January as crews returned to work following a prolonged
holiday vacation. Activity will trend higher over the next two weeks as
completions are accelerated in the Permian and Eagle Ford specifically, but it
will remain seasonally slow in comparison to the last three years. In 2017,
while pricing was comparable, the market was still driving forward to prove out
acreage and optimism arose from the OPEC+ agreement struck in Dec of 2016.
These components pushed activity up, but the market is structurally different
at this point of the cycle in 2020. Seasonality will factor into the recovery,
but the movement of proppant has been slow to follow limiting the speed of
completions. The pace of additions will remain slow over the next few weeks
based on the growing issues across the supply chain- product demand/
coronavirus/ realized prices.
The front half of 2020 will be supportive of moderate activity as the spike in crude pricing allowed for hedging, but the steep backwardation in the curve only provided enough room to get “favorable” terms through about June of this year. The rejuvenated CAPEX budgets and favorable hedges will keep activity front loaded in the first 6 months of the year. The below seasonality chart and WTI curve helps highlight the shift higher in the front months while the rest of the curve remained depressed. This is driven by the overarching issue of slowing demand across the supply chain driven by a refined product glut. The outbreak of the coronavirus (more on that below) will act as a massive headwind as industries remain shut throughout China. Refined product exports have already been surging, and now with this large slowdown in domestic demand- there will be an even bigger surge into the open market.
The below shows the seasonally adjusted national frac spread and based on normalizing the chart- there is support for activity to get back to the average of about 315.
The increase in
the national spread count will be driven mostly by the Permian and Eagle Ford
as the rest of the areas see a slower response in activity. The Bakken
(Williston) has already seen an increase but will level off as the economics
(while still weak) support activity geographically closer to refiners/export
terminals. The reason I believe there will be a muted recovery in these areas
is driven off the following:
Oilfield Service commentary surrounding
E&P commentary regarding US activity
Proppant deliveries/loadings into key
Headwinds persisting on realized prices as
refined products grow (more on that below)
The canary in the
coal mine will remain the proppant loadings- below is a look at the Permian and
Eagle Ford (Seasonally adjusted).
Permian Seasonally Adjusted Frac Spread Count
Permian Seasonally Adjusted Proppant Loadings
Eagle Ford Seasonally adjusted Proppant Loadings
The above breakdown of proppant helps
drive home the typical decline in year-end loadings as equipment is idled and
everyone heads home for the holidays. But, the turnaround is quick once
everyone gets back to work in January. The current backdrop is bucking the
trend with proppant loadings remaining at seasonal lows as completion work
increases but at a much slower pace. Rig activations have started to creep
higher, but at a very controlled rate with little reason to increase it too
quickly. Many of the SMID Cap E&Ps are facing significant headwinds as
investors focus on living within cash flow, and it will come at the expense of
production. The market faces an alarming amount of demand issues, but supply is
also facing headwinds as General Haftar has cut supply coming out of Libya.
OPEC+ has talked about maintaining cuts (recent commentary from Russia and UAE)
through June at their next meeting scheduled for March. The rumors have started
to grow stating a March cut is possible but given current physical loading
schedules it doesn’t seem likely. Nigeria has already sold about 2M barrels a
day worth of oil (above their OPEC+ target) in March, and Russia has maintained
a strong export presence above OPEC+ targets. Demand issues are going to
accelerate (more on that below) that has already resulted in shipments being
deferred, and I expect some of these future loadings to be canceled as refined
product builds grow globally.
What does the Coronavirus
mean for us all?
It is always a black swan that causes the cracks we have been discussing
to truly be pulled front and center. The virus is an event that has pulled
center stage- and to be clear- it isn’t because this has a massive casualty
rate (2.3 vs normal flu of .114), but rather the infectious rate that it
carries. This happens to be highly contagious- and just like a cold or flu-
contagious when no symptoms are showing. With an incubation period of 1-14 days
(average of 10-14 days), it is proving to have an infection rate of 2.6-3.8
(average is closer to 2.6-2.9), which is huge and makes quarantining nearly
impossible. By the time the Chinese government reacted, the virus already
spread well outside the initial city limits of Wuhan. The virus wasn’t treated
seriously for several weeks, and of the initial people diagnosed many of them
never went to the seafood market. This is just an example of the prolific
nature of the virus, which effectively doubles every 6 days. The panic is being
compared to SARS/ Bird-Flu but the timing is vastly different. Ground zero-
Wuhan- is now attached to the rest of China through high speed- rail, roads,
and airports that have only been completed over the last 10 years. The
infectious nature, interconnective China, and fear are leading to a mass
slowdown across all of China. A new estimate for China’s Q1 GDP has been
shifted to 5% (still seems high) and will continue to shift lower the longer
facilities remain shuttered.
The following is a summary of commentary from several experts that have
put together some fantastic commentary that is simple enough for even me to
understand. The coronavirus is an RNA virus that mutates rapidly with an
example given of a single family that had 6 different versions of the virus
among all the infected. The virus mutates in a volatile sense making vaccines
near impossible because by the time one is ready- it could be utterly useless
by the time it reaches the populace estimated at 9-12 months. The focus has
shifted to anti-viral treatments, such as things used to treat AIDS (another RNA
virus) that stops the mutation process and effectively destroys replication
enabling the body to defeat the infection. There is now a wider spread of the
coronavirus outside of Wuhan versus inside, which is indicative that the
quarantine came too little too late. The spread of the virus is now outside the
walls of the attempted isolation, which means there will be a ramp of
infections through at least February. The death rate remains low and is only
problematic for those with weakened or compromised immune systems and can be
viewed as a really bad flu. It doesn’t mean a continued mutation can’t make it
worse- just that the current setup makes it highly contagious but not a death
sentence. The contagion is being hypothesized to grow as it is proving to now
be airborne or spread within a 1-2 meter radius. The underlying problem remains
a person is contagious even when no symptoms are present- which can vary from
1-14 days making it very difficult to track. With an infection rate of 2.6-2.9,
the spread will continue to get worse and cases won’t stop until the number
falls to 1 or below.
China has effectively cordoned off 26 provinces with about 65 million people isolated to their region with no ability to travel. This is still only about 5% of the Chinese population of roughly 1.3 billion, but as people can be walking around infected with no symptoms the expectation is for this to get worse through February. As the cases grow, China’s industrial sector will be directly impacted as people are told to stay indoors and away from crowded places. These are industries that don’t function with a “work from home” option. The below gives a breakdown of the expansion rate, which won’t stop expanding until it falls below 1. To put this into context: Seasonal flu has reproductive number of 1.3; Spanish flu was 1.8; SARS was 2.5-3, after quarantine was 1. For a value > 2, you need to quarantine at least 50% of all case to contain the virus, but according to experts this level of containment is not possible at this point. This makes the below a likely trajectory over the coming days.
None of this is
meant to be an alarmist view or reason to live in a bunker for the next three
months, but rather to highlight the damage it will due to crude, refined products,
and Chinese GDP. China is expanding the Lunar Holiday to February 3rd-8th
(depending on location), which will keep industrial facilities and other GDP
accretive regions down for an extended period. This will directly impact
everything from oil demand (consumption), refined product demand, internal
consumption, and total travel. Based on the quarantine, miles driven will fall
drastically as travel is impossible in key industrial regions, factories remain
shuttered limiting the demand of diesel/fuel oil, flights have been canceled
limiting jet fuel, and chemical/refining facilities operating at reduced
utilization rates. Either way- this will directly impact China’s GDP, which
expands into the global economy based on their exports and consumption.
Our target for the
crude move was $52, which was reached and now starting to rally a bit off the
lows. As my old boss used to say- “too much too fast” – so a bounce was going
to happen as the market normalizes. Some commentary has highlights by
extrapolating the SARS oil shock into today’s China results in a reduction of
about 260,000 barrels a day according to Goldman Sachs. This is a grossly
misstated number based on current Chinese run rates on a refining and
petrochemical metric. China has seen refined product exports increase over 53%
after reaching a record of about 12M barrels a day of crude imports. This flows
into both refining and petrochemicals, and just based on the current oversupply
of refined products in the global market Chinese exports were already
struggling to find a home. Local demand was already softening with guidance of
a 2020 GDP targeted at 6%- so we already had a slowing economy, mixed with
falling local demand for refined goods, and now a quarantine across 26
provinces. It is safe to say that 260k barrels a day will prove to be a low
estimate for crude demand with something closer to 500,000 barrels and likely
rises towards 750k-1M as the virus spreads limiting activity. So as the virus
spreads, other regions will experience a slowdown in travel- not an all stop
quarantine- but a means of limiting trips and travel. The ripple effect will
cause additional gluts in refined product, so between the glut and limited
workers at facilities- run cuts will strike across the Chinese system. This
will directly impact crude demand by redirecting cargoes through re-sale,
deferral, or heading into storage.
There have been a bunch of new events
The Iraq US Embassy was attacked with 5
rockets- 3 hitting the intended target and one striking the cafeteria. It is
unknown how many injuries occurred, but it is clear some impact occurred which
will result in a ramp in activity against Hezbollah in the region.
There have been a ton of protests across
the region against the Iraqi and Iranian governments that are increasing the
uncertainty in the region. They have been put down with brutality (live ammo)
against relatively peaceful protestors, and it will only lead to more animosity
and the continuation/ increase of protests.
Libya has walked away from the cease-fire
without anything formal signed, and General Haftar maintains his closure of the
oil facilities. Libyan production is heading to 72k barrels a day from its
current 262,000 barrels. These facilities are offshore and insulated from the
issues on land. General Haftar is
demonstrating his control of the key Libyan revenue source, and while this is a
large disruption- it is temporary.
issues remain fluid as now tankers are sailing away empty as the blockade is
still holding firm based on the shutdown led by General Haftar. It has resulted
in about 1.18M barrels being pulled off the market. This came by way of
shuttered facilities in the Gulf of Sirte, Hariga Terminal, as well as Mellitah
and Zawiya terminals following the loss of oil flow. The issues remain
temporary as this is a clear show of force, but isn’t causing any lasting
damage to the facilities or source rock. The issues can be resolved quickly on
a physical movement level- the political side is vastly different. (a summary
of earlier comments are below).
A USAF plan has crashed in Afghanistan,
and so far, it looks to be a plane crash. This means it wasn’t shot down by the
Taliban, but right now, all information is fluid.
The news is playing up the concussions
from the Iranian ballistic missile attack, but when a missile explodes a few
yards away- there is bound to be a residual effect on those in the area. These
consequences won’t be enough for the U.S. to strike Iran directly, but the
continued attack on the Iraq green-zone will keep the U.S. engaged with Iranian
The biggest issue is and will remain the
massive glut in refined products. OPEC+ nations have already commented
(specifically UAE and KSA) regarding a potential additional cut in March if oil
continues to drop. We already have canceled shipments out of Russia and
Nigeria, and I believe their will be additional cancellations.
Houthis attempted a missile/drone attack
on Jazan- a city on the coast of the Red Sea and close to the border of Yemen-
but was unsuccessful as all incoming assets were intercepted. The area hosts a
400k barrel a day refiner (not fully operational), a military base, and several
other important facilities. The refined products are slated for domestic
consumption and some local export but doesn’t have any oil producing/exporting
assets. The attack is an escalation, but not unexpected following an escalation
of tensions in Yemen.
Nigeria and Russia
have increased total output in March based on the combined loading programs
across oil and condensate. Nigeria is expected to export about 2.02M barrels a
day, which is up 6.4% m/m. This is going to be problematic as more crude is
left on the water due to the shutdown of China, refinery turnarounds in March,
and seasonal weakness. Russia has also announced something similar for January
by reaching an output level (so far in Jan) of 11.283M barrels a day- which is
a five-month high. This comes on the back of the new agreement excluding
condensate from the total- but it is unclear how much of the growth is driven
by condensate growth. Russia failed to meet its 2019 OPEC+ deal throughout most
of the year, so it isn’t much of a surprise to see a continued non-compliance
setup from the region. Supply in the market remains relatively stable with Venezuela
exporting about 1M barrels a day, Guyana operational, Norway at about 1.55M
barrels a day, Russia, Nigeria, Angola, and the U.S. are keeping the world
amply supplied- which is limiting geo-political fears throughout the Middle
East. Even with fog and a shutdown Houston ship channel for a day or so, the
U.S. still exported about 3.5M barrels a day last week.
The bigger issue
has been refined product builds on a global level, and the impact that will
have on total crude demand. Q1’2020 was already supposed to be a tough period
for builds and crude demand, and the Chinese coronavirus is just making that
worse. So while people say- “China demand will be short-lived and not that
bad”- which could be true, but it is happening at the worst possible moment from
the perspective of the oil supply chain. Below is a quick snapshot of U.S.
refined product demand:
Finished Motor Gasoline- Seasonally Adjusted
Distillate Fuel Oil- Seasonally Adjusted
have been following a normal seasonal trend of builds across the facilities,
but it will start to increase this week and accelerate driven by issues
throughout China. Singapore/ Fujairah/ Europe are other key places that builds
should start to rise as China slows consumption of refined products and
maintains some exports. As utilization rates fall, exports have the potential
to remain stable/if not elevated as product is turned abroad making up for
lower rates of throughput. Crude pricing will remain stable here as support is
generated by OPEC+ talks, and the fall from $65 back to $53 in WTI. Oil prices
will remain range bound in the near term, but the risk remains to the downside
as product builds weigh heavily on the near to medium term pricing structures.
Libya Commentary from Previous report
Libya is moving
front and center as the Libyan National Army and the Government of National
Accord (UN Recognized) failed to come to an agreement after General Hafter
(leader of the LNA) refused to sign the truce. The cease-fire still remains in
place after being brokered between Russia, Turkey, and all Libyan parties. The
next attempt at coming to a “longer-term” agreement will be in Berlin later
this week. Saber rattling has increased as Egypt demonstrated “readiness”
drills in response to Turkey sending proxy troops to Libya. General Hafter
holds the upper hand currently based on the areas under his control-
essentially cornering Tripoli. So far, the LNA have held off on a new offensive
in Tripoli and Misrata. The cease-fire took effect Jan 12th, and so
far- crude production hasn’t been impacted and should remain relatively stable.
Both sides NEED the oil revenue to survive going forward, so all infrastructure
and assets will be spared. There could be some near-term stoppages if fighting
gets too close, but NO ONE and I mean NO ONE is going to target anything oil
related. This is something to watch for near term disruptions, but little in
terms of long-term impacts.
The energy market closed out the year with a big drop in the frac spread count, which carried forward into the second week of January with a move down to 275. The drop was driven by the Permian, which has seen a big decline over the course of 2019. The Permian activity now resembles something closer to 2017 but will rebound back soon as activity accelerates with new spending in Q1. This should support rig activity as DUCs need to be replenished as some of the quoted drilled but uncompleted wells will maintain that “status” due to many issues making them useless at this price deck. Some of the wells were drilled for the “parent-child” which has yielded poor results, had a poor landing (fell out of zone), or is drilled in an area that isn’t economic at this strip. This will keep rigs relatively flat after the substantial decline of about 100 rigs over the last year.
The frac spread fell below 300 for the first time since 2017 as activity slowed down well ahead of normal seasonal adjustments. Typically, completion crews slow down into the holiday season, so a down move is expected- but the scale and pace were a bit surprising. The pendulum always swings too far in both directions, so there will be some support for activity as completions crews start to come back from holiday. There may be one more down move towards 270, but this should be the low (for now) as activity picks back up with new CAPEX programs. The CEO of Patterson was on CNBC talking about how the rig count bottomed in Dec, which is likely as some work picks back up in Q1’2020. It is hard to see too much growth as E&Ps look to manage portfolios as hedges increased throughout Q4 taking advantage of the rise in crude pricing. The backwardation of the curve steepened as companies looked to buy protection even as the front month ran- so the average hedging price probably averaged around $56-$58. Things have reversed considerably following the recent events with Iran (more on that below), as the fundamentals in oil play out to the downside.
There remains a large amount of marketed spreads (about 500) with many of them sitting idle as only 364 are currently active. Companies such as Patterson (Universal), Keane, BJ Services, Halliburton have a lot of capacity on the sidelines that could get redeployed to a new basin with reduced pricing (hard given current costs) to compete for work, or get scrapped or idled indefinitely. Halliburton has already talked about shifting equipment and manpower down to the Permian, so some of those assets could come back- but some capacity will be retired given the age of some fleets and increase wear and tear due to the rise in proppant and pressure reducing the useful life of assets. This will help keep a lid on U.S. production as exit 2020 falls below exit 2019, but activity will recover enough to keep total 2020 oil production for the year above 2019 oil production of about 12.4M barrels a day. The problem will remain realized prices as the world the demand for heavier crude rises around the world. API Gravity is a term everyone should get more comfortable with as “heavier” crude finds more favor- especially oil that is on the heavy/sweet end of the spectrum. API Gravity is a measure of how heavy or light a petroleum liquid is in comparison to water. China has brought online massive facilities, but many of them are complex requiring a heavier blend of crudes to operate. This has created tightness in some of the global spreads, but as the refined product market struggles under cyclical demand declines and structural oversupply- oil demand faces many headwinds as economic run cuts and extended turnarounds limit refining capacity. Oil pricing was inflated by the geo-political uncertainty (which is fluid but ebbing lower) as Iran faces growing local opposition (bearish crude) and Libyan factions discuss a ceasefire.
Even with some properly timed hedges for U.S. E&Ps, oil growth will face significant headwinds as Russia considers “life after the OPEC+ deal.” E&P companies had an opportunity to hedge some production in the first 6 months of the year at prices ranging between $56-$58 as the backwardation steepened considerably driven by the OPEC meeting and geo-political uncertainty. The above chart highlights where WTI prices went quickly allowing for some “decent” priced hedging in the first half of 2020. Russia has come out saying they are considering life after cuts as you “can’t cut forever,” which is interesting as they actively increase their condensate production. Many will point out that OPEC countries don’t include condensate production in their totals (which is true), so it makes sense for Russia to exclude those figures. On the flip side, it also frees Russia to increase their condensate production considerable as ESPO is expanded and gas is pumped into the Power of Siberia. The additional condensate can be blended into Urals as well to reduce total sulfur content, and increase flow as Ural demand has fallen due to IMO 2020 requirements. It also opens up the opportunity to “classify” something as condensate that doesn’t actually meet the API gravity standards. (We have never seen OPEC+ nations lie… I know!) Typically, Russia consumes all the condensate it produces, but with new wells coming online- Russia is facing a surge in condensate production, and the new OPEC+ quotas allow for expansion away from the eyes of the market. I will discuss in greater detail below on the geo-political situation.
The oversupply in the market will worsen now that China has increased runs across their new state-owned facilities and started pushing more refined product. China tightened the physical oil market as oil flowed in to bring new equipment online. It is important to note that China has also been slowing down the ramp of some facilities, and even at this reduced pace- continue to export a record amount of refined products. In the below chart, it is clear where the new facilities turned on with more coming over the coming months.
This is just a quick example of a facility ramping: “Zhejiang Petrochemical Company Limited continues with the trial runs on the 200,000 b/d Crude 1, 100,000 b/d Residual Hydrotreater, 40,000 b/d FCC Gasoline Hydrotreater, 9,000 b/d Alkylation and 76,000 b/d Reformer 1 at its Grassroot 400,000 b/d Zhoushan (Daishan) Refinery. The units were previously expected to come online by the end of December 2019, however, now plans are to begin commercial production by the end of February, 2020. Meanwhile, a 76,000 b/d VGO Hydrocracker, 52,000 b/d BTX 2 have successfully started up on December 18, 2019, and the 200,000 b/d Crude 2 which started up on May 21, 2019, is currently running around 80% capacity and scheduled to reach full throughput by the end of February, 2020.” “Negotiations for the January paraxylene (PX) Asia Contract Price (ACP) have fallen apart because of a wide bid-offer gap. Japan’s JXTG Nippon Oil & Energy placed its offer at $930/t cfr, while all other sellers offered at $920/t cfr. All the sellers declined to change their offers from initial levels. Bids for the January PX ACP were at $720-770/t cfr. The ACP-linked sellers are JXTG Nippon Oil & Energy, Idemitsu Kosan, SK Global Chemical, S-Oil and ExxonMobil. There are six buyers – OPTC, Capco, Yisheng Petrochemicals, Shenghong Petrochemicals, Mitsui Chemicals and BP. Negotiations for the January benchmark ACP were brought forward to 27 December because of the year-end holidays.” The additional capacity is hitting prices across petrochemicals and refined products on a global level. As margins worsen, the question remains who will be the first to cut runs?
How does this link back to the U.S.? The U.S. typically exports from the Gulf of Mexico into Lat Am and Europe, but with the new wave of products coming out of Asia the whole energy trade flow is adjusting. The new product from China is filling local demand just as other product from South Korea and India is pushed out of Asia and into other areas- such as Europe and Africa. This limits flow from the Middle East into Asia, so pushes more Middle East product into Africa, Europe, and some LatAm demand. So now you have European product that is competing into the LatAm market as well as the East Coast of the U.S. Now that we are back to the coast of the U.S.- where is the place that the product can compete? The U.S. can try to protect market share in LatAm and Europe, but it is getting harder as more refined product is moving around the world at fire sale prices. This has caused a buildup of U.S. product, which is now reverberating back through the system with rising builds in Europe and Asia. It is a key structure that is weighing on crack spreads and pricing as product can’t flow along its normal routes.
The pace of Exports will fall for refined products, but crude exports will recover as demand rises given the increase in shipping rates and the spread widening between Brent and WTI. This will keep exports elevated from the U.S. on a crude level.
To make matters worse, South Korea and China have been focused on a view that others should roll out economic run cuts- so each country has been producing products at unfavorable pricing waiting out the rest of the market. U.S. refinery utilization rates have kicked off the year near the 5-year low from 2016.
The pace of builds will increase on a seasonal level as Martin Luther King Day is the last big travel weekend before we hit the winter lull. This will result in a reduction in utilization rates, which is so far below the average and trending lower. The slowdown in exports has pushed more product into storage and keep crack spreads capped. It is already showing up in time spreads, and will struggle as the flow of product out of China accelerates.
The market is struggling with both a structural
change out of Asia, and the cyclical impact of lower demand on a global level.
There is a positive view that the China/US Trade deal will unlock more near
term demand, but the market is saturated in light/sweet crude, and the trade
war still has many steps involved to get back to a “normal” trading
relationship. In the near term (aided by seasonal slow downs), WTI should trend
lower towards $53, completion crews will shift back to 300, Permian back to
100, and rigs should find some support at these levels.
Libya is moving front and center as the Libyan National Army and the Government of National Accord (UN Recognized) failed to come to an agreement after General Hafter (leader of the LNA) refused to sign the truce. The cease-fire still remains in place after being brokered between Russia, Turkey, and all Libyan parties. The next attempt at coming to a “longer-term” agreement will be in Berlin later this week. Saber rattling has increased as Egypt demonstrated “readiness” drills in response to Turkey sending proxy troops to Libya. General Hafter holds the upper hand currently based on the areas under his control- essentially cornering Tripoli. So far, the LNA have held off on a new offensive in Tripoli and Misrata. The cease-fire took effect Jan 12th, and so far- crude production hasn’t been impacted and should remain relatively stable. Both sides NEED the oil revenue to survive going forward, so all infrastructure and assets will be spared. There could be some near-term stoppages if fighting gets too close, but NO ONE and I mean NO ONE is going to target anything oil related. This is something to watch for near term disruptions, but little in terms of long-term impacts.
Iran remains a key focal point, and now France/ Germany/
and the UK have triggered the dispute mechanism in the 2015 Joint Comprehensive
Plan of Action. This was driven by Iran’s violaton under the agreement terms,
and European leaders now have 15 days to resolve their differences or the UN
sanctions snap back into place. This would be more of a symbolic gesture as
many of the sanctions have already been re-instated, and will find new support
given the shoot down of the Ukraine airline and rampant killing of protestors.
The protests are ramping against the current regime, and chanting for the end
to the current regime (which is punishable by death). This is also coming after
about 1500 protestors were killed following the rallies against the rise in
fuel prices. These protests occurred throughout Nov and Dec, so the anger
against the regime has only been fanned with the death of their enforcer
(General Soleimani) and now the killing of innocent Iranian citizens when two
missiles destroyed the plane. Below is a follow-up of the Iran response to the
U.S. precision strike.
Iran Fires Ballistic Missiles into Iraq as Soleimani
is buried in Kerman
Iran officially launched 15 ballistic missiles (NOT
ROCKETS!!!!!!!!!) into Iraq striking two Iraqi bases housing both U.S. and
The IRGC launched the following:
10 Fateh 313
missiles at Ain al-Asad (very similar to the Fateh 110 Missile)
5 Qiam-1 at
3 of them
failed in flight
1 was shot down
by a US CRAM
All relevant militaries placed assets on high alert
in anticipation for a response to the killing of the high-level people listed
in my previous report. The high alert allowed equipment to pick-up the launches
instantly and take appropriate measures to ensure no loss of life. All
personnel were able to take cover, and the sheer size of Ain al-Asad also means
a “successful” strike can occur without causalities. A helicopter can be
replaced… a runway can be rebuilt… a life is irreplaceable.
The attack was a way to boost morale at home or as
it was quipped “funeral fireworks” as the strike was timed with the official
burial of Soleimani in his hometown. Iran launched a strike against Iraq
assets, as the tit-for-tat continues to take place outside of Iran borders. I
mention this because Iranian assets have launched attacks on Iraqi citizens in
multiple regions, which has spurred further protests. Here is just one
example-“Iraqi protestors attack pro
Khamenei Hashd al Shaabi militia building in Dhi Qar, #raq. The fight against
Soleimani & Khamenei’s oppression continues.” The U.S. and Iraq government
need to send a signal of unity at not tolerating further aggression, but Iraq
must go further and focus on expelling the Iranian assets operating within
their borders. The U.S. has been moving assets around the region in order to
provide air support and a potential response if deemed necessary. The early
indications are that the USAF at al-Dhafra (located in the UAE) and Diego
Garcia are on high alert (just meaning they can launch aircraft in under 15
mins). The U.S. has moved high value assets F-35s and B-52s to Diego Garcia in
order to provide support throughout the region.
It is also worth noting that the Iraq
meeting held on expelling the U.S. from their sovereignty could not come to a
vote or hold a quorum because all Sunni and Kurdish members held a walk out in
protest. This just means that what was “officially” entered into the record
books was a non-binding request. So out of 328 people only 170 remained to hear
the potential timetable for U.S. withdrawing assets. It is also possible for
the U.S. to remain in Iraq within the semi-autonomous region controlled by the
Kurds. “The vote, he explained, was a party-line vote by Shia Iran supporters
in the parliament. Kurdish and Sunni lawmakers had boycotted the session
despite threats from the very same Shia militia that kicked off the current
cycle of violence, leading to a barely functioning quorum in the chamber.
Of course, to admit threats of political violence
from pro-Iranian militia would undermine the media narrative that the
parliament, like the militia mob that attacked our embassy, represents everyday
Iraqis. What these pro-Iranian lawmakers passed was no United States ouster,
but a non-binding, partisan resolution that the United States should leave. The
“quorum,” Abdul-Hussain writes, “was 170 of 328 (half + 4, just like Hezbollah
designated a [prime minister] in Lebanese parliament with half + 4).”?”
Iran has stated they will next strike Israel and Dubai
if the U.S. responds to the attack, and based on the course of action- the U.S.
is within its right to strike Iranian soil since the launches occurred from
inside Iran. The launch sites are well documented, as well as other strategic
sites that would be of importance. I find it unlikely that the U.S. will launch
such a counter due to the ineffective (thankfully) nature of the ballistic
missile attack resulting in no causalities. The U.S. may instead take action on
Iranian assets and proxies within the Iraq borders, but most of the Iranian
populace doesn’t support the current regime and it would be foolish for the
U.S. to provide propaganda. Some will point to the funeral procession as saying
this is false, but when you close all bases, government buildings, schools, and
business and require people to show up- it is easy to show a large “outpouring
of support.” I am by no means saying some of these people weren’t vehement
supporters- 35 people were killed and others injured as a surge and riot
occurred just to touch his coffin. It also shouldn’t be lost on the populace
that he was a popular war hero from the Iran- Iraq war as well as a very savvy
military strategist and leader. So some may have come out for support, others
out of respect for his service in the Iran-Iraq war, and others because they
had too. The generational dynamics of the country are clear, and this regime is
facing a changing tide at home.
Those in power have been in power since 1979, but
the younger generation doesn’t want to live under the thumb of a repressive
regime. If we look throughout time, the Persian Empire (Iran) has a long
history with Europe, India (other parts of Asia), and throughout the region.
The current toxic relationship between Iran and the west is something (if we look
at this as measured in generations and not single years) a blip in the long
history of cooperation and trade between the two parties. This is coming full
circle, and a U.S. response against the populace, holy sites, or important
civilian assets would just galvanize the population and delay a conversion back
to an open society. Nothing happens overnight- especially generational cycles-
but the movements are in place and taking out one of their top assets can help
speed the process. Soleimani was responsible for putting down many of the
protests throughout Iran, Iraq, and Syria, and is responsible for killing,
jailing, torturing, and raping 1,000’s over his reign. The Bush and Obama
administrations have always considered him as a viable target, but deemed the
ends didn’t justify the means. This has changed over time as protests against
the Iranian government have intensified across Iran and Iraq.
An interesting point to be made- Iran carried out a
precision attack against Abqaiq, but failed to strike “revenge killings” as
they called it. Does this mean the remaining technology isn’t as good as
perceived? (Iran has an estimated 2k ballistic missiles) Did they miss on
purpose to save face and truly don’t want direct conflict with the U.S.? Was
there an inside deal between multiple parties to eliminate Soleimani? Some of
these are farfetched and others are plausible, but at the moment- everything
points to a limited U.S. response and no escalation at this time. The
assumption is additional attacks on Iranian proxies within Iraq, but not a
strike on Iranian soil currently. Anything is possible as the whole remains
fluid, and we will get more details over the next several days- but things will
calm down over the next few hours. It doesn’t mean we tell our USAF to stand
down or take anything off of high alert, but it just means this could be an
exit ramp for de-escalation. Iran also shot down a Boeing 737 Ukrainian
passenger jet carrying 180 people using two anti-missiles crashing near Tehran
just after takeoff. The government tried to blame mechanical error and
bulldozed the site, but intelligence gathered from the U.S., Europe, and Canada
forced Iran to admit it’s error, and has enraged the populace launching even
bigger protests throughout the country against the regime. Sadly- this wouldn’t
be the first time something like this has happened, and just after the attack
from Iran- China and U.S. barred passenger jets from flying anywhere near the
On the market front, WTI hit a high of $65.65 before
turning lower to sit at about $63.63 up about 1.5% from the close today. The
S&P futures reached a low of 3181, which was down about 40 handles from the
close as gold future briefly spiked to over $1600. The oil markets will hold
some risk premium from the initial attack while the rest of it fades into the
morning, and if the EIA confirms the API report of a massive product build- oil
prices will quick fall. All of this remains negative for refiners across the board,
and provides a good time to fade crude. Gold remains a key holding, but timing
is everything on re-entry. Even if the risk premium remains, there are many
nations (Russia and KSA) that would quickly look to sell into this elevated
price environment. There is a significant amount of oil supply available in the
world and a massive glut of refined products around the world. The main goal is
to take advantage of fear and price dislocation as fundamentals always win out
in the commodity/physical world- which can’t be said for the equity markets.
The final point is on the U.S./China trade agreement that is expected to be signed this week in Washington D.C. So far the details emerging are as follows:
agree to purchase $200 Billion in U.S. goods per year
$75 Billion in
$50 Billion in
$40 Billion in
billion and $40 Billion worth of services
In exchange- the U.S. will lower the 15% tariff on
$120 billion in goods imposed earlier last year to 7.5%, and delay imposing the
new 25% tariffs that were initially slated to hit in December of 2019. The U.S.
also took the symbolic action of removing China as a “currency manipulator”,
which has no impact on operations. The deal reverts the standoff between China
and the U.S. back to October, and doesn’t even scratch the surface of the real
issues of bilateral tensions across IP theft, state support of Chinese firms,
IP protection, state- sponsored espionage, and a litany of other bigger issues.
The biggest issue for the U.S. will be designating a way to “retaliate” and
“measure” if the deal is broken or if things worsen on the bigger issues. There
has already been a lot of questions if China could actually absorb that amount
of new goods from the U.S. or is this just another Chinese tactic of “appease”
with no real desire (or ability) to honor the agreement. China (on a state and
corporate level) has always signed deals and blatantly ignored every piece of
the terms if they were no longer in China’s favor. They have walked from
countless contracts, joint ventures, and other agreements once it no longer
suited their needs- regardless of the terms everyone signed on too. The
official terms will be key as the devil will be in the details, and the above
is purely the “leaked” or “scooped” terms that have been put forth by China and
the U.S. Each side will try to pick the details that maximize the spin on why
this is a good deal, but the full information will be needed for everyone to
decide if this is positive for the market.
risk will remain high across the trade deal as well as Middle East tension.
Iran proxies will continue to launch rocket attacks against Iraqi bases that
house coalition troops and equipment. As of this writing, a rocket and mortar
attack is being carried out on the Taji Military Base North of Baghdad. These
attacks will continue to occur throughout the region as Iran attempts to drum
up support from their proxies, while they tackle rising domestic turmoil.
Headline risk remains high, but the underlying fundamentals demonstrate
headwinds for crude and refined product pricing and demand. The goal will be to
find the signal in the noise and focus on the underlying market fundamentals.
Protests have escalated in both Iran and Iraq- both against the Iranian government and the IRGC (Islamic Revolutionary Guard Corps.)
In Iran- protestors are demanding a change in leadership due to squandered funds on proxy wars, poor employment, and a lack of overarching civil liberties.
In Iraq- Iraqi Shia’s (predominantly in the southern part of the country) are protesting against the influence of Iran in the Iraq government- as well as many similar social issues.
There are many similarities between the two protests, and they all focus on the lack of opportunity due to high unemployment and corruption squandering oil money
I mentioned previously: “The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.” The issues have been building over the following course with some key escalation points below:
Iran used mines to attack a tanker
Gibraltar seizes an Iranian oil tanker
Iran seizes a British oil tanker
Iran shoots down Global Hawk US Drone
Iran has infiltrated the Iraqi government blocking operations from within, and is a key reason for Iraqi Shia protests- Iran involvement and corruption
Iran targets the Abqaiq-Khurais facility in Saudi Arabi
K1 military base in Kirkuk, Iraq comes under rocket fire killing a US Military Contractor and wounding other US Soldiers reportedly carried out by the PMU (Popular Mobilization Units.)
There have been other rocket attacks, but until K1 were carried out without loss of life or injury
Each of the attacks on US and Iraqi Military Assets were supposed to be investigated by the Iraq government, but has been slowed down by politicians tied to Iran. There was a growing view that Soleimani (and general Iran) assets have important seats in parliament, and have effectively stonewalled investigations.
In response to the K1 attack, the US carries out an attack in Iraq and Syria killing about 27 and destroying facilities all believed to be a part of an Iranian proxy called Kata’ib Hezbollah (Kataib Hezbollah).
Following this attack, the PMU and Iranian proxies attack the U.S. Embassy in Baghdad requiring the deployment of the Marine Rapid Response Team.
The U.S. took the attack on their sovereignty, and escalated it further by targeting a convoy near the Baghdad airport killing:
Qasem Soleimani- Commander (General) of IRGC Qud Forces
PMU’s head of PR
Senior Hezbollah/ PMU leaders
Mohammed Redha al-Jabri, head of protocol of Iraq’s state-sponsored Popular Mobilization Forces
deputy head of Al-Hashed, Haj Abu Mahdi al-Muhandis
General Hussein Jaafari Naya
Colonel Shahroud Muzaffari Niya
Major Hadi Tarmi
Captain Waheed Zamanian
There are also unconfirmed rumors that US Special Forces have raided several buildings of Iraqi PMUs capturing Qais Khazali, leader of Asa’ib Ahl al-Haq & Hadi al-Amiri, former head of IRGC’s Badr Organization in Jadriyah, Baghdad
Germany has come out and placed the blame at the feet of Iran (which is a break from previous views held between the US and Iran.)
Response from the Cleric Muqtada al-Sadr was a bit different calling on Iran to avoid escalating and continue to criticize the pro-Iran Militia. Al-Sadr has also started talking about resurrecting his Mahdi Army.
Information remains fluid, and there is increasing intelligence being reported that Iran’s Soleimani was planning a bigger attack on the U.S. Based on his flight from Lebanon, the people he was traveling with, and actions at the US Embassy- there is reason to believe these were credible.
The U.S. has increase the Rapid Response Team in Kuwait with the deployment of 3500 troops as asset movements remain fluid across the area.
Impact to oil will be minimal and will fade as headwinds persist across the supply chain- especially in the refined products area.
This move will fade as refined product builds continue to rise globally and force economic run cuts.
Iran has been provocative in the region with consistent activity around rocket attacks and mobilizing assets in and around Syria and Iraq. Tensions have been on the rise as protests rip through Iran and Iraq all against the Iranian government, and their involvement in proxy wars spanning across the “Shia Crescent”. The U.S. has shown restraint while dealing with Iran given the fear of galvanizing the local populace against the West. The Iranian people are reaching a tipping point, and the inability of Ali Khamenei to put down the uprising is a telling sign. The IRGC and government have used violent tactics as well as turning off the internet in order to disperse the protestors. They have also taken more aggressive actions against international actors in order to project power and help isolate protestors.
The U.S. killing
of so many high-level Shia assets was a calculated risk as many of them have
been responsible for deaths throughout Iran, Iraq, and Syria (including US
soldiers). There has been talk of “acts-of-war”, but this all took place on
Iraqi soil and begs the question why such a high-level Iranian was in Iraq. A
key talking point has been Soleimani’s involvement with training
counter-terrorism, but the growing concern was his involvement with attacks
against U.S. assets (including the embassy) and a potential bigger motive in a
coup. The U.S. has tolerated a significant amount of provocation as the focus
has shifted into Asia and away from the Middle East. After trillions of dollars
spend in Iraq, the U.S. (as outlined below) has been pulling out assets which
began in Syria and Kurdistan. As the Iranian’s attacked the KSA facility, it
started to adjust the flow of US military back into the region, but with a
bigger focus in Saudi Arabia, Kuwait, and Bahrain. As protests raged in Iraq,
Iran sent in assets to help “control” the situation which resulted in more
deaths and instead enraged people further.
As Peter Zeihan
highlights, Qassem Soleimani has been the “fixer” for many of Iranians problems
on the battlefield as well in politically sensitive situations. He has put down
protests with an iron fist and used his skills as a military leader to carry
out highly effective guerrilla attacks and battlefield logistics. The problem
was- Iran overplayed its hand with an outright attack on a US Embassy… just
look at the Iran Hostage Crisis where US personnel were held hostage for over a
year and Benghazi. The attack in Baghadad called in the Rapid Response Team
that helped deter things from getting worse, but a message was sent through a
very carefully orchestrated attack. The U.S. has clearly been keeping eyes on
MANY of Iranian and Iraqi high level personal. The fact so many very senior
people were traveling together- highlights the U.S. caught them in a lapse of
judgement as they assumed the U.S. would continue its passive nature in the
region. The targeted attack means the US (and allies) has some deep
intelligence penetration around Iran’s leaders, and is a wake-up call to many
of those in the region. The U.S. named the IRCG a foreign terrorist
organization in April, which provides legal cover to carry out attacks when
provoked. This was a small cover that was widely forgotten about, and is a key
reason having that many high level people in one convoy was a very risky
endeavor. The only net increase in personnel into the region came after the
attacks on KSA, as current troop movements are adjusting balance of man-power across
the GCC (Gulf Cooperation Council). 
Rym Momtaz in this
highlights that Soleimani has been a recruiting tool as his designation as
“Iran’s most important military leader.” There was a growing belief that he was
untouchable and could move about with ease and carry out Iran’s operations
domestically and abroad. Khamenei has now vowed a response, which is possible
but will need to be highly calculated because the U.S. has now shown restraint
but green-lit the use of deadly force. The U.S. strikes have killed about 27
militia in 5 different locations and a convoy of high value targets. The threat
will put all U.S. assets in the region at risk and on high alert, but the reach
of Iran is limited given the years of sanctions, low oil prices, and extensive
Israel has been
targeting Iranian convoys around Syria to limit the movement of equipment into
key Lebanon strong holds where Iran has significant influence. Israel actions
will help limit the scope of an attack on U.S. assets in Lebanon and Jordan,
but by no means makes it impossible given the embedded nature of Hezbollah on a
global level. The new IRGC Quds Force Commander Ismail Qani has now come out to
double down on attacking Americans all over the Middle East. While these threats
have to be taken seriously, the U.S. human and signal intel is very strong and
any movements by Iran will be watched closely for a counterattack.
The drawdown of
U.S. assets from the Middle East has adjusted to a relatively stable level with
redeployment and adjustments of equipment and manpower around the area. C-17s
and ship movements have been active as the pieces of the puzzle are adjusted to
provide support to the Rapid Response Teams, counter terrorism Special Forces,
and anti-missile defenses. Iran’s ability to close the Strait of Hormuz is now
near impossible given the U.S’s willingness to use live fire and not tolerate
provocation. If Iran attempts to take action in international waters or
shipping lanes- they will be met with decisive action.
In terms of
actions, crude should normalize lower as headwinds persist across the space
with Russia posting oil production above OPEC+ levels as well as Nigeria. The
bigger issue remains the growing glut of refined products on a global level,
and this is not something an Iranian action will adjust. Iran has been
exporting limited oil, and at the moment, there hasn’t been any real disruption
to oil production and exports. The “softest” target for oil disruption would be
out of Iraq’s Basrah port. This has a very specific caveat as Iran utilizes
shared fields to export into the market (under the Iraq flag) through this
area. This means that other areas- specifically in the GCC would be ideal
locations, but have seen a heavy increase in defenses since the KSA attack.
This limits the scope of a response, but by no means makes one impossible.
As the EIA data
confirmed, oil barrels manage to avoid Texas when the tax man comes along to
count. This pushes refiners to reduce imports, pull more crude from storage, and
make more refined products. The U.S. remains with all time high gasoline in
storage, which has pushed product back into Europe by shutting down flow into
the US. Builds in Europe have also grown as more product enters from Asia and
other markets with limited export markets. China has created short term
tightness in the oil market with new imports and a rise in their quota by 10%
year over year. The little talked about (but bigger issue on pricing) is the
increase in refined product export quotas by 53%. There is an ever increasing
amount of refined product looking for a home with very few places able to
handle the new flow. Russia is raising its condensate production, and will send
more into the market over the coming months just as new facilities become operational-
specifically in Guyana. Saudi Arabia has strategically cut light crude pricing
into Asia and Europe to try to compete against US exports, so the flow of oil
isn’t abating- but as refinery run cuts accelerate demand for oil will fall
precipitously as crack spreads are indicating.
situation will remain very fluid, but the U.S. has put itself in a position of
strength in the escalation process by playing their hand very well on the
geo-political front. Iran has already tried spinning this as an attack on their
sovereignty, but it has been rightfully rejected by the locals. These are the
same people facing 35% unemployment, social persecution, and a deteriorating
quality of life. The Iraq parliament has called a special meeting where they
will most likely condemn the violence and say this was an infringement of their
nation. While we can play devil’s advocate, it is the host nations
responsibility to secure embassies and bases at which international and local
soldiers and personnel are stationed. Instead, the government (which has been
wildly ineffective- more on that below) has failed to deploy troops or
investigate the underlying cause of the rocket attacks. This is due to Iran’s
involvement in the government, and how embedded the PMU is within the Iraq
military ranks. The PMUs became embedded in the Iraqi military after fighting
alongside each other to expel ISIS from the region, and instead of returning to
Iran have remained in the country increasing their influence and proliferation.
This may seem “frightening” but the Iraqi military (and many locals) aren’t all
that happy with the presence of these entities, but lack the ability to expel
them from the ranks.
Iran could also
respond by increasing their uranium enrichment and going against the JCPOA on
missile development and heavy-water reactor. This could be a way of retaliation
in a way of saving face, while limiting the escalation process as a direct
altercation with the U.S. is out of the question. Iran can also increase their
missile deliveries to Palestine, Lebanon, and Yemen to increase attacks on US,
Israel, and GCC nations. The overarching problem (highlighted below) is the
poor economic condition that Iran finds itself, which really limits its
options. Russia is happy to keep Iran involved in Syria, but wants to be sure
to limit the reach and scope- so Russia is agnostic to the current situation.
Turkey welcomes any weakness from Iran, so they find themselves isolated
between Russia, Turkey, the US, and GCC nations. Their only help could come
from China, but China has limited ability to step in and delivery any form of
aid outside of continuing to purchase crude. China doesn’t have the assets to
enforce or project any real strength in the region, and Russia will also look to
maintain the upper hand with any of the proxy’s relationships. This leaves Iran
isolated as they no longer carry favor in large parts of Iraq, have lost a “war
hero” and “marketing tool” hailed as the “most valiant warrior and effective US
Challenger, facing major security breaches on their inner most level, economic
struggles from sanctions and low oil prices, and protests throughout the
country. All of these points will keep the issue regional, with limited
contagion in the area until at least the funerals have passed. Iran is very
calculating and precise and don’t often make missteps, so there will be some
form of saber rattling and retaliation- but the U.S. has taken the upper hand.
on the Middle East Conflicts
The Ever-Changing Middle East Landscape:
The events in the Middle East won’t push lasting price increases to crude pricing
Outside current geo-political impacts —Heavy-light spread will tighten with heavy/sours getting a bid in the market due to both structural and cyclical changes in the market
Current Iraq protests will be localized with minimal impact to crude pricing.
Contagion of Iraq protests to other regions is unlikely.
Iran and the U.S. will remain at odds with little or no chance of an agreement for the foreseeable future (or at least not before elections).
An attack on Iran in response to the strike on the Saudi facility will be limited in scope to coastal assets and radar stations to avoid civilian casualties and turning populace views against the West.
The U.S. pulling out of Syria will lead to an increase in destabilizing the region as the YPG are extended and won’t be able to effectively stop an expansion of Turkish forces into Northeast Syria. It is unlikely Turkey will make it all the way to Euphrates, but will build a “buffer” zone. If Turkey gets too aggressive, it will unify the Kurds across Syria, Iraq, and potentially, Iran.
The Syrian situation (as it stands) will have little to no impact on crude pricing as they aren’t a key player, and the only Turkish asset is the Ceyhan pipeline originating from Kirkurk.
The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.
The events in the Middle East won’t push lasting price increases to crude pricing
Outside current geo-political impacts —Heavy-light spread will tighten with heavy/sours getting a bid in the market due to both structural and cyclical changes in the market
Current Iraq protests will be localized with minimal impact to crude pricing.
Contagion of Iraq protests to other regions is unlikely.
Iran and the U.S. will remain at odds with little or no chance of an agreement for the foreseeable future (or at least not before elections).
An attack on Iran in response to the strike on the Saudi facility will be limited in scope to coastal assets and radar stations to avoid civilian casualties and turning populace views against the West.
The U.S. pulling out of Syria will lead to an increase in destabilizing the region as the YPG are extended and won’t be able to effectively stop an expansion of Turkish forces into Northeast Syria. It is unlikely Turkey will make it all the way to Euphrates, but will build a “buffer” zone. If Turkey gets too aggressive, it will unify the Kurds across Syria, Iraq, and potentially, Iran.
The Syrian situation (as it stands) will have little to no impact on crude pricing as they aren’t a key player, and the only Turkish asset is the Ceyhan pipeline originating from Kirkurk.
The key overarching theme is a rise in Middle East tensions, and while the current situations aren’t enough to lead to a broader conflict—the groundwork is being laid.
Impact Based on Current Events
current Middle East situation won’t impact U.S. companies at the moment given
the limited scope and minimal impact on supply. The demand problem on a global
level is an increasing problem, which is now made worse by sanctions placed on Cosco-
China Ocean Shipping Company Limited. The blacklisting of about 100 oil
carrying vessels was in retaliation for transporting Iranian crude. By limiting
the availability of ships, the cost to transport oil has nearly tripled across
the globe- with the most recent news: “OC and HPCL book VLCCs from West Africa
to India at costs of $9.5m or more, nearly triple the rate a month ago, amid widespread gains in crude shipping
rates. Vitol offers Forcados on Platts window.” The fact that U.S. crude has to
travel further to Asia will inherently lead to a higher cost given available
vessels, which will put pressure on realized prices and spreads. In fact, rates
to move crude is so high
refined product tankers (clean tankers) are moving crude. This
will persist as the market capitalizes on the shortage created by the Office of Foreign
Assets Control’s (OFAC).
IOCs and majors will be able to offset some of these costs by leveraging supply
chain economics and reducing expenses throughout the process, but the smaller
E&Ps are selling crude into a market that is experiencing rising costs
(shipping) and reduced demand (crude quality, economic heads, seasonality).
Some spreads are stronger in the physical market driven by location and quality
of available shipments, which will persist in the market. This opens up
opportunity for majors that have a broad exposure to various locations and
crude qualities-especially the ones that control their own shipping fleet. The
fact companies are shifting refined product tankers to move crude will also
lead to tightness in the movement of products. This helps to drive home the
fact—even though the U.S. is shifting around military assets, there remains a
laser focus on economic impacts through sanctions on hydrocarbons and ships hitting
both Iran and China.
of the shipping impact, the Middle East situation won’t drive up U.S. prices as
any supply disruptions will be short-lived and small in scale. While the shifts
at the moment are relatively small, the area is become less stable with rising
tension between Sunni and Shia factions, which is being expressed between
countries and within borders. This risk helps to support U.S. flows over the
long-term given the inherent stability of the U.S. infrastructure and business
operations. The winners will remain the companies that are vertically
integrated, while SMID cap companies will struggle to compete against larger
entities with balance sheets and international cash flow. The ability for
companies like- Exxon, Noble, Chevron, and BP, to extract value from abroad and
funnel into operations within the U.S. and manage the process from the
well-head to the dock/refiner provides valuable upside. The limited scope of
Iraq disruption won’t materially impact U.S. E&P and oilfield service
companies doing business in the region. The need for expertise, equipment, and
continuity will also protect assets from sabotage at the moment, but these
situations will consistently be monitored. The political situation will remain
fluid globally driven by economic impacts, seasonality, and shifting
geo-politics- so stay tuned and more below on the current Middle East problems
(just naming a few).
The U.S. is in the
process of shifting assets within the Kurdish (YPG: People’s Protection Unit)
held locations, which make up the largest contingent of the SDF (Syrian
Democratic Forces). This comes at a precarious time as tensions are rising
throughout the Middle East. Turkish President Erdogan has been pushing for a
safe zone that runs 20 miles deep and 300 miles along the Turkish-Syrian border
east of the Euphrates.
Erdogan wants to place 3 million Syrian refugees back into northern Syria,
which is about 75% of the current refugees believed to be in Turkey. There have
been tension at the border between Turkey and Syria, with Turkish border police
firing warning shots as the border remains closed and guarded by about 500
miles of fence. The area where Turkey and Free Syrian Army forces reside in
Afrin has been inundated with refugees that are stretching the economic limit
of the area.
have said for several years that as ISIS falls, loose allies would turn weapons
on each other as the battle for land and resources push armed groups to battle
each other. President Erdogan has always had the desire to acquire land to
re-establish pieces of the Ottoman Empire. This comes at a time where Russia,
Iran, and al-Assad (Syrian Forces) continue to launch questionable attacks on
civilians. The lack of civilian protection has driven refugees to the Turkish
border incentivizing or supporting a potential need for a “safe zone”. The
Kurds have done a lot to maintain control of the area, while maintaining and
securing ISIS detention facilities throughout their controlled areas. The
ability to properly guard these areas has already been strained, and the
removal of U.S. assets could complicate the situation, especially if the Kurds
(People’s Protection Units) are forced to defend against Turkey without
support. Turkey has already launched initial strikes against ammunition depots
targeting anti-aircraft equipment, and the Kurds currently have little help
from the outside world limiting their ability to strike back. The question
remains open—would Turkey and
Russia join forces to carry out strikes against Kurdish held regions? Could
this re-ignite a broader Syrian Civil War? The short answer is: Turkey will go
at it alone in the near term, and this won’t re-ignite the Civil war at the
would face recourse within its own borders if they launched an offensive attack
against the Kurdish populace, but the current issues will bleed over into Iraq,
who is currently facing its own upheaval. The vote for Kurdistan was cut short
as Iraq (and some Iran assets) moved into Northern Iraq (where most Kurds
reside in Iraq) to squash the movement of freedom. The U.S. did nothing to stop
these proceedings, and the same is being carried out in Northern Syria with the
U.S. offering limited to no support. The Kurds have been the most effective
fighting force against ISIS, and were key allies to the U.S. in its destruction—and now with a claim of “mission
accomplished,” the U.S. is leaving a power vacuum that will be filled with
warfare along tribal lines influenced by the whims of Russia. It is unlikely
Turkey would look to fight all the way down to the Euphrates, but they will
look to establish a buffer zone along their border—under the guise of creating a cushion
zone. The interesting component will be if there is any movement from Iraqi
Kurds into Syria, or will it be deemed a lost cause since the Kurdistan vote
was split based on specific Kurdish party affiliation.
Syrian announcement comes on the back of rising protests and violence
throughout Iraq, driven by the poor economic conditions for large parts of the
populace. The main grievance of protestors surrounds rampant corruption and
nepotism with a failure of the government to increase economic and social
services to allow jobs and oil revenue to reach all citizens of Iraq. There
doesn’t appear to be one distinct leader in the protests as they continue to
rip through multiple cities: Baghdad, as well as other areas in the center and
south. Iraqi security forces have so far killed about 40 protesters (as of Oct
4th) with numbers expected to be closer to 100, with hundreds
injured. Iraq’s parliament has tried to slow the spread of protests by
promising reform. Iraqi Prime Minister Adel Abdul-Madi promised a new stipend
program to poor families as well as the firing of about a thousand government
employees accused of corruption. This has done little to quell the protests, as
these comments and promises have been common and fleeting over the last several
Shia cleric Grand Ayatollah Ali al-Sistani has condemn the use of violence,
with the Shia leader Muqtada al-Sadr’s Sairoon taking it a step further and
proposing his bloc will stop participating in parliament until the current
government leadership resigns. The situation could spiral quickly as the split
of Sunni and Shia in Iraq is about 42% to 51% respectively, with some putting
the spread a bit wider. The failure of a Shia government without a quick
adjustment could spring up in-fighting along religious lines making things
worse. On the other hand (and more likely), this could provide an opportunity
to replace Adil Abdul Mahdi in Iraq by taking advantage of the upheaval. There
is always concern that Saudi Arabia is planting discontent to stir up the Sunni
populace and put pressure on the Shia dominated government. Based on current
reports, there hasn’t been a great deal of outside influence to the protests
that appear to be more “grassroot” oriented. As I mentioned earlier, protests
aren’t new to Iraq, but these are different given size and scale. The Shia
Popular Mobilization Units could gain political favor as they have abstained
from putting down protests and kept relatively close ties to Iran. At the
moment, Iraq protests remain localized with limited wide-scale impact.
The current impact to oil will be minimal throughout Iraq as any party understands that oil revenue is paramount to maintaining peace/unity in the region. There may be disruptions as some protests take place near oil fields or, more importantly, export hubs (such as Basrah). The current protests won’t be enough to keep a premium in the oil markets as demand remains the core concern. The broad economic slow-down will be further impacted by seasonality as refiners enter their fall maintenance season. Protests will continue throughout the southern region, and the below map highlights the country’s oil regions and pipeline networks that could be impacted.
Even if ISIS or
other terrorist groups look to take advantage of the situation in Iraq, it is
unlikely anyone would destroy equipment, as ISIS appreciated the importance of
oil infrastructure as a means of revenue. In an attempt to create more chaos,
there could be some damage to infrastructure, but most would be small in scale
and quickly fixed by each faction jockeying for control. The lack of formality
and leadership in the protests will (at least for now) keep them from spreading
or becoming more than just a disruption and display of broader displeasure. In
the near term, this doesn’t seem to be the beginning of broader civil unrest
turning into a civil war, but rather a move to highlight the poor economic condition
of many regions. It should be of no surprise that as oil prices remain
depressed, oil-based economies will see a rise in unemployment and cuts to
social funding driving further unrest. Iraq won’t be the only spot to see a
rise in tensions.
is a perfect example of a place that has seen growing animosity as the populace
failed to see the benefits of the Iran Nuclear Deal. This has led to a rise in
tensions internally as the additional revenue didn’t translate into local jobs
and economic uplift. There is no near-term solution to the Iran deal as the
U.S. looks to put pressure on the government and The Iranian Revolutionary
Guard to drive a regime change. The problem is, the 15% (or so) that support
the government are also the individuals that control large parts of the
military and local funding. This will limit any effective protests or civil
unrest while the U.S. looks to pressure Iran. At the same time, this will
restrict the U.S. military’s ability to strike targets within Iran as to limit
civilian casualties and avoid turning popular opinion against the U.S. and the
West in general. The populace (for the most part) has shifted their anger away
from the West and focused it more on the current regime, so the goal is to
apply maximum pain while limiting shifting local demand. The frequency of
protests has risen in Iran, but the inability to create a cohesive unit— based on crackdowns and limited resources
—will keep protests
from really creating a regime adjustment.
The only thing that will allow for a new deal (outside of regime change) would be the limit and discontinued use of ballistic missiles by Iran. This was a key issue with the previous agreement, as it failed to limit the development, use, and delivery systems of ballistic missiles. The current Iran government is unwilling to even consider this as an option, which will keep sanctions in place. The limit of heavy crude in the market will keep the trade for Iran crude flowing at volumes ranging from 500k to 1M barrels per day, which the U.S. has (for the most part) turned a blind eye to. The U.S. ignores some of these barrels, as they fulfill a need for heavy sour crudes in key allied interests across South East Asia and limits some of the price premium in the open market that would impact U.S. purchases. Iran has also effectively moved crude through Iraq pipes from shared fields, with kickbacks flowing to Iran. This is a well known (but mostly ignored) part of the increase in Iraqi exports, but the shortage of heavy crude in the market has kept exports flowing. The below chart highlights the spread in Basrah vs Brent, where a large part of Iran crude finds its way to the market:
spread of protests from Iraq to Iran will be tough as the Iranian government
has much more control across the populace (though this will rapidly change as
generational cycles hit Iran). As those in charge are aging and will struggle
to hold on to control, the Iranian Revolutionary Guard allegiance can be bought
to the highest bidder. We are still several years away from having meaningful
change, but with many of those still currently in power from 1979, the
generational cycle will provide a shake-up. The hope (or so it seems) by
President Trump was to accelerate the adjustment, but that is highly unlikely.
Iran will have to tread lightly with Syria (as they have their own Kurdish
population that is already unhappy with the Iranian government), as well as
Iraqi unrest in areas such as Basrah spreading. Given the lack of leadership of
the Iraq protests, the spread in Iran is unlikely and anything that pops up
would be fleeting.
pricing will fade as refined product movements continue to fall below 5-year
averages as demand wanes and refiners hit their maintenance season. The Iraq
protests will remain localized given their lack of cohesive leadership, and may
cause disruptions in crude exports, but not long-term outages. This will be
something to watch, but nothing to be concerned about in the near term. The
Iran sanctions will remain in place, with little movement between both sides—U.S./ Iran—given entrenched positions and the limit
for U.S. to give ground in trade negations. The spread between heavy and light
sweet crude will continue to collapse with heavy crude experiencing growing
tightness. As Fernando Valle from Bloomberg has highlighted, Mexico and
Venezuela are in terminal decline, with Mexico’s fields deteriorating
exponentially due to age and underinvestment, while Venezuela is impacted by
sanctions and mis-appropriation of funds driving the production decline.
Venezuela could see production rise with proper investment and management,
while Mexico has a long-term issue on source rock. Iran could bring production
online relatively quickly if a U.S. deal is finalized, but there is global
apprehension of investing within Iran as the global economy worsens. This means
Iran could get back to 3.7M barrels from its current 500k-1M. Growth past 3.7M
will be hard to achieve within 2-3 years of lifting sanctions based on the
hesitancy of investment. For example, China has reportedly pulled a $5B
investment in Iran due to sanctions, and the U.S. sent a message by sanctioning
Cosco—a Chinese shipping
company that shipped sanctioned crude—sending dayrates to 15 month highs and rising.
Syrian situation between Turkey and the Kurds will remain fluid, but has little
impact on crude given the location. If the Iraqi Kurdish population gets
involved, it could cause some disruption, but the Iraqis need the cash flow
through the Ceyhan pipeline that flows through Turkey. The U.S. has already
said they wouldn’t stand in the way of Turkish military actions, and current
reports say the Turkish airforce has destroyed a military depot with
anti-aircraft weapons. The issues will be localized to Syria with limited
impact to oil production and exports. The bigger problems will be actions taken
against Iran for the Saudi Arabia attack. The loss and recovery of Saudi Arabia
flow highlights the resilience of their underlying system, but also the glut of
light crude that sits in the market.
The bigger impact
could come from further loss of heavy crude in the market, which will be made
worse by policy changes, such as IMO 2020. The International Maritime
Organization adjustment to bunker fuel burned in ships will have impacts across
diesel (ULSD/HSD), gasoline, and octane. Crude pricing remains capped to the
upside due to worsening economic data, U.S./China trade deal (that won’t happen
for a long time), and seasonality. This will keep a lid on Brent and WTI
prices, but the changing blends and needs in the broader market will keep a
persistent spread between Brent and WTI and tightness in heavy vs light. The
spread between Brent and WTI will widen as shipping costs continue to move
higher, as about 100 vessels were sanctioned by the U.S. The political
situation across the Middle East is always fluid, but their remains growing
tension across the region with any one specific move enough to create a broader
conflict. Several years of weak oil prices has eaten away at cash reserves, and
tempers (both internally and externally) are beginning to flare in response. A
quick removal of U.S. forces could be disastrous as local assets are already
stressed in Syria leaving the area vulnerable, and the lack of U.S.
commentary/control in Iraq could destabilize the entire region. While all of
these components impact supply, crude flows continue to rise from non-OPEC
regions as the global slow-down intensifies. Cyclical pricing mixed with a
structurally changing world won’t end peacefully.
on the Saudi Attack
What the Abqaiq impact will be to the
market?- Crude Quality Matters!
the near term, crude pricing will jump in response to a shortfall in the market
($3-$4 will stay in the price after the dust settles). The $3-$4 represents the
new political risk that will linger even after operations come to a normalized
level globally. The spike in pricing could rise to as much as $10 depending on
longevity of the downtime- but that move would be short lived. Saudi Arabia
will be able to take some actions to keep oil flowing into the market: 1) Draw
down from reserves to fill sold volumes; 2) reduce refinery runs (import
refined products) while selling into the market; 3) cut petchem facilities
utilization rates. The loss of natural gas production from the facility will
require an increase of refined product burn in the power generation market,
which can be found in the floating market. KSA can sell from near term storage
of 50M -60M barrels, so near term disruption to supply is unlikely- but it will
drive prices higher immediately due to political risk and potential extended
supply risk. The country and Saudi Aramco has global storage of about 175M
barrels with “quick” access to about 50M. The complex (containing 3 separate
facilities within it), Abqaiq, has the capacity to process 7M barrels of oil
per day of Arabian Light (32.8 API and 1.97% Sulfur) and Arabian Extra Light
(API 39.4 and 1.09% Sulfur). “The Abqaiq Plants facility handles crude pumped
from the Ghawar field. It is linked to the Shaybah oil field through a 395-mile
pipeline and to the export terminal in Yanbu through a natural gas liquid
pipeline.” The facility can also produce Arab Super Light (51 API and .09
Sulfur). The crude in the region, while sweet, has a lot of sulfur that
requires processing through hydro-desulfurization units. If any of these units
are lost (there are 18 in the complex)- it would cause a bigger issue in terms
of crude quality. This could result in prolonged downtime if enough of the
assets were damaged/destroyed but the complex has many of these assets on the
premise. The lost production can be replaced by U.S., West African (Nigeria and
Angola), ESPO/Urals (Russian), and Brazilian grades. There are others- but
these are the most widely available flow, and many of them have spare capacity.
As early as 10 days ago- Angola had 13 October shipments and Nigeria has had
about 3 deferred shipments. Russia has doubled ESPO production to about 700k
barrels a day as Brazil has ramped production from the coast. The below chart
highlights some grades that can find additional demand in the near term- or
whatever KSA can’t cover through their storage network. The problem will be
logistics in the near term as many replacement barrels are in places further
from the end users and will get tighter as volume is quickly purchased to make
up the difference. In the near term, Nigeria, Angola, U.S., and Russia have
spare cargoes to put into the market, but a prolonged disruption (over 30 days)
will cause tightness in the market. As we enter shoulder season, the demand for
oil always wanes as refiners enter maintenance season- which means that the
loss of KSA supply technically won’t be as impactful as the call on oil
producing nations always shifts lower in the shoulder months (fall and spring).
“The Abqaiq Plants facility comprises three primary processing units – an oil processing
unit, an NGL facility and a utilities unit. The oil processing unit consists of
multiple spheroids and 18 stabilizer columns where hydrogen sulphide and light
hydrocarbons are removed from the crude oil. The NGL facility contains eight
compression trains, stripper columns and de-ethaniser column. The utilities
unit supplies power, steam, treated water and instrument air to the oil and NGL
facilities. The power needed by the facility is generated by six power
generators – three steam turbines and three combustion gas turbine generators.
Steam generated by 14 boilers is supplied to the oil processing unit, NGL
facility, turbines and compressors. 1” The timing of the reactivation will
depend on the type of equipment impacted, and some key assets were struck
extending total downtime. The complex is built with triple redundancies with
assets both above and below ground. The precision of the attack points to a
coordinated effort with an understanding of refining/processing and the
facility. The strike took out several of the desulfurization towers and
spheroid storage tanks. The facility has many desulfurization units so that
impact won’t be as widely impacted. The problem is- the storage tanks are
required to stabilize/ process the crude (remove the light ends and
impurities.) This means that even though the stabilizers were left relatively
untouched- they will struggle to operate with no place to put the removed
products (resulting in an extended downtime). KSA has redundancies to shift
flow into unaffected storage tanks, other facilities, or by flaring some
products. This will prolong downtime as the tanks are replaced, and due to the
nature of their contents it will be an arduous process. By extending the repair
time, this will keep a minimum of 1M barrels out of the market for an extended
period. The fire will always look worse as when a facility is struck with that
kind of attack (fire) protocol will shut down many of the valves (automatically
to contain the fire) and to initiate flaring (burn anything being processed) to
keep equipment from exploding from improper pressure/ cracking. This creates an
“all-stop” in order to allow personnel to assess all the damage and begin
making repairs. The equipment and redundancies will be turned on in a ramp up
fashion to ensure the integrity of the equipment- for example- a high pressure
line that is cracked and leaking fluid near an ignition source would be
problematic to say the least. This is why many of the reports say “by Monday”
because it will take several days to assess damages and adjust the flow of
product to avoid damaged assets. There is a high likelihood there will be lost
production of 2m barrels (including NGLs) and not the full 5.8M that is
currently offline. The 3.8M or so barrels will be processed through their
redundancies while the rest of the facility is fixed (which could take months)
Depending on severity- I would assume the full 75% is operational within 30
days. In the meantime, Kuwait/UAE will bring on a spare 1M barrels while KSA
activates idled capacity or parts of their oil complex that consists of their
spare capacity. The bigger issue is what does this do to crude pricing. Based
on the reports regarding the severity of the damage, about half of the
production will be out of the market for an extended period of time. This will
put the floor of crude pricing at a minimum of $3 uplift across the curve even
after other areas, such as Kuwait/ UAE bring on spare capacity of about 1M
barrels. The crude market will respond with a quick $3-$4 move based on
geo-political/ military escalation risk. This will stay in the market as the
damage is processed, and next steps are evaluated in retaliation. The impact to
supply (if more severe) will peak at about $10- if we assume the whole facility
is offline for 30 days (highly unlikely). The market is very long NGLs- so that
can easily be replaced given current volumes and pricing, and the light/sweet
market is also well supplied. The problem will be the loss (if any)
desulfurization units as the world prepares for IMO2020. There is also a
plethora of light crude available in the market- so this event will help absorb
some of these spare cargoes (from Angola, Nigeria, and U.S. specifically). The
U.S. has also seen their crude purchase slow as the flow stuck off the coast of
China has been moved into India and South Korea- keeping them well supplied in
light/sweet through the end of Oct. The extent of the facilities damage will
keep about 25% of its volume out of the market. The attack on the facility most
likely originated in Iraq, Basrah based on location and early reports (still
the most reliable versus the Houthi nonsense). The ability to go about 1,000Km
over Saudi Arabia to strike the facility with 10 drones (cruise
missiles/drones) seems highly unlikely. The Abqaiq facility is close to the
Persian Gulf, and would be more susceptible to an attack launched from the Gulf
vs over land. The Yemen originated missiles have proven to be unsophisticated
and haven’t had the ability to reach 1) that deep into KSA territory 2) deliver
the kind of precision impact. The bigger question is- how did Iran (or some
other entity) find the ability to strike the lifeblood to Saudi https://www.hydrocarbons-technology.com/projects/abqaiq-aramco/ Arabia’s crude
flow. If we assume KSA has the ability to pump 12.4M barrels at peak- the
complex handles 7M barrels of it. This means the facility (given the location)
would have multiple lines of defense regarding anti-missile/ aircraft and
personnel implementations. This facility should have multiple levels of
defenses especially since it was targeted in 2006 in a failed terrorist attack.
I have attempted to highlight the escalating tensions throughout the world, and
as the global economy slowscertain countries/regions will be worse off than
others. This will lead to rising tensions and conflicts that will flare up. The
bigger question will be- is this event big enough to pull everyone into a
bigger conflict. Throughout history, many major wars were caused by a series of
events that culminated in a broadening military action. This action also comes
at a time when global GDP is struggling and a crude price shock would be
detrimental for emerging markets. The US Dollar strength has already impacted
countries, and now a price spike would cause more pain as additional foreign
reserves are needed to keep oil and refined products flowing. On a global
level, a weak economy, elevated crude pricing, and strong dollar is going to
stress emerging countries and struggling markets. This is going to intensify
the need to act in a way to stabilize the slide of economic growth, and given
the failures of QE and Central Bank Easing- escalation of tensions will only
continue to rise. The fact the attack happened now and not in July is crucial
as we are currently entering refinery maintenance season, which will reduce the
call on the global oil market. This will limit the upside of crude pricing, but
an extensive downtime that enters into winter will drive up prices further. The
focus should be further down the curve- 3 to 5 month contracts as the extent of
the damage will prolong cargos. I think we are the precipice of a broadening
conflict timing remains uncertain- but at the moment: buy crude and U.S.
integrated/ high quality E&Ps/ and Petrobras.
The frac spread count resumed its downward trend with the national forecast coming in at 335 vs 340 last week. The trend remains on a lower path led by the Permian with the only sustained increase being the Mid-Con. Most regions have remained relatively flat with small gains over the last few weeks in the Utica, Mid-Con, and Eagle Ford while the Permian has declined each week. The OPEC+ decision (more on that below) will do little to stem the slide into year-end. Proppant loadings currently sit at 5 year lows, with little indication these will rise into year end. The WTI curve helps to highlight the OPEC+ comments on production have done little to adjust the back months, which also comes under pressure as any price increase is being used to hedge U.S. production. OPEC+ delivered a gift by allowing for better placed hedges, but the issues remain consistent with a slowing global economy and struggling crack spreads.
The below chart helps to drive home the very methodical move lower beginning in June of this year. Activity will keep following a similar trend, but will see some uplift in 2020 as budgets are renewed and hedges help protect some completions. The DUC count remains on a downward path as rigs continue to roll-off with little to stop the decline in the near term.
National Frac Spread Seasonally Adjusted
The proppant data shift in the Permian supports the decline in completion crews, and shows the extent of the slow-down. The fact that completion crews in the area continue to be released means the proppant loadings will shift lower into year-end. This will keep pressure on pricing and remain a headwind well into the middle of next year.
Permian Proppant Seasonally Adjusted
The WTI crude
curve helps to highlight that supply increases and soft demand remain a problem
across the next several years. The curve is far from predictive, but helps U.S.
E&P companies hedge production- and after the OPEC meeting- they were able
to lock in slightly better pricing.
These are the kind of activities that will keep U.S. production sticky at 13M barrels a day with exports rising driven by new infrastructure and limited U.S. demand. U.S. refiners can only handle a so much light sweet crude, which means a large portion of the oil is sent into the global market. The fact that Russia (and Nigeria) has now excluded condensate from the new OPEC+ “cuts” will allow more light-oil to enter the market and compete directly with U.S. exports. This is complicated further as chemical and refining assets facing terrible margins begin to roll-out economic run cuts.
WTI Crude Curve
As crude prices rise, it puts more
pressure on refining and chemical margins unless they can pass along price
increases to cover the increase in feedstock costs. Based on the declining
demand in the global market, there will be little chance of an adjustment in
the downstream market. Instead, margins will come under more pressure, which
will put additional downside risk on oil demand as economic run cuts reduce the
oil throughput. Gasoline margins have been negative for close to six month,
which means that distillate has been carrying the crack but as economies
struggle it has put pressure on the distillate crack. It has been balancing on
razor thin margins, which have started to fall into negative territory.
mounting on chemical plants as well for similar reasons, but new facilities
continue to be brought online and many are now coming back from maintenance. So
while the price spike on paper looks good, it will speed up the downstream
nightmare while market share is lost and alternatives are adopted.
The most recent
data on China helps to highlight the shift in their market, and the current
accounts problem developing in their system as imports rise and exports decline
limiting their access to U.S. dollars. Many of the margin issues across Asia
all began as the two major Chinese refiners became operational as more product
was pushed into the market.
of world scale refining and chemical assets has flipped trading lanes as more
refined products are exported. China used to be the buyer of last resort, but
as the construction of advanced industrial assets are completed products are
being pushed back into the open market. This is reducing margins and creating
oversupply across many products in different parts of the world. China’s
reasons to maintain production is two-fold:
Become self-sufficient in products with a
higher margin in the hydro-carbon chain
Export products with elevated global
Employee large groups of highly trained
The last point is key, because in an oversupplied market many facilities will initiate “economic run cuts” which just means a facility will operate below their normal seasonal utilization rate. This helps to reduce the oversupply in the market and product margin. The view in China is “others” can cut, and they have already been operating at negative margins in order to force competitors to lower rates. The fact Chinese industries historically operate outside of normal economic theory will put increasing pressure on the refining and chemical space. “I think globally it’s increasingly a competitive environment for road fuels. China is already a net exporter of over 1mn b/d combined of gasoline, diesel, and jet. It’s the fastest-growing exporter of those fuels in the world. But over-supply is also percolating through into the seaborne market: Indian diesel exports are rising; everyone is trying to desperately seek out net short regions and they’re having to ship product further and further overseas. And we’re seeing a situation emerge now in China where these refineries are importing crude perhaps from Latin America and they’re exporting finished products to those same markets from which they took the crude. It’s a tricky arbitrage, one would imagine.”
The OPEC Cut That
So as this all plays out- it will be interesting to see if OPEC+ remains steady in their projections.
has “officially” highlighted what we have known all along… the slow down in
demand. The bigger picture will be outlined in a coming write-up of Asia
oversupply and declining demand. The “new” cuts are set off the baseline of Oct
31st, 2018. So lets clarify- what was OPEC and Russia doing on Oct
2018. In order to keep things consistent, I will use the self-reported numbers
from OPEC nations. In 2018, OPEC was producing 33.1M barrels a day (and other
sources like Energy Intelligence has it at 32.2M). The initial cut of 1.2M was
supposed to reduce production within OPEC by 800k barrels with Russia cutting
by 280k barrels. This means OPEC was set to reduce production to 32.3M barrels
a day, and if we are kind and say no one cheated it brings us closer to 31.9M
barrels even. So now we are ADDING 500k barrels a day in cuts, which takes OPEC
(assuming they take all the cuts) down to 31.4M barrels a day. As of Nov 2019,
OPEC is producing 29.7M barrels a day- so the “new” cut actually locks in
something that is ABOVE current production levels. In order to offset it
further, Saudi Arabia has pledged to keep the voluntary cuts of 400k barrels
per day. This brings the total from 31.4M down to 31M, while OPEC is pumping at
29.7M barrels a day. The issue remains cheating because Saudi has said they
will only maintain the additional 400k barrels a day as long as everyone stops
cheaters have been Iraq and Nigeria, which have pledged to adjust their
production to meet the new targets. The below chart puts into context what the
difference was between all the countries. Something I have highlighted in the
past, the only reason the OPEC+ “cuts” had any semblance of a benefit was
driven by sanctions on Venezuela and Iran. The “new cuts” haven’t even gone
into effect yet and Russia/Nigeria are discussing why the numbers were “wrong,”
and how adjustments to condensate will keep them in compliance while still
pumping at higher levels. OPEC normally excludes the production of condensate,
which is something Nigeria is looking to capitalize on by claiming Egina is not
oil. Nigeria is producing about 2.2M barrels a day, with about 1.8M being
considered oil. Condensate is typically an API level ranging from 45 to 70,
which makes this next quote very interesting: “Country is testing Egina
production in the market until end of the year; testing includes classification
of Egina output as crude or condensate; “our partners are optimistic that Egina
oil will fall into the condensate category”. NOTE: Egina has API gravity of
27.3 degrees, low sulfur content of 0.165%, according to Total.”
production last year, and produces about 200k barrels a day- which would be
taken away from their “oil” quota and would put them in compliance with the
cuts while not reducing anything. By Russia excluding condensate, the ESPO
pipeline increase from 1.2M to 1.6M can be excluded from their calculation as
it is being classified differently. With East Siberia ramping and gas fields
increasing to fill the Power of Siberia, the amount of condensate from Russia
is expected to grow by about 1M barrels a day.
OPEC Production 2019 vs 2018
Now lets shift to
Russia, which was pumping 11.5M barrels a day in Oct 2018. They were supposed
to reduce by 280k barrels down to 11.22M barrels a day. This total was only hit
ONE TIME in 2019, and it was caused by production halts from a pipeline with
the wrong specified crude shutting in 1.1M barrels a day. Even if Russia is
required to take 100k barrels of the “New” 500K cut- it would just put them
right back where they should be.
Russia Oil Production
Iraq is an interesting situation as
protests escalate across the country, and led to the resignation of the Prime
Minister and a shake-up within the government. The issue remains unemployment,
lack of social welfare programs, and an end to Iranian influence. The fact that
the protestors in Iraq are protesting Shia’s (and not Sunni’s) against the
involvement of Iran in the local government. The protests have resulted in
hundreds of deaths, the burning down of Iran consulates, and unrest throughout
Southern Iraq. The shortage of cash in the country has been helped by pumping
over their allotment, which has brought additional cash into the government.
Iran also uses the shared fields as a way to get oil in the market under the
Iraqi flag and receive kickbacks. The Iraq Oil Minister, Jabbar Alluaibi stated
that Kurdistan has reduced production to come into compliance with production
targets. The issue remains the shortfall of cash in Iraq, and if they are
willing to remain compliant in the hopes of displacing the lost volume with
additional revenue per barrel. The new restrictions will also put pressure on
Iran getting paid from oil removed from shared fields, and could very well be a
backhand way of tightening the screws on Iranian financials.
The country has been facing mounting pressure along the same lines as Iraq in regards to political pressure driven by unemployment and anger over corruption. These problems remain localized, but the aggressive handling of protestors is only spurring more resentment and calls for addressing rampant corruption in both countries.
The new numbers are just laughable because
it also requires “no more cheating” in order for it to work. The one thing we
can all agree on- cheaters are going to cheat. Iraq and Nigeria have
consistently been over their allotment from 150k to 250k barrels every single
month. The same can be said about Russia, leaving Saudi Arabia stuck carrying
the lion share of the cuts. Saudi Arabia has also been producing BELOW their
allotment, and in the “new” cuts they still have the ability to produce 10M
barrels a day. The bigger issue remains demand of refined products, and as I
have been stressing- it is all down across the board. Lets look at just U.S.
crack spreads in order to drive home the issues.
The new structure
of allowing condensate to be excluded in the production cuts brings a new twist
to the “cut” as it provides Russia the ability to produce an additional 400k
barrels, Nigeria 300k from Abo and Akpo, as well as from Oman, Kazakhstan, and
GCC nations. The freedom to pump and classify things as condensate will help
countries skirt production cuts. Some
other key developments from the recent news cycle:
It is dependent on countries NO LONGER
cheating and we know- “cheaters gonna cheat.” Saudi Arabia has leveled a threat
that if people keep cheating they will pump at levels to crush competitors.
Saudi Arabia has now priced their IPO at
$8.53 at the top of the range: “The shares have been priced at 32 riyals
($8.53), with a formal announcement expected later on Thursday, according to
the news agency. This means it is set to raise $25.6 billion and will likely
beat Alibaba to be the world’s largest ever stock market flotation.”
Brazil has formally declined to join OPEC
allowing them to grow without any limitation to cuts.
Russia is bringing on new gas fields, and
is focused on exporting the new flow of condensate which will put pressure on
prices and drive North American ethylene margins even lower.
The issues remain
global as the “deal” leaves crude flowing unchanged with growth rising across
Non-OPEC entities, and more condensate getting pushed into the market from
OPEC+ nations. Russia has brought on new fields to supply gas as well as new
oil fields in East Siberia. The growth can be seen in total as Russia has
gained about 1.5M barrels a day of production (even with the cuts) while Saudi
Arabia has lost anywhere from 250k-500k.
Refiner margins will remain under significant pressure as issues persist in the market of falling demand and slowing exports from the U.S. Crack spreads across the world remain depressed, and it is leaving more oil in the market that will remain based on this “new” deal of a cut. The issues are reverberating through the system and remain at the chemical level as well.
The rampant production of condensate (naphtha), which is now excluded from the OPEC cut calculation, means there will be growing availability of feedstock. Pressure is rising across the chemical supply chain as it hits across Asia- specifically in South Korea a core bellwether. The below chart highlights the pressure on HDPE, which is supposed to be a higher value product. As new facilities come online and chemical capacity that was down for maintenance ramps back up, pressure on prices/margin will rise. The issue also remains new facilities in China ramping up that is pumping out refined products and chemicals at a rapid pace.
China has been the buyer of last resort
for the last 20 years, but as their construction of assets has shifted under
Made in China 2025 and the Belt and Road Initiative- demand for products has
dwindled. The pressure will remain across the board as the economy weakens, and
their inability to stimulate the local market is exacerbated.
India is facing a similar problem with a slowing economy reducing domestic demand for refined and petchem products putting more on the water. The other issue (facing both countries) is an issue with current account balances as exports slow (the intake of USD) and imports rise (and outflow of USD). The limited access to foreign reserves keeps a lid on the type of stimulus and loans that can be generated to keep GDP supported. The above chart highlights just how bad the margins are regarding a high value petchem of high-density polyethylene. The stimulus China used in end of 2016 to the beginning of 2018 helped spur the market as a whole, but the chart above (and the others on refinery margins) demonstrates just how much worse things are vs 2016. This is driven by the new assets China has brought online, and they have indicated an unwillingness to cut runs as the state owned companies believe others should reduce operations in Asia and Europe. The problem is- South Korea has also responded with something similar, which will exacerbate an already difficult situation. The issues provided above will only get worse as the global economy continues to slow as demonstrated with recent economic indicators out of Germany, South Korea, Japan, and China- while the U.S. remains on a slowing trend but still the best looking house on a bad block.
Where do we stand in U.S. Shale? – Week before Thanksgiving 2019
U.S activity is experiencing another step-down in activity as more completion crews and rigs are released. The issues are compounding on a global level as oil demand falls amid struggling crack spreads and a struggling economy. I don’t need to reiterate this again, as any previous reader knows I have been highlighting the weak demand environment. The softness in realized prices is putting more pressure on North American energy companies with activity dropping in every basin. E&Ps have also started to delay their filing of completed wells, but our way around that is by watching freight and proppant data. This is combined with weekly EIA information, and shipping data collected daily to understand the flow of oil and refined product.
The frac spread count is projected to fall again this week, and will be printing something closer to 330 on a national level by the end of November. The Permian, DJ, and Eagle Ford will experience the biggest roll over in activity as we head into 2020. The 345 active crews reported on 11/15/2019 is a 52-week low, but will accelerate over the next few weeks and will exit 2019 at a number closer to 300 on a national level- with another 15 crews coming from the Permian. The below chart helps to put into perspective the decline by comparing three years of data, with the following seasonality charts showing how things have changed over the last 5 years.
The shifting oil markets will make for a very interesting OPEC+ meeting as investor capital has dried up for E&Ps, oilfield service, and midstream companies. The U.S. has grown at a rapid pace for the last 5 years, and I am predicting a slowdown in U.S. production looking at exit 2019 to exit 2020. The average production levels from 2019 to 2020 will go from about 12.2M barrels per day to 12.6M barrels a day (a 400k barrel a day increase), but the move into 2021 will see production from the U.S. slowing. OPEC+ can “speed up” the downfall by not adjusting the current agreement, which will send WTI to $47 as new non-OPEC production comes online further oversupplying the world. Saudi Aramco is now talking peak oil demand, and has taken action to move further down the hydrocarbon value chain in order to protect margin. This integrated strategy will help stabilize growth as stagnate crude prices are likely to remain for the next several years driven by structural and cyclical changes in the market.
Primary Vision National Frac Spread Seasonal Chart
Primary Vision Permian Frac Spread Seasonal Chart
The frac spread count is only one metric, which is still the most important one, but by also evaluating proppant loadings into areas helps to identify the speed of completions. The below charts highlight how proppant loading into the Permian and Eagle Ford are at 5 year lows. This comes back to- how can completion crew activity also not be at a 5 year low? There are some simple answers, and others that get more complex and takes a deeper dive into the data. The easy first:
Crews are considered “activity” as they are being paid to wait at the site, but are actually not completing wells at a current pace.
Crews are active at a lower utilization rate- where instead of operating 24/7 or 12/7- it is more along the lines of 12 hours every 5 days.
Proppant is being used from storage either at the site or rail yards making the numbers a bit skewed to the downside.
It is most likely a weighting of all three that is creating the skew in the data, unless there has been a huge shift in the way companies are completing wells. I can say with confidence- there isn’t any less proppant going down a well than previously. It can vary well by well based on source rock and pad setup, but the below kind of drop off would mean loadings dropped by over half per well- which just wouldn’t happen. The more complex answer is a lag in the data being reported to the state agencies (which technically isn’t allowed) that creates a problem for monitoring completions. This is an interesting issue that we cover in great depth through a different report.
Primary Vision Permian Proppant Seasonal Chart
Primary Vision Eagle Ford Proppant Seasonal Chart
While rigs are released at an accelerating rate, the question turns to the drilled but uncompleted wells (DUCs) in the market. How many of them are viable at this price deck? Will some of them never be completed because they were drilled poorly? How many are related to the infill program that has failed to work and will be abandoned? There is always a natural DUC rate given the lag between drilling and completion, and the fall in rig counts- at a faster pace vs completion crews- will close that gap. The problem is- many of these numbers are overstated- and filled with wells that don’t make economic sense in the current environment. The majority of the cost in a well is at the completion stage, so as pricing is depressed across all three streams- the economics won’t work. As E&Ps focus on reducing costs and living within cash-flow, the ability to produce wells at a loss will be hard to finance. Some wells won’t work as they are old (2016 or older) and didn’t place the well properly limiting total recoveries, or were done under a drilling program that has proven ineffective- parent/child relationship. The below chart helps to highlight how the process of completing DUCs has accelerated, but will slow as we go through 2020 as the best wells are completed and brought online.
The cyclical data remains a core concern across the board with little to show a sign of improving. Some data points have stabilized, but only after more aggressive central bank action. This has currently stemmed the slide in the equity world, but even if you don’t read a single word of the next section and instead just look at the charts… you will get the point quickly. Refiners in Asia (specifically Singapore) have been hit by negative margins as China and India pump out more product overwhelming the area. The new flow of product has shifted the movement of refined goods and is impacting margins, which will create economic run cuts in other areas. This all leads to a decline in crude runs limiting overall demand. The 2020 crude oil demand story has been highlighted by the IEA and OPEC, but the severity of the industrial/manufacturing slowdown still isn’t fully appreciated. The new capacity coming online and no additional cuts from OPEC+ is set to push WTI below $50. I was on Bloomberg TV 11/19 reiterating the impossible nature of a China/US trade deal, and now with Congress passing the HK Human Rights Bill- a trade deal seems even less likely.
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In support of weak activity, proppant deliveries and loadings remain well off seasonal pace and are at 5 year lows across the U.S. This reduced activity highlights pressure on current U.S. production as we head into the end of the year, but also provides for pricing power with proppant providers and rail companies looking to sell volumes. The depressed pricing and willingness to move product will support completion activity as these levels with a small increase through year end. The cost savings will help spur some additional activity into Nov, but well off of seasonal norms and well below the typical increase in activity. It will also keep pressure across U.S production in the very near term. The bigger focus for E&Ps into year end is maintaining or reducing CAPEX, which has already started with some adjustments in production targets for 2019.
Permian Proppant Loadings
Eagle Ford Proppant Loadings
Proppant loadings still remain at 5-year lows into the Permian, but there will start to be an increase in proppant deliveries as activity stabilized while remaining well off typical pace. The Eagle Ford is fairing even worse with little in terms of adjusting activity into year-end, while the Permian will see some increase in activity into Thanksgiving.
U.S. refiners remain well off seasonal averages and have utilization rates that are below depressed levels caused by Hurricane Harvey. There will be a small increase over the next two weeks as East Coast refining margins have recovered a bit, and will incentivize additional utilization as more European product moves to Lat Am. The limitation on European product will keep margin strong in the near term for PADD 1 activity.
Typically, U.S. product fills Lat Am demand, but with heavy maintenance across the U.S. complex and oversupply in European markets- refined product is still making the cross-Atlantic trip- but to Lat Am instead. The weak U.S. activity will keep more refined product moving from storage, while limiting the demand for crude both domestically and the floating market.
Crude demand will remain under pressure driven by sky-high shipping rates, weakening global economies, and seasonality. Pressure remains across the crude complex with more expected from Angola, Nigeria, and other OPEC/non-OPEC nations even as current offerings for Nov haven’t cleared yet. We have said repeatedly that global oil demand was going to grow well below expectations, which is now being reflected in the data. The bigger problem remains demand being soft across the whole complex- oil and refined products, which will result in builds in all areas and take longer to clear even when demand picks up. Just given the nature of the headwinds- global cyclical headwinds, trade wars, and structural change based on policy and new production/refiners- not even geo-political uncertainty is enough to sustain a rise in crude pricing.
U.S. Refinery Utilization Rates
I still believe that global oil demand is even lower than what is posted below. I think total growth is much closer to 400k barrels a day vs the current one highlighted below. This means we will get builds across the complex unless OPEC+ cuts more, which is unlikely given their unwillingness to yield any more market share- which is demonstrated by Nigeria and Angola taking production higher (just to name a few). These builds also come at a time when Venezuela and Iran are sanctioned limiting their flows, and the Neutral Zone is expected to come back online in 1Q’2020 (which accounts for another 500k barrels a day).
The overall market rallied on the back of a potential “mini-deal” with China that would lead to a broader benefit, on top of the ever-expanding balance sheets of central banks globally. Demand continues to struggle as signified by weakening refining crack spreads across the space. Margin softness is exacerbated by the cost of shipping crude and products due to the sanctions placed on Cosco by the U.S. The “Phase 1” trade deal essentially moves us back to 2 weeks ago, but does nothing to alleviate the core issues. It is also problematic that President Xi (instead of focusing on this) is out meeting with India’s Prime Minister Modi, which just means that China is sending its JV team to a Varsity game. The proposed deal has raised more questions than answers as Chinese officials say more has to be discussed before anything can be finalized- and this is in regards to a “mini-deal”. The deal would just delay new tariffs and open up an avenue to purchase agricultural products with some small (but poorly defined) financial and intellectual property adjustments. Both of those terms appearing in a potential deal was enough to send the market higher, but they remain buzzwords with little meaning in the proposed deal. The bigger issue is how far apart both sides are on such a simple deal- with an unwillingness to adjust incoming tariffs on U.S. agriculture products without the U.S acting in-kind.
The weakness continues to appear in key growth markets- such as India- highlighted by the weakness in diesel consumption as well as oil demand.
India’s Sept oil product consumption is the lowest in 25 months across key products:
“India September Oil Product Consumption Lowest in 25 Months- India’s oil consumption fell 0.3% y/y to 16.01m tons in September, the second monthly decline in fuel demand in the financial year that started April, according to data published by the oil ministry’s Petroleum Planning & Analysis Cell.”
India’s gasoline consumption in September rose 6.2% y/y to 2.37m tons
Diesel demand declined 3.3% y/y to 5.83m tons
Naphtha usage down around 26% y/y to 844k tons
LPG consumption +5.9% y/y to 2.18m tons
Petcoke use +18% y/y to 1.74m tons
It is important to highlight that the demand/consumption numbers were weak even with lower prices compared year over year.
A key bellwether for oil demand has been Nigeria and Angola (West Africa in general) with Angola announcing 46 cargoes for December which is off multi-year lows and include 2 deferred cargoes from Nov. Nigeria still has more than half of their cargoes for November with an expected increase in December loadings as well (not including deferrals.) Crude movements have been impacted by refiners going into maintenance season and ships trying to minimize distances to limit total costs. U.S./China talks remain far apart on many key items, and I don’t see this adjusting in regards to the Cosco shipping sanctions. The sanctions are impacting U.S. exports- especially because large parts of our oil must travel the furthest distances. Typically, additional crude will be pulled from areas in the ME and Africa into Asia, and the U.S. would backfill into Lat Am and Europe- but slow demand across the system has brought shifting trade to a halt. Instead, countries are cutting refinery runs to operate out of storage and manage refined products from the floating market/storage.
The geopolitical landscape is very fluid at the moment with issues ranging from BREXIT to Middle East upheaval to the U.S/ China trade war and the little talked about South Korea/Japan trade war. There is a global rise of protectionism and nationalism that is driven by weakening economies and over-levered countries that are struggling to stimulate growth. While the geo-political backdrop makes great sound bites, oil pricing is driven by supply/demand economics. The current Middle East battleground won’t be enough to drive price appreciation unless the supply side is significantly impacted. The new flow of oil from Nigeria, U.S., Russia, Brazil, and North Sea and deferred cargoes from areas such as Nigeria, Angola, and the U.S. have been more than enough to fill the short-term disruptions of Middle East conflicts. The current political upheaval in the Middle East (outside of KSA) remains regional and sporadic that won’t have lasting impact on supply at the moment. This is why demand is a big focal point, because even if the trade wars go away tomorrow— the bigger issue of economic slowdown outweighs any benefits. PPI, ISM, Export/Import, Shipping, and other data points highlight the bigger overarching issue that is plaguing the market. Demand is struggling with major economies contracting, and the law of diminishing returns limits the effectiveness of any form of quantitative easing. So unless a geo-political event can really disrupt supply measured in the millions for more than a few days— demand will continue to matter more to pricing metrics.
The Iran situation will continue to impact oil pricing as the current embargoes takes about 2M-2.5M barrels a day off the market. Iran is able to put about 500k-1M barrels into the market through Iraq pipes, Iran ownedships, ship-to-ship transfers, and “ghost shipping” through turning off transponders (which led to the Cosco- a Chinese Shipping Company- sanctions.) The shortage of heavy crude in the market (a staple of Iranian flow) will help maintain tightness between light-sweet spreads. The current sanctions aren’t going away anytime soon (or at least before U.S. elections) as President Trump wants to appear tough on trade following the removal of U.S. military forces from Syria (a mistake) and putting additional pressure on China following the Cosco sanctions. The only way negotiations could begin would be a willingness for Iran to forgo the deployment, development, and testing of ballistic missile systems. This is a non-starter for the Iranian government and military limiting the ability for any deal to be brokered. The growing divide between Iran and Saudi Arabia (greater between Shia and Sunni) will continue to expand, and will result in additional attacks on both a military and economic level.
As mentioned previously, Middle East discourse is rising driven by the last 4 or so years of depressed oil prices resulting in stressed economies, reduced social subsidies, and declining foreign reserves. The region has always had tension driven by tribal and religious divide going back thousands of years, but the relationships have always ebbed and flowed over the years. The lasting wars and declining cooperation- such as Syria and Yemen or Arab Spring in general, collapse of OPEC in Nov 2014, and the GCC (Gulf Cooperation Council) under duress driven by the divide between Qatar and other Gulf nations— is highlighting how problems have continued to build over the last several years. Everyone will point to the Saudi Arabia attack as a singular event, but the discord was sown years prior and are rapidly declining now with the added stress of struggling economies with depleted currency reserves. The discord in the Middle East has been smoldering for years- limited to regional conflict, but is now reaching a point that will bring the issues to the center stage.
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The national frac spread (fsc) continues to decline as work remains slow across the U.S. with noticeable shifts in the Permian, Eagle Ford, and Williston. Realized prices will remain under pressure driven by seasonality (refinery maintenance season), oversupply of refined products, and glut of light/sweet crude in the market. This is all impacting E&P balance sheets driving them to reduce rig counts as well as frac spreads in an attempt to live within cash flow. The below is a breakdown of the slowing activity versus previous years with changes from 8/30 to 9/27 resulting in growing reductions: Permian- 14 / Eagle Ford- 7. These were key locations that should have seen stable activity as pipelines came online in the Permian, and the Eagle Ford filters into the LLS (Louisiana Light Sweet) market, which should have been strong with the Saudi Arabia attack. Instead, the Permian pipelines were filled with capacity competing for space on other lines, oil behind pipe, and current operational spreads. The U.S. exports did rise, and will be reflected in next week’s EIA report, but the total number still remains underwhelming given the expected impact of the global supply chain disruption. Typically, E&Ps will increase activity by bringing on more completion crews from now until Thanksgiving, instead- we expect a stabilization where national spreads hover around 375 versus the normal rise.
The chart below highlights how this is the longest slow period without an uptick in frac spreads since Primary Vision began collecting data. Based on the current available data, there could be a decline to about 375 before there is a bounce in activity. Either way- the data highlights the limited activity across the U.S, which will stabilize at these levels over the next two weeks. The pressure on crude, natural gas, and natural gas liquid pricing will keep activity muted across the U.S. Weak natural gas prices has already sent the Utica and Haynesville to historic lows, while the Marcellus sees the most stable activity driven by low breakeven costs. Robust NGL pricing helped support activity throughout 2018, but current pricing pressure has limited activity in several basins including the Mid-Con and Utica. There is a lot of pent-up demand for natural gas liquids in the global market, but the U.S. lacks the effective infrastructure to get it to market in a cost effective manner. This is quickly being addressed, but it will take time to bring the new coastal facilities online. LPG demand has risen globally, and the recent disruption caused by the Saudi Arabia attack has sent countries throughout the world, scrambling to replace the lost cargoes. The U.S. is in position to be the swing producer of NGLs, but that is still 24+ months away, so the rise in global NGL pricing won’t translate to rising frac spreads in the near term. As the energy financial markets struggle, there will be limitations on the available capital for struggling companies to issue equity or debt. The degrading balance sheets of many service and E&P companies will keep activity low, and as hedges roll off activity will continue to decline in an attempt to preserve cash.
Soft demand for U.S. oil will continue as domestic and international refinery utilization rates decline during typical maintenance season. The U.S. decline in utilization rates is currently below the 5-year average- per the chart below. This is on the back of slowing U.S. product demand along seasonal norms, pressure in the export market for refined products, and expected product builds. The limitations in the European markets and muted Latin American demand has kept a lid on U.S. exports, which has pushed domestic refiners to slow down activity further than normal. European refiners are also in turn around, and this is typically a time when the arb opens up for distillate from the U.S. to Europe. Instead, the European markets are being fed by a glut of distillate originating from West Africa and Asia.
The international market is signaling additional headwinds for U.S. crude and products that will persist throughout the remainder of the year. There was a big disruption in the market when the third largest oil producer in the world was attacked, and any premium left in the oil market from the supply shakeup has evaporated. This is driven by demand that continues to fall as indicated by economic markers globally, and an oversupply of light/sweet crude in the market that quickly backfilled the disruption. The persistent pressure on crude demand is also at the crux of Saudi Aramaco’s drive to sign on long term crude deals to solidify their placement of KSA oil in countries, such as India and China. The oversupply of light/sweet crude in the market will continue to pressure U.S. exports in a world experiencing a slow-down in total demand.
Several recent events have shifted crude movements around the world.
The Saudi attack has impacted their ability to upgrade/ process crude at the facility. This means that customers will either accept a “lower quality” crude (higher sulfur than initially agreed) or go out and find new shipments on the spot market. The cost to replace would be expensive so it is easier to just accept the lower grade, and blend on their side, while adjusting shipments going forward until Abqaiq can process oil to typical specifications. This will take months given the specific nature of machinery that was impacted.
KSA has been able to get close to normal operation and is making up any shortfall from storage. Saudi Aramco has enough spare capacity away from the facility that they can pump above exports in order to backfill storage, while meeting near term export demand. It will just take time to get the operations going and the crude to areas that have experienced draw downs. The company has announced they have currently achieved these levels and is already filling drawdowns.
The decline in crude quality has pulled more shipments from West Africa, the U.S., and other regions, which will persist through November as Saudi Aramco’s ability to upgrade crude remains impacted. While this move cleared some deferred Nigerian and Angolan crude into the market, purchases have slowed into November with Nigeria increasing export to a 4 year high of 2.14M barrels a day while Angola is still sitting on 40% of their initial cargoes for Nov.
This points to a continued slowdown in total demand globally as builds in products continue and crude demand slows.
The decline of 736,000 barrels a day in September for Persian Gulf OPEC oil exports wasn’t enough to support pricing as product draws underwhelmed, and WAF spare cargoes filled the void and responded with increases in November loadings.
The weak global oil price has led many OPEC+ nations to adjust their y/y demand growth estimates.
The new U.S. Sanctions on Chinese Shipper Cosco: Cosco Shipping Tanker Co and Cosco Shipping Tanker Seaman & Ship Management Co have been added to the Office of Foreign Assets Control’s (OFAC) designated nationals and blocked persons list. This has blacklisted about 100 tankers in the oil trading business, which has sent countries and companies scrambling to charter other vessels to maintain operations. This pushed dayrates to 11 month highs.
Gasoil/Diesel in floating storage in West Africa has shifted the movement of cargoes as more flow into Europe. Even though European refiners are in turnaround- storage levels remain elevated. This has impacted the shipment of distillate from the U.S. into Europe pushing U.S. exports to seasonally adjusted lows that are below the 5-year average. This will persist and continue to pressure U.S. exports from the Gulf as Lat Am demand remains below normal.
Economic data globally continues to highlight a slow-down in economic activity, which will remain an overarching theme as we evaluate refined product demand. Refined products have quickly been building above seasonally adjusted averages in Singapore, Europe, and Fujairah.
Leading and current economy indicators point to a contraction that is being reflected across the refined product market, and is resulting in a total slow down of oil demand across the complex. The Saudi attack provided a near term bump, but it quickly faded as pressure resumes across the landscape.
The pressure in oil highlights some key facts following the Saudi attack:
Demand for crude remains under pressure
There is more than enough crude in the market to supplement, but it took time to deliver as it was originating from further distances
KSA has been able to effectively fill the void created by the disruption faster than the market expected as we explained in our previous analysis.
The U.S. frac spread activity continues to decline on the national scale with 8/30 projecting active spreads at 395 down from the peak of 482 from the week of April 5th. The biggest declines have been in the Permian by approximately 25 spreads released in the area. Based on our seasonality work, activity in each region should start ramping at this period, but with the current price deck and focus on living within cash flow this increase is highly unlikely. Instead of an increase, completion crew activity will stabilize along the depressed lines. The biggest declines occurred in the Permian, Eagle Ford, and Williston, and the area that will see some reactivation of crews will be in the Eagle Ford. The ability to blend crude with Gulf of Mexico provides a better-quality product versus what is flowing from the Permian. Even with Epic (600k), Cactus II (335k in 2019- expanded next year), and Gray Oak (900k in 2020) either online or operational by year-end- E&Ps will divert uncontracted flow to these pipes to streamline operations and fill their firm transport obligations. This just means Permian E&Ps’ with firm transport won’t have to drill to meet their commitments, but rather balance the approach with oil stuck behind pipe, diverted flow, and new completions.
Completion crews will trend closer to 2017 versus 2018 as E&Ps continue to evaluate drilling programs and evaluate ways to reduce cost while maintaining production targets. Natural gas activity will remain challenging as pricing is below many cash cost break-evens (if not all of them) putting pressure on realized prices. The NGL basket was providing some uplift, but with competition in the market, limited export capacity, and naphtha pricing has pressured pricing across the complex. Some companies with hedges can weather some of the storm, but there will be some additional slowdowns in the Marcellus- especially as we head into the shoulder season. The Utica/Haynesville has reached a point that will remain relatively stable at 7 and 9 crews respectively. The additional LNG activity in the Gulf Coast will help support Haynesville activity as this spread count.
The demand for U.S. crude will remain challenging as demand slows and countries have reached limits for their ability to run U.S. grades. India has purchased many distressed cargoes floating off the coast of China stuck in the tariff battle, so the question will remain- is India now tapped out or will they be back in the market for U.S. grades with available cargoes out of West Africa. I would say India uptake of U.S. volume will slow into end of Oct. South Korea made the following statement: “Platts: South Korea refinery official – “We have been testing new US grades to check whether they are suitable for our facilities or not, though we can accept only a limited increase in shipments from the US because we have already sharply increased imports of US crude.” The plethora of naphtha and light distillates in the market will put pressure on the sale of light-sweet crude, especially U.S. blends.
WTI pricing stabilized as the U.S./China agree to continue talks, but as I explain later- these “talks” will continue with little resolution as both sides continue to drift further apart. This will shift U.S. crude into other regions- South Korea/ India- as China absorbs more capacity from Saudi Arabia and rest of the Persian Gulf leaving SK and India increasing purchases from the U.S. Based on the commentary and current flows into each country, the U.S. will struggle to find additional locations to place shipments.
The EIA posted healthy draws across crude, gasoline, and distillate- but implied demand has adjusted lower, which is typical around the seasonal adjustments for 1) end of driving season 2) shoulder season. Crude imports will continue to rebound as exports face headwinds through the end of the month and into Oct. Gasoline imports will remain subdued as builds start to ramp with demand slowing and refinery utilization remain relatively strong for the next 2 weeks or so. Exports out of the U.S will be pressured as more European and MENA product competes for a home, and will result in rising storage within the U.S. As refiners go into maintenance season just as new pipelines come online with falling export demand, storage at the coast and in cushing will fill quickly causing pressure across realized prices. This will result in the spread between WTI/Brent to expand by $2 and put rising pressure on WTI Midland Light.
International Crude Market Update
The global crude market remains volatile with tweets and trade war comments shifting near term prices by 3% or more up or down in a day. While the market focuses on China and U.S. comments, it is better to dig deeper and focus on the supply/demand forecasts of the physical product. Russia increased production/exports in August that was above the OPEC+ agreement but should fall back inline for Sept (or so they say). The production and export have risen from Russia that now claims to have the lowest break-evens in a decade. Russia has been increasing exports of naphtha, and will increase crude export of ESPO Blends (35.6 gravity and .48% sulfur). The crude slates will continue to be a focus especially as European refined product storage remains well over seasonal averages. The slates will get heavier as the market remains awash in gasoline and naphtha. Some respite will come in the shape of additional exports into Western Africa, but it will be short lived- especially as the driving season in the U.S. comes to a close. This week will be a bullish one in the U.S. as draws are always strong in crude and gasoline ahead of Labor Day weekend. The increase in refinery maintenance in the U.S. will lead to stranded Permian oil at the coast (due to falling exports and soft local demand), which will put pressure on local pricing hubs.
Even though total output is normalizing (according to Russian officials), the exports of specific grades are adjusting as crude quality continues to shift front and center. This comes on the back of softening Ural refining margins, competition from West African Blends, and Persian Gulf OPEC exports rise. Gasoline margins remain under pressure globally with more builds across the global complex, which will only get worse as we head into shoulder season and ramps in ultra-low sulfur diesel runs ahead of IMO2020. Russia- as shown above- highlights that even in an “agreement” scenario is producing well over the last 5-years’ worth of data. The below chart shows the spike in production across the listed countries on the left as Nigeria, Angola, Russia, and Libya drive expansion in their output levels. The mix of crude is key as West Africa is medium/sweet- while Russia and Libya can provide key heavy blends the world is currently missing. The problem has been the inability of Angola and Nigeria to clear shipments over the last few months- “At least one-third of 41 Angolan cargoes for October loading are still available, say traders with knowledge of matter. Pace of sales slower than normal; most Angolan cargoes typically sold out at this time of a month.”
The below highlights the steady flow of crude from the Persian Gulf, which will continue to drift higher as refiners within China ramp up with some offset due to reduced teapot output. The problem will remain the under-reported Iran barrels that continue to bleed into the market, and as the China/U.S trade continues (and it will for the foreseeable future) China will start increasing their runs of Iran crude. Two refiners totaling 800k barrels a day of throughput were built with the view that Iran was going to be a big part of the slate- so there will be additional exports from Iraq, Iran, and Saudi Arabia.
Even as OPEC production has hit 5 year lows, crude pricing remains under pressure as demand remains the core concern with gasoline margins struggling and only supported by distillate cracks. The distillate crack will be key as to refinery operations, and slowing demand (seasonally adjusted) and rising stocks will start to put pressure on the remaining crack. Builds have been reported across Singapore, Europe, Japan, and Fujairah with little respite as economic data continues to worsen on a global front. Flows of refined products to the U.S. have fallen from Europe to a 6 month low, and with shoulder season upon us this will continue to drive builds globally as product attempts to find a home/ cheap storage. The Mid-east to China oil tanker rate shifted to a four-week low as demand remains the top concern. Even as OPEC production remains at 5 year lows- global crude prices remain under pressure as shown by cracks, storage, and shipping rates.
The focus remains misplaced on tweets/ commentary that lacks context and viewed through a lens offers little relief to the current cyclical and structural implications across the crude market. The China/U.S trade deal remains far apart with little middle ground remaining to work through. China is facing an identity crisis at home with the CCP ramping commentary around party allegiance and sacrifice, while looking at strengthening deals with other nations to make up for lost crude/ naphtha/ food imports from the U.S. As we head into shoulder season, product builds and distillate cracks will be indicative for crude pricing over the longer term. China is hardening its stance- which on the surface may not seem apparent- but the rhetoric in key speeches and positioning indicates a long-drawn out fight. Polls within the U.S. still highlight political support for being “tough on China”, and now with renewed WTO grievances filed and tariffs increased on Sunday- this is far from over. Demand destruction will continue driving seasonally adjusted large builds across the complex in the shoulder season resulting in crude pricing pressure. The lack of demand for U.S. crude will result in softening of realized prices and pressure across the basket of products.
Completion activity typically adjusts based on weather as freeze-offs or difficult conditions shift when wells are frac’ed in the short term. This was a bigger factor when more activity took place in seasonal areas, but as the shift has moved further South, weather relationships have been measured in days or weeks vs months. The holiday schedule can be a factor when realized oil prices are low, but if prices are elevated- work will continue. The focus of using a 4-week rolling average helps to normalize some of the blips that can be caused by weather related interruptions. The bigger driving issue, as highlighted by the data is (shockingly) realized prices- and the ever important- margin/revenue. If realized prices fall by $5 but costs fall $6, activity will remain strong going forward. The energy sector will remain under pressure, and the data highlight who is activity in the most lucrative areas for pricing and future growth.
The data highlights a lot of common talking points: the Permian and Eagle Ford will remain the growth engine through the next wave of completions. The Bakken will always have a place in the market provided the quality of crude, but completions will be focused around maintaining production and less about growth. This has resulted in a drop off in activity as the Williston entered “development” mode sooner than the south provided the maturity of the region. Halliburton remains very active in the Permian, and is experiencing a ramp in activity as the first of three pipes enters service. The Eagle Ford remains active provided the infrastructure that is currently in-place and the blending that remains active with Gulf of Mexico crude hitting the shore. Eagle Ford light-sweet is a perfect blend stock for the Gulf of Mexico heavy-sour, while the Permian doesn’t have the same optionality based on location and pipe restrictions driving the addition of a new benchmark- WTI Midland Light. This will trade at a discount to WTI Cushing and WTI Midland. Differentials- driven by location, quality, and access (pipe and export)- are a key factor for evaluating profitable activity, and is a pivotal for distinguishing E&Ps that have value in this market and others destined for bankruptcy or bought for pennies on the dollar.
Seasonality data won’t be as relevant going forward with the growth factor originating in New Mexico, Texas, and Louisiana that will experience freeze-offs but nothing as detrimental as the Canadian break-up season. This highlights the importance of the 4 week rolling average to identify- companies with rising spreads by basin and E&Ps. Seasonality will come into play closer to holidays, but it will be fleeting with blips created by extreme cold resulting in freeze-offs and hurricanes/rain impacting logistics. The data highlights the consistent drilling activity in the Permian, but as we get more granular there is specific information as to “who.” The Eagle Ford attracted more capital when the Permian reached a significant bottleneck, but as pipelines enter service capital has shifted back into the Permian. The adjustment has been measured as there was already oil behind pipe, so it won’t take many additional spreads to fill the pipe that has started to deliver to the coast (as reflected in completion crew seasonality chart below). The bigger issue will be the coastal bottleneck as docks and export capacity is 18-24 months behind pipelines at a minimum. As the world experiences a growing flood of light sweet crude, the longer-term problem will be competition in the floating market- which brings me full circle regarding costs. Maximizing efficiency and reducing all-in costs are pivotal in competing on the global stage. Earnings have done little to stem the tide of the stock price decline, and with the major headwinds in the macro environment and crude pricing- there is little to prop up pricing in the short term.
As a reiteration from a previous writing, Primary Vision has clearly shown the discrepancy between oil and gas, which is projected to continue at least into 4Q. Activity remains well off 2018 levels and resulted in multiple spreads/ equipment being stacked. The stacked equipment has been old equipment reaching the end of its useful life, which is cheaper to use for spare parts instead of overhauling or replacing in the current environment. Several of the large oilfield service companies have announced 2Q earnings that are moderate to disappointing with soft guidance going forward as active remains sluggish in NAM.
These declines are reflected across multiple basins and operators with only a select few shaking off the trend and seeing an increase in activity. XTO, Cimarex, and Energen are some examples of increases. Cimarex doesn’t have many options given their acreage position, while XTO is taking advantage of their integrated model. By taking equipment off the market, it has helped protect some pricing for companies such as Haliburton- but others haven’t fared so well- such as RPC. The data remains consistent that E&Ps that control more and more of the hydrocarbon life cycle will maintain drilling plans. These companies- such as XOM, CVX, PXD, COP, EOG- can take cost out from other parts of the supply chain as oilfield service pricing doesn’t have much left to give. This also leads to the bigger problem for smaller E&Ps- if XOM and CVX are able to make an additional $6 running light-sweet crude through their refiners- do they care if they lose a $1 at the well-head?
This isn’t the first downcycle in the energy space and it won’t be the last, but it has been long based on the shifting structural make-up of the market. The U.S. is now exporting light-sweet crude at levels never imagined, China is exporting refined products and growing, OPEC+ is facing a market share challenge, and global policy is impacting refined product movement/consumption all the while a global economy sputters to a halt. The structural and cyclical impacts are all hitting at the same time, and the guide through the turmoil will be data-oriented activity in order to achieve profitability and pick up the pieces that make money. Primary Vision will be able to stay ahead of the trend by evaluating any seasonal adjustments, 4-week average trends, and completion crew projections across the lower 48. The color will provide a guide for earnings power (utilization rates), production levels, and general trends for future growth.
The North America crude market is going to continue to struggle as crude prices remain under pressure. Oil rigs are now heading below 2017 levels, which will be reached in the next week or two as oil prices start to impact E&P investment. Rig counts have fluctuated within a tight range, but will begin rolling over as DUC completion remains a core focus. Completions will outpace 2017 on a seasonal level, but the trend will be lower as pricing weighs on E&P balance sheets. Typically, completion crews trend lower into the close of Aug, but reactivate through Sept and maintain elevated rates until Thanksgiving where rates drop for the holiday season. The biggest question to be answered- how do E&P companies react and how can we see the information in the data?
Baker Hughes Oil Rig Count
CAPEX will remain focused on completions and pressure pumping, but will underwhelm as cost remains prohibitive for SMID Cap E&Ps trying to preserving capital. The shift is in the data- more proppant, water, and stages but less wells being completed. Frac spreads are currently running at elevated utilization rates as pressure pumpers shelve spreads that have either reached the end of their useful life and/or require overhauls that currently don’t make economic sense. This may seem counterintuitive- why would an E&P keep spreads when looking to stay cut costs? The short answer is- there are pipes to fill out of the Permian, guidance to hit, contracts signed, and hedges in the near term. Over a longer time period, completion crew utilization rates will decline, and not see the same acceleration in Sept-Oct that has happened the last two years.
Primary Vision National Frac Spread Count
The data points to a rise in proppant levels and water, which is “pulling” production forward by increasing it through the first 3-12 months of the well, but sacrifice the length of time it will produce. The market saw something similar in 2015, but this time E&Ps are already recovering close to 15% more of hydrocarbons in place based on new well designs. Frac spreads will be kept busy with less wells, but instead higher levels of proppant, stages, and intensity (water). By just taking an example- Pioneers well ShackelFord- 101H to 103H consumed almost 51M pounds of sand and 65M gallons of water with something similar in 104H-106H. Another example is Driver 116H-118H consuming 66M gallons of water and 51M pounds of proppant- these are the type of numbers that will start to trend higher. Diamondback uses something similar- for example- Victory State 602H-603H was 40M pounds of proppant and 42.4M gallons of water. This is larger per well on the pad vs Pioneer- so there is flexibility to take some of these wells higher. Most wells are now drilled utilizing pads and slickwater, with the water based fracs benefitting from higher proppant loadings and intensity to drive near term production gains.
Seasonality will play a roll in the slowdown, but the bigger shift is (shockingly) the change in the price deck of the drilling portfolio. E&Ps across the U.S. are struggling, and those that will survive either control the full hydrocarbon supply chain (XOM, CVX) or are fully integrated from the well head to the dock (PXD and COP). There are others that have means to survive with firm transport and some integrated processing such as FANG and MTDR. The pressure will remain across independents that don’t have international holdings to help bridge the cash burn. These companies will be consolidated over time, which will lead to an adjustment to drilling over the long term. Full development is starting to be rolled out, and efficiencies will continue ranging from streamlined supply chain all the way down to e-fleets.
While the long-term trajectory is slowly unfolding, the current price deck and mix of oil, natural gas, and NGLs must be addressed. The rig count is already reflecting an adjustment in spending with more rigs getting released. The DUC count offers more than enough running room, but the biggest cost for a well is its completion. So how does an E&P maintain production guidance while minimizing cost- frac fewer wells, but the ones completed pump as much proppant and fluid down as the reservoir can handle. This will pull forward production from the specific wells helping to maintain production guidance while attempting to live within cashflow. The Permian will remain active even as realized prices come under pressure due to companies reducing cost. While price deck is important, it is key to consider total cost and if the E&P has any flexibility to reduce cost. For example, if crude prices fall $5 a barrel and the E&P reduces cost $5 a barrel- did anything really change? In 2015, there was a lot of price that came out of the service sector that doesn’t exist in the same way- so E&Ps that will survive (not so much thrive) will be the companies that are vertically integrated and can reduce costs in the supply chain.
Primary Vision National Frac Spread Count
The global market remains in a precarious state even as production has come off from the highs in Nov/Dec of 2018. Libya is coming back online with more product stranded in West Africa as Saudi Arabia cuts prices into Asia while announcing a reduction in exports. With the trade war heating up, China is sitting on a large chunk of Iranian crude that could easily be run through their system. Even as OPEC production has come off, oil storage has grown as well as global refined product storage. This is supported by builds across EIA/ ARA/ Singapore data that remain indicative of low product demand. The supply/demand picture remain problematic as OPEC remains at lows driven by Iran, Venezuela, and the OPEC+ deal while North Sea, Brazil, and North America expand. Angola has cut back some sales as deferrals rolled shipments back several months and Nigeria remains stuck with cargoes. This is all complicated as the market sits in August with the shoulder season just around the corner. Saudi discussed that customer requests were 700k b/d vs August- but the data doesn’t support the commentary nor will a cut in further exports be enough to get oil prices higher in any meaningful way. As Saudi exits their elevated oil burn seasonal period (summer) plus a reduction in exports, there should be a much larger drop in production numbers- if they don’t appear- it just points to more crude being placed in storage to either replace draws or to be unlocked in a strategic manner (oil remains an economic weapon).
A bright spot some may point to is the recent China data: July crude imports 9.66 mln bpd, +14% on yr, but this also led to fuel exports up 20% on the year as there is a growing surplus. The oversupply is being generated by more facilities coming online (more supply) while local demand remains problematic and has led to negative margins in June. Diesel provided the uplift in July to bring slightly positive margins while gasoline margins continued to trend negative with no reprieve in gasoline margins any time soon based on global demand and storage trajectories for gasoline. The U.S. has seen gasoline demand fall to the 5-year average as storage levels are now well above the 5-year average- highlighting how the rise in exports haven’t been able to offset a bigger fundamental problem- demand.
Pressure will remain across the energy supply chain with little to support refined product demand as economic data continues to highlight the global slowdown. This has already started to reverberate as builds have increased through the system even as oil supply has declined. Saudi Arabia has discussed potential ways to stem the tide of the price slide- but there is little opportunity unless KSA is willing to cut exports further. This would just leave more optionality for U.S., Russia, Iraq, and WAF crude to find a home, while Libya brings volume back online. Russia is going into turnaround a bit early so more crude will be available in the near term- keeping
pressure in the market. Price risk remains to the downside over the next few weeks as the market faces oversupply heading into shoulder season. In the U.S., as new pipelines come online crude will quickly fill and overwhelm coastal (export) infrastructure shifting the bottleneck to the coast, which will keep a lid on U.S. crude pricing as the international market struggles.