Crude oil recently touched a three-year peak, rallying for the third week in a row, as global output disruptions forced energy companies to pull large amounts of crude out of inventories. The oil market is pricing in optimism that in case of prolonged supply disruption, there will be an increase in storage draws that will be needed to fulfil refinery demand.
US oil refiners are already searching to replace Gulf crude, and have turned to their supplier Iraq, and Canada in case it happens. Royal Dutch Shell, the largest oil producer in the US Gulf of Mexico, said the damage to offshore transfer facilities from Hurricane Ida will cut production early next year.
Oil demand is seen growing steadily amid an ongoing economic recovery while the supply outlook remains stable thanks to production discipline by the group of top producers known as OPEC+. Currently, the winter may look months away, but investors’ sentiments suggest they have the habit of forerunning things, as there is going to be huge competition for pipeline spaces once the season changes.
Currently, a slowdown in the comeback of US production due to disruption after Hurricane Ida along with a shortage of butane to add to winter blends of gasoline is supporting both crude oil and natural gas. To add to this, no new lockdowns in Europe, a robust recovery in China road activity, and the United States’ move to remove its ban on foreign travellers from Nov 2021 lift the prospects for an upside in the coming quarters. Reports from OPEC also indicate that global crude oil consumption could rise by an additional 3,70,000 Bpd if natural gas costs stay high.
Data shows that Hurricane Ida led to the shutdown of more than 90 percent of gas production facilities in the US Gulf of Mexico. Currently, some 16 percent of oil production in the Gulf, accounting for 320,909 Bpd, remained shut due to complications caused by the storm.
Investors will keep an eye on developments in China Evergrande. Currently, those concerns have subsequently subsided as the company made an onshore coupon payment and the People’s Bank of China injected liquidity into the financial system. However, reports suggest that offshore bondholders are yet to receive interest payments by the end of the trading week.
The main risk here is that an Evergrande default could weaken China’s economic growth, and thus global output. China is after all the world’s second largest economy, and a major consumer of oil. Some concerns remain over China's first public sale of state crude oil reserves with PetroChina and Hengli Petrochemical buying four cargoes totalling about 4.43 million barrels. Despite them paying a relatively low price of $65 per barrel on all crudes, the desired effect of sending a strong signal to markets did not materialise.
For India, there are signs of a recovery with the country’s oil imports hitting a three-month peak in August, rebounding from a nearly one-year low in the previous month, as refiners in the second biggest importer of crude stocked up in anticipation of higher demand.
The Energy Information Administration (EIA) reported a seventh consecutive week of decline in crude oil inventories. However, data on gasoline inventories disappointed investors as it showed a rise of 3.47 MB compared with expectations of a draw of 1.4 7MB. Distillate on other hand showed a drawdown of 2.55 MB compared to expectations of a draw of 11.1 MB. Crude production jumped by 5,00,000 Bpd to 10.6Mbpd, as Gulf offshore facilities resumed operations. Overall, the EIA report was bullish with supplies only to get worse in the coming weeks due to stretched inventories, which supports prices. On the rig front, drillers added 10 this week, lifting the oil and gas rig count for the 14th month in a row.
OPEC faces the challenge of ramping up production as per agreed levels even as producers from countries outside of the Middle East struggle. The compliance was reported to have gone up to 116 percent in August from 109 percent in July. Focus will also be on Iran, which is likely to resume nuclear deal talks in a few weeks.
Natural gas prices rocketed last week as demand continued to outstrip supply. The weather is expected to remain warmer than average throughout most of the US in the next two weeks, increasing cooling demand in a period when the weather is expected to become milder. Prices even rallied following a smaller-than-expected build of 76 Bcf in inventories compared to forecasts of 75Bcf.
Meanwhile, the EIA, reported that the industrial sector natural gas consumption will rise throughout 2021 and exceed pre-pandemic 2019 levels. It forecasts growth to continue into 2022, and natural gas delivered to industrial consumers to average 23.8 Bcfd. If realised, this amount would be near the current record high for annual industrial natural gas consumption set in the early 1970s.
For oil, market watchers will track the upcoming OPEC+ meeting, scheduled on October 4 to discuss the strength in energy markets. In the previous meeting, the producers’ group agreed to stick to the existing plan to release 4,00,000 Bpd in the market in October.
In this meeting, it looks like the group will continue to ease supply cuts and stick to its plan of easing at least 4,00,00 Bpd in November. However, investors cannot rule out the fact that OPEC+ can decide to ease more than 4.00,000 Bpd particularly if disruptions remain for a prolonged period.
-- Navneet Damani is VP-Commodity Research at Motilal Oswal Financial Services. Views are his own.