Primary Vision Insights – September 14th, 2020

By Mark Rossano

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The crude markets “woke up” to the oversupply in the Asian markets over the weekend, as the glut has persisted as we now shift firmly into shoulder season. Even with the glut, China has so far held firm and started importing more U.S. crude in line with previously announced purchases. “Tentative U.S. crude cargo departures towards China currently sits at 840,000 barrels per day for the month, the second highest volume on record, according to data intelligence firm Kpler, as cheap oil prices and the Washington-Beijing trade deal incentivizes purchases.” [1] These are still early indications, but the shipments so far will help support some local spot pricing- specifically Magellan East Houston and Louisiana Light Sweet. The sailing time is about 3 weeks from Texas to China- depending on route and vessel speed. This will put more crude in transit, and while it could be resold while heading to China- it will likely be used to help fill new oil storage facilities or backfill capacity. As we talked about in the last write-up, the U.S. crude purchases were driven more by trading houses and speculators. Typically, this type of buyer could be looking to flip the crude in transit- so the amount of product moving could be shifted downward or have a different home. Several large firms have also taken advantage of the recent drop in tanker rates to buy up some long term contracts, which enables them to take advantage of storage as contango widens. Brent closed today 9/9/2020 at $40.53, which equates to a spread of about $.91 vs LLS and $1.58 vs MEH. The bid out of China and more competitive pricing out of Russia and the Middle East- will reduce European purchases and support the spreads between Brent and LLS at about $1-$1.25 and Brent vs MEH at $1.50 to $2. We don’t see many changes on spread pricing vs the write up 2 weeks ago when we gave a similar backdrop. So far we see additional imports steaming towards the Gulf of Mexico with U.S.-bound VLCCs increasing by 2 to 25, which is the highest since May 22.

It is important to appreciate where the crude curve currently sits as the front months have been pulled lower to account for the overhang in supply as we head into shoulder season. Prices will be pulled lower as steeper contango is priced into the market allowing for storage as refinery crack spreads remain depressed and/or negative. “Oil traders have started to seek out available U.S. onshore storage amid growing weakness in the WTI futures market structure, says Steven Barsamian, COO at The Tank Tiger, an independent brokerage and consulting clearinghouse.”

“Those won’t cover the cost to rent tanks which now average at ~44c/bbl per month for the nation, although it could be as high as 80c/bbl in locations like Houston, he adds Interest to store is also picking up despite high crude inventories which are seasonally at the highest in nearly 30 years, as there are still tanks available “Although most tanks have been leased for all of 2020, we are showing available storage for sublease,” in the lower Mississippi like St. James and Clovelly in Louisiana, or even Cushing, Oklahoma, he says”

This will keep pressure on the front months, but the belief (hope) of OPEC+ support helps prop up the back end of the curve. More pressure is entering the market though with Iraq asking for “more time” to become compliant while the UAE produced over their quota for 2 months (more on that later). The problem remains a lack of local demand and refinery throughput placing more crude on the water “above” allocations. Even with the initial shift lower (which we have been talking about), we believe there is additional pressure down to about $32 as the overhang is made worse by shoulder season, refined product overhangs, and lack of Asian demand. Our first stopping point was $37, but as we progress through Sept the pressure will mount sending us lower as more refiners curb runs driven by economic run cuts. The U.S. will come under additional pressure as OSPs (Official Selling Prices) are reduced across the board limiting demand for WTI and sending more local production into storage.

WTI CRUDE CURVE: Orange = Now/ Green- 1 month ago/ Blue- 3 months ago

Even with the rise in pricing pressure, completion activity has accelerated off the lows with the most recent number hitting 87 for Sept 4 th . The 4-week rolling average has now been pulled up to 81 and will remain around 80-85 through the remained of September. Activity will be supported by Appalachia, Permian, Williston, and the Eagle Ford. We have been talking about growth in the Williston and Eagle Ford over the last few weeks, but as we go forward- the Bakken will start to normalize at between 9-11 spread while the Eagle Ford will continue to attract several additional spreads. Anadarko and Haynesville have attracted additional work but will level off at the current activity listed below. The Permian and Eagle Ford (or just Texas in general) will see the most growth through the remainder of the month. We will continue to see spot activity in some of the fringe basins due to contractual obligations, managing decline curves, and some competitive pricing offers. In a previous write-up, I went through the different reasons activity would never fall below a specific threshold and a perfect example of that is the Uinta-Piceance basin. There are specific refiners that rely on crude flowing from these areas, so the end users will pay a premium to maintain operations. When activity was slowing aggressively, some refiners were starting to panic that they were going to lose feedstock and went out to incentivize E&Ps to maintain operations. This is why we thought activity was going to level off at about 50 (we hit 45) before we bounced higher as end users pushed to keep some work flowing.

Overall, we are expecting national activity to maintain an 81-83 four week rolling average through Sept, but on a weekly level could get as high as 93. As crude price concerns creep back into the market, the pace will slow in the fringe basins with a bigger focus in core areas such as the Permian. E&Ps are really gearing up to close out the year on a solid footing and meet the steady demand in the export markets. The export market will be able to support flows of about 2.7-2.9M over the next few weeks as China remains the largest buyer so far holding to the large purchase announced in August that if reaches total will be about 37M barrels in Sept. So far China has been pulling in about 750k to 850k a day, but that could slow down just given many of the buyers were speculators as we talked about it before.

Even with a reduced PADD 3 (Gulf of Mexico) refinery run rate, Texas crude production will still have optionality between stable exports, refiners, or storage. So even as prices decline further, we will see enough support to keep activity at least flat or just slow down slightly. Appalachia will be supported by the strength that remains in the natural gas curve even as total storage remains at peak levels. The view is that natural gas production will remain at about 85 bcf a day as demand is stable and associated gas remains limited vs expectations from 2019 into 2020. Natural gas will remain driven by overall weather- especially if we get some early cold weather into not only the U.S.- but also abroad helping to absorb the spare LNG capacity left in the market from COVID deferrals.

Activity will also be supported by hedges for the remainder of 2020 that have locked in prices and will enable E&Ps to help slow the decline curve as we head into 2021. Based on the chart below, some hedges were added in 2020 for next year, but given the pressure on pricing- many E&Ps have held off locking in depressed pricing. “Following the reporting in 2Q 2020, 61% of 3Q 2020 production and 57% of 4Q 2020 production is hedged. This is above average, but well below the high 72% production covered in 2Q 2020, according to our database.” After COVID really took hold in the U.S., the goal aggressively shifted away from production growth (which started to adjust last year) and really focus on living within cash flow. The problem E&Ps face is the ever-pervasive shale decline curves that require at a minimum 150 spreads just to hold the line in the sand.

The above and below charts help to drive home the levels of hedging deployed to support the second half of 2020’s activity to manage revenue and cost expectations.

We have already seen shale production fall from the highs of 9.31M barrels a day to 7.25M as shut-ins peaked and completion activity dropped off from over 300 spread to a low of 45. The bounce off the lows has been driven from the return of production, and some normalization of activity to a point. The estimate for the end of Sept is about 8.1M barrels a day, which shows a reduction of about 1.2M barrels a day from March peak. It is impossible to climb back up to the highs, but we have been STRESSING that E&Ps want to live with decline curves of 10%-15% this year and from peak to current we are sitting at about 13%. It will already be a huge hill to climb to get back to a growth profile, but to let 20%+ declines set it- the hill becomes a mountain to climb.

Total United States Shale Oil Production

So, between hedged volumes, refinery demand, and exports- E&Ps will have enough support to keep activity trending higher through Sept. We expect peak activity to be about 115 this year, but average closer to 97 depending on pricing because if we stay in the low $30s- it will be impossible to support the additional completion activity. The 150 and above spreads I reference earlier is meant to hold the line in the sand at the current production rate, if we want to climb back to march levels we would need to see over 300 spreads currently active in the market.

China is currently the biggest buyer of U.S. crude as demand wanes in Europe because the U.S. barrel experiences rising competition from rising floating storage and spot cargoes and Official Selling Prices (OSPs) being cut throughout OPEC+. China remains the focal point because the market is finally starting to react to what we have been highlighting since Chinese floating storage was rising throughout April-May. We have been very consistent in not only highlighting the growth in floating storage, but also how it wasn’t draining due to falling demand across all of Asia. “China’s crude inventories have fallen to 71% of total capacity in the week through Sept. 10, according to data from Ursa Space Systems.

Inventories reached a record high of 73% in the week through Aug. 27, with stockpiles having increased in 13 of the 15 weeks from May 21”

Chinese crude storage remains near record levels even as imports slowed throughout August: Imports slipped to 47.48 million tons, compared with 51.29 million tons in July and 53.18 million in June, according to customs data Monday.

August shipments, equivalent to 11.23 million barrels a day, are still up 13% from a year earlier but down 7.42% m/m China’s seaborne crude arrivals dropped 5.4% m/m

The problem with Chinese purchases going forward is the lack of state-issued allowances for imports. Even with some of these headwinds, “the number of supertankers hauling crude to China has risen to a 3-week high, according to ship-tracking data compiled by Bloomberg. U.S.-bound ships gained to the highest level since late May.” Between continuing port congestion and falling local demand, the arrival of new crude will just put additional pressure on global crude pricing. In order to address the rising refined product storage levels, “China’s state-owned oil refiners are set to boost gasoline and diesel exports in September by 13% m/m to 3.3m tons, according to a report posted on the official Wechat account of industry consultant JLC.” The increase in Sept would be an increase of 4.8% y/y, and so far from Jan to Sept refiners are setup to use about 65% of their export quota. These shipments are going into a market that is already saturated with refined products as we highlight in our OPEC+ and EIA YouTube shows.

The headwinds in the Asian markets for crude is putting more pressure on Brent pricing and enabling for a steeper contango putting additional crude in storage. OPEC+ has cut pricing across the board in order to incentivize more purchases from refiners to try to help margin by giving steeper feedstock discounts.

Due to weak demand and negative margins, refiners haven’t increases runs instead they have been cutting runs across the board- especially in India. We assumed that we were going to get at least a $1 cut out of KSA, and they officially announced a reduction of $1.50- which is a start but won’t be enough to spur additional demand. Refiners are still operating with negative margin across the global complex, but the price cut does allow for profitable storage- which is starting to roll out again. “Abu Dhabi National Oil Co. set the official selling price of its flagship Murban crude at a 50c/bbl discount to the Dubai benchmark for October sales, according to a price sheet seen by Bloomberg.

Price down $1.35/bbl from 85c/bbl premium set for Sept. That’s the second consecutive decline in OSP and the biggest drop since May

The competition is heating up within OPEC+, which is going to keep growing as Iraq AGAIN failed to reach compliance and now are asking for more time to reach compliance. The other problem is now the UAE has pumped over their allotment: “The UAE -- traditionally a loyal partner of group leader Saudi Arabia -- pumped a little bit over its agreed limit in July, according to OPEC data. It has admitted doing so again in August.” This is creating more uncertainty as a key member of the GCC (Gulf Cooperation Council) broke rank and over pumped. “The strongest signal that something was amiss came last month from the IEA, which estimated in its closely watched oil market report that the UAE pumped 3 million b/d in July. According to Petro-Logistics, which tracks international oil-shipping movements, the country supplied even more than that in August. Research firm Kpler also said the country’s exports are higher than official output figures, while tanker data compiled by Bloomberg show the country shipped about 2.9 million b/d last month. Those figures are significantly higher than the 2.693 million b/d of August production announced by Energy Minister Suhail Al Mazrouei, which itself was more than 100,000 b/d above the country’s OPEC+ target.” The problem remains local refiners as many Middle East countries have faced their own local slowdowns and refiners have been forced to cut runs. This puts more exports on the water, which has been a big focus for us as we have consistently said that exports were much higher vs what the production cuts would entail.

The UAE is no different with exports rising as their local refiners ran at a slower rate: “Deriving a country’s output from shipping data isn’t an exact science. Many countries, the UAE included, have their own refineries that process crude domestically at a rate that varies from one month to the next. Some exports may come from storage tanks, rather than out of the ground, and apparent crude exports can be inflated by blending with a light oil called condensate, which is exempt from OPEC+ quotas. It’s also hard to tell whether vessels are completely full when they leave loading terminals.” These types of issues are happening on a global level with refiners running at reduced levels. The numbers will surprise to the upside throughout Oct with India, Europe, and the U.S. announcing additional reductions. The below gives a snapshot of what is currently announced, which will be a big overhang in the crude market throughout the shoulder season.

“The lowest Saudi oil price in four months is having only a modest impact on demand in the world’s biggest consuming region, with four of 10 Asian refiners saying they’ll try and buy more of the kingdom’s crude. The other six cited weak margins and sluggish fuel demand as reasons for not trying to purchase more from OPEC’s biggest producer.”

The physical market has been signaling a growing oversupply as crude runs slow and more oil is pushed into global storage. Not only is demand disappointing the market (not us because we have been bearish with data, but supply is also returning to the market with Brazil, U.S., Norway, and OPEC+ bringing oil back to market. The issues highlighted below directly impact the movement of gasoline and diesel throughout the market. The consumer and general business activity remain hindered by slow economic that originated well before COVID, but the virus blew away the coverage of liquidity and put a bright spotlight on the major cracks running through the global markets. We can see that general activity still remains over 20% below pre-COVID levels and have plateaued here especially with a new rise in cases in places such as India, France, Spain, the U.S. China and India continues to struggle with both countries experiencing a recent slowdown for different reasons. China has been hit by the internal struggles regarding floods, debt rising, non-performing loans, bankruptcies, unemployment, and generally a struggling consumer. India has been hit by a new record of cases that are spreading throughout the country and limiting the movement of products- not only is the consumer struggling industries are running at 80% of capacity or lower. We have been talking about Indian refiners that have slashed throughput- which has gone from 85%-95% down to 45% to 65%. This is DIRECTLY correlated to problems in the market as Asian floating storage has already started moving higher while builds in West Africa and the Middle East also rise.

The storage data remains firmly in the bearish side with rising levels of storage across the board with new data out of China:

Shandong Storage Levels Turn Higher Again

Asia Crude Oil Floating Storage

The activity levels across Asia are resulting in the slowdowns with more pressure across all the high frequency data points- specifically lockdown indexes and the consumer sentiment levels. The key here is the shift in consumer movements- government mandated restrictions aren’t needed in the same way as the consumer naturally pivots when cases rise as people avoid additional shopping/ travel/ or general movements when cases rise. The uncertainty across all countries- not just the U.S.- causes a shift in spending patterns. The spending reductions are exacerbated due to job losses and the lack of job security on a global level.

India High Frequency Data Points

South Korea High Frequency Data Points

The lack of oil demand is reverberating through the system as cargoes are slow to sell out of Angola and Nigeria- even after Sonagola has issued 4 price cuts on several spot cargoes. “Cargoes of Nigerian crude are building up again off the ports of Gibraltar and Ceuta in the western Mediterranean, where one vessel has been idling for more than three months, perhaps indicating that the West African country is once again struggling to sell all its exports.

Almost 4m bbl of crude from the country are on Suezmax tankerseither anchored in the western Mediterranean, or due to arrive shortly, tanker tracking data monitored by Bloomberg show

Sonangol made a third price cut to its offer of three spot cargoes for October loading.

Even while oil starts to pile-up, Nigeria has cut refined product subsidizes in order to save $2.6B a year, which is also going to hit demand within the country. This is resulting in more gasoline floating offshore even as Europe is sending more refined products into West Africa. This is coming as additional flows are heading from Asia into Europe, while the EU is sending more gasoline into the U.S. and WAF. The U.S. is going to get somewhere between 25-30 cargoes of gasoline over the next several weeks, which will help backfill PADD 1 (East Coast) as some of it was purchased when the arb reopened during the Colonial pipeline leak and again during Hurricane Laura.

“This month’s drop in oil product shipments to the U.S. won’t be as sharp as previously thought, following a pick-up in bookings in early September.

23 tankers have been booked so far to load about 851k tons in coming days and more cargoes are expected to emerge In addition, 9 tankers have already sailed with 333k tons, mostly gasoline and blending components Click here for a PDF of the vessels observed in Bloomberg tanker tracking and fixtures Click here for a BMAP 67 tankers sailed with 2.51m tons from Europe for the Americas last month”

I will save the additional weak economy rants for another weak as the current data continues to point to a slowdown across manufacturing and spending with the consumer weakening further and global trade slowing. I will provide a more in-depth report with updated charts as next week has a treasure trove of new data points for the remainder of Aug and how Sept is shaping up. I figured our loyal readers could also take a break from a 7k-10k word document! The next write-up will include our economic views for the remainder of 2020, and how we see the beginning of 2021 shaping up.