[ihc-hide-content ihc_mb_type="show" ihc_mb_who="10,13,14,16,18,19" ihc_mb_template="1"] By Mark Rossano I will do a broader Q3 backdrop for oil demand and geopolitics next week as we get more data following the July 4th spike that was a mixture of structural and cyclical impacts. The OPEC+ agreement remains at a broad stalemate as the UAE wants a to increase their baseline to 3.8M barrels a day. The current deal (set to expire in April of 2022) bases their cuts off of a 3.1M barrels a day level. The UAE has invested over the last several years in infrastructure and their fields to increase total production capacity. In the least surprising news, they want to start earning money off of the billions invested. As the UAE expanded their capacity, the baseline agreed to became a bigger overhang on a percent basis as their production abilities also grew. The deal initially struck was at 3.1M, which was closer to their production levels, but since the agreement it has grown by just over 1M barrels a day. The UAE has called for a “restriking” of their part of the deal in order to not take such a large hit if the deal is to continue. We called out the UAE has an issue back in Nov/Dec when they “cheated” in July when the UAE pumped about 3M barrels a day. According to the deal, the UAE was only supposed to be at about 2.693M barrels a day. This created a big breach that Saudi Arabia called them out on with the UAE admitting to about a 100k barrel over production, which they promised (and did) make up for over the following month. But, when the group came back together in Nov- the UAE started to discuss their involvement in the agreement and more broadly OPEC+. From Nov ’20: “The move is unusual because the UAE -- the biggest producer in OPEC after Saudi Arabia and Iraq -- has long avoided public clashes, preferring to solve disputes quietly behind closed doors. It’s unclear whether the warning is designed to force a negotiation over output levels with OPEC+’s leaders Saudi Arabia and Russia, or if it represents a genuine policy debate. Any decision to leave OPEC would need the approval of Mohammed bin Zayed, the UAE’s de factor ruler and Abu Dhabi’s crown prince. Tension between Riyadh and Abu Dhabi has grown since late summer, when the UAE breached its OPEC+ quota and got a stern warning from its neighbor. Emirati policy makers seem increasingly frustrated by what they see as an unfair allocation of production caps and as the UAE economy reels from shriveling oil revenue and the coronavirus pandemic.” OPEC+ allowed on two different occasions for Russia to increase their production levels while everyone held to the initial agreement. This also comes after Iraq, Russia, and Nigeria consistently cheated without any repercussions and NEVER making up for their overproduction. The UAE’s position at the end of 2020 was : 1) they were hit by COVID and the economy needed an injection of cash (hence the increase in production) 2) the expansion of production capabilities. At the most recent OPEC+ meeting, several members wanted to extend the deal from April 2022 to Dec 2022 and increase production by 400k barrels a day and a total of 2M from Aug ’21-‘Dec’21. Mexico and the UAE rejected the extension of the deal from April to Dec, but the UAE refused to agree to 400k production bump unless they get to produce at greater quantities. This set in motion (again) what began back in 2020, but only worsened as their capacity has grown and they look to increase cash flow after spending billions. There is also a big political divide between Saudi Arabia and the UAE has steadily grown as the UAE withdrew from Yemen- officially ending their direct involvement in Feb 2020. Pressure was mounting between the two allies as they differed in opinion on how to proceed. Both countries had direct involvement, but also relied extensively on proxies within Yemen- but their paths began to diverge. UAE wanted to cut involvement and their proxies were willing to make a deal/ceasefire with the Houthis in the region. KSA and their proxies broadly refused and altercations ensued between both entities in Yemen and behind close doors behind the GCC members. The UAE decided to accelerate their withdrawal of personnel and equipment from Yemen as well as ending monetary and air support for the civil war. This left KSA alone (and bitter) about having to carry out support mostly alone (UAE still supports to some capacity). The political issues have continued to mount on the Yemen front, but both have been moving in a positive direction with Israel. The UAE was the first to cross the line signing a peace agreement in Sept 2020, while KSA has so far avoided any “official” ties to Israel. Israel has been effective in putting pressure on the “Shia Crescent” and hitting Iranian proxies at every turn. The complexity of the UAE and KSA relationship has only grown as their goals have diverged. Both want higher oil prices (obviously), but the UAE has a lower breakeven and spent a significant amount in CAPEX while KSA tries to slow the supply of crude and keep prices elevated. The UAE made another move by launching the Murban Crude Futures contracts in March 2021 that settle in physical crude and DO NOT have a destination clause. This is a big break from the historical Middle East structures that always have a destination clause attached. A destination clause prohibits the resale of the oil to another party- for example- if Shell purchases Saudi crude, they have to take it to their destination (lets call it Houston) and put it into storage or a refiner. If they want to resell it- the crude (technically) has to be offloaded from the ship into a tank and back from the tank to a new ship. This helps limit competition between barrels, which just means that if say Exxon wants some KSA crude they have to buy it from Saudi Aramaco and not on a resale from Shell. By eliminating the destination clause, it opens up for more broadly traded barrels originating from the Middle East. It also removes the need for “term buyers” or longer-term contracts and increases free floating crude that will be “market priced.” Many of these features (if not all of them) is a big beak from the way things “used to be done” and was another signal that the UAE was breaking away from KSA standards. The UAE is currently exporting about 2.853M barrels a day (as of June), which is well above the June and even July target of 2.735M barrels a day of production. They could claim that they are producing within the allotment and just selling the difference from storage- but that is highly unlikely. The UAE now having capacity estimated at 4.1M barrels or will keep them pushing for an increase from a baseline of 3.1M barrels to 3.8M to base the OPEC+ production cuts. My view remains that Saudi Arabia has a lot to lose if the OPEC+ deal breaks down, and they will come to some sort of an agreement with the UAE. It will “likely” be a “meet in the middle agreement” by allowing the UAE to increase baseline to 3.4-3.5M barrels a day instead of 3.8M. In return, KSA will slow their increase in returning OPEC cuts, but will keep bringing back their extra cuts that they did above the OPEC agreement of about 1M barrels a day. The problem will be trying to get all parties to agree to the bigger increase from the UAE as the physical market sales are crossing at steeper discounts and deferrals remain a problem. It is unlikely that the UAE agrees to the extend the agreement under the 3.1M barrel a day baseline- which they have already ignored for June and so far in July. Discounts to Dubai in Brent, WTI, and West Africa have grown driven by a weak Asia and additional Middle East barrels coming to market. Iraq has struggled to sell cargoes resulting in a cut in total exports. It is resulting in cheaper spot pricing in order to keep cargoes moving as Asia remains a weak buyer. The physical market remains well supplied with Angola, Nigeria, Iraq, and Congo struggling to sell their Aug loadings as some deferrals struck again kicking some capacity out of July. There has been a steep drop off on pricing with bids for crude crossing at $3 BELOW dated Brent. The current OPEC+ disagreement will not result in less crude hitting the market- you don’t disagree on raising production and revert back to the previous levels at reduced levels. Instead- it would result in some countries trying to increase sales, which will depend clearly on what the market can actually tolerate. Nigerian grades trimming their offers. Angola struggling. MED sweet down Pace of sale of Angolan and Nigerian cargoes for August is slower than normal as deep backwardation and a wide Brent-Dubai spread have deterred buying interest from Asia. IOC to award tender for late August loading tomorrow Mercantile Exchange. The OSP was $5.26, or 7.9%, higher than $66.40 for July. More than half of 38 Angolan cargoes and nearly 70% of Nigerian cargoes for August loading have yet to find buyers: tradersBrent-Dubai EFS now at $4.38/bbl; that’s the highest premium for the global benchmark over Middle Eastern crude in more than three years, according to PVM dataRepublic of Congo’s Djeno, a popular grade among Chinese buyers, recently traded at discount of $1.90-$2/bbl to Dated Brent, about 50c deeper than a month ago: tradersGunvor sold 100k tons of Urals for July 18-22 to Glencore at Dated -$3.65/bbl: trader monitoring Platts windowTraded price was the lowest since mid-April 2020Litasco sold 100k tons of Urals for July 17-21 to Total at -$3.45/bblPetraco offered 85k tons of CPC Blend for July 21-25 at -$2.30/bblSocar offered 90k tons of CPC Blend for July 23-27 at -$2.15 A total of 28 cargoes of Russian ESPO crude totaling 2.84m tons are scheduled to be shipped from the port of Kozmino in August, according to a preliminary loading program seen by Bloomberg. Equates to 672k b/d, vs 695k b/d in JulyAugust program comprises 27 cargoes of 100k tons and one of 140k tons PLATTS: Socar sold 90k tons of CPC Blend for July 23-27 to BP at Dated -$2.25/bbl: trader monitoring Platts windowTraded price was the lowest since May 14 Totsa bid 100k tons of Urals for July 23-27 at Dated -$3/bbl All the while- China remains well supplied with crude in storage- both onshore and offshore India reported new deman numbers that are mixed based on the weakness from last year. Even at a much easier comp- some of them still underwhelmed: Gasoline consumption +5.6% y/y to 2.41 million tons, the highest since MarchDiesel consumption was at 6.2 million tons, -1.5% y/y, down the most since FebruaryNaphtha consumption -3.1% y/y to 1.19 million tons, the lowest since SeptemberLPG consumption was at 2.26 million tons, +9.7% y/y, up the most since June 2020Petcoke consumption +13% y/y to 1.6 million tons In total, India consumed about 16.3M tons of oil products in June vs 16.1M a year earlier, which is still well-off normal pace. It will keep seeing a steady increase as the country reopens, but the record price of petrol will slow the pace of activity and put pressure on a full recovery. The key economic bellwether- diesel- still remains disappointing and points to additional weakness across industrial activity. The PMI data already came in well below expectations, and the recent data points to a steady rise in manufacturing (still below expansion) but Services seeing steady headwinds. The underlying consumer is struggling after the second wave with COVID cases stopping their downward trend. India was also taking advantage of the cheaper import market, but that has slowed: “India’s imports of gasoline and blending components slowed to a trickle during the first week of July after a surge in June, according to ClipperData, which didn’t provide a figure for shipments. However, early signs for the month show crude imports picking up, which should see refiners report higher run rates for July as other parts of refined-product demand gather pace domestically.” India refiners maintained about 85% activity through the state level lockdowns, but the export targeted ones will be slowing some runs- while the ones selling more domestic increase capacity. This will keep total oil inflows fairly stable as the international market doesn’t provide the same opportunity as an export given some weaker pricing. The downward trend in COVID cases has paused and started to rise in Europe, Asia, and Latin America. So far- the vaccines are proving effective against the variants in keeping people out of hospitals, but there is usually a lag of 2-4 weeks between case spikes and hospitalizations so it will be important to watch the data over the next few weeks. Grains have been volatile as pricing pressure hit when some needed precipitation was expected to hit key growing regions. The bearish price moves were quickly reversed when the planted acres and end stocks missed expectations (especially Y/Y). While the U.S. has enough food to sustain itself, what we don’t send into the international market becomes a bigger problem- especially for emerging markets. It is made even worse when you look at the weak grains data coming out of India following the problems in Brazil. There is some time to catch-up, but given the way the rains are going- it seems unlikely. The U.S. is facing a drought across key growing regions ranging from grains to citrus to nuts. Given the current trajectory for precipitation, it is unlikely we see a big trend change that will keep a big overhang on yield as droughts persist. The areas to watch will be some key “bread-basket” states such as Iowa. This is coming at a time where our grain stocks are at near decade lows, which will keep prices elevated. China remains a big buyer of grains from anywhere available, and right now (even at reduced levels) the U.S. still has enough to support that backdrop. This has supported pricing because even as prices have reason- it has kept the U.S. competitive in the open market. The next key number will be the South American Crop Production: The expectations is for the USDA to cut crops by 6.3 mmt based on the drought we discussed and some frost damage that occurred earlier. Conab already took down their estimates by 3 mmt bringing their total to 93.4 while the USDA is sitting at 98.5 mmt for June. I see a lot of pressure to the downside as the crops are adjusted lower. “Brazil's 2nd corn crop is the one they most heavily export, and losses there usually translate into more U.S. business. But U.S. corn sales have been historically light in recent weeks, old and new crop. So it hasn't yet produced the expected impact.” China is incentivizing more corn production, but it is coming a bit late in the cycle. The problem with China farming- their yield peaked between 2014-2016 and hasn’t seen much improvement. They are hitting a point of saturation that is limiting the ability to expand food production while their population keeps growing. This is on top of their battle with droughts this year, floods last year, and some sporadic armyworm infestations. The food we consume requires a lot of water (I know SHOCKING!) and as droughts become more prolific- it is creating problems for yield. As prices go up- especially for meat- consumers move down the value food chain: Steak to Pork to Chicken to Soybeans to Corn to Wheat to Rice. There has already been a broad shift lower, but given the swine flu/bird flu issues- prices have remained elevated even as some demand fell. The extensive drought in the U.S. began in 2020, and has only worsened (on the extreme side) in 2021. Based on the current data, this won’t abate any time soon. [/ihc-hide-content]