Despair and austerity hit global energy markets

We are beginning to see the makings of energy cuts in Europe, a highly unpopular step that governments are unlikely to take if given any other choice, highlighting the acute desperation that exists for oil and gas supplies.

Another sign of this desperation is Biden’s plan to release 180 million barrels of crude oil from the SPR at a rate of more than a million barrels per day. This is a huge number that will bring the SPR down to lows not seen since the 1980s (~388 million barrels) when US oil consumption was substantially lower than it is today. This decades-low emergency inventory would come at a time when US production has stagnated and oil companies are resisting calls to invest/pump more, and at a time when demand continues to rise.

The UK said on Friday it would also release more oil from its reserves.

The drastic actions will be interpreted in the medium term as cause for concern. OPEC+, on the other hand, appears content to stay the course, agreeing on Thursday to keep production increases agreed for May. At the same time, Canada continues to raise the price of carbon, thereby raising the price of gas.

Germany’s economy minister has activated its early warning system for low gas levels and called on businesses and private consumers to save energy. France’s gas distributor is also expected to issue a decree in the coming days…

We are beginning to see the makings of energy cuts in Europe, a highly unpopular step that governments are unlikely to take if given any other choice, highlighting the acute desperation that exists for oil and gas supplies.

Another sign of this desperation is Biden’s plan to release 180 million barrels of crude oil from the SPR at a rate of more than a million barrels per day. This is a huge number that will bring the SPR down to lows not seen since the 1980s (~388 million barrels) when US oil consumption was substantially lower than it is today. This decades-low emergency inventory would come at a time when US production has stagnated and oil companies are resisting calls to invest/pump more, and at a time when demand continues to rise.

The UK said on Friday it would also release more oil from its reserves.

The drastic actions will be interpreted in the medium term as cause for concern. OPEC+, on the other hand, appears content to stay the course, agreeing on Thursday to keep production increases agreed for May. At the same time, Canada continues to raise the price of carbon, thereby raising the price of gas.

Germany’s economy minister has activated its early warning system for low gas levels and called on businesses and private consumers to save energy. France’s gas distributor is also expected to issue a decree in the coming days detailing a plan for possible gas rationing. The Dutch Economy Ministry also said it would soon ask its citizens to use less gasoline.

Europe and the United States have spent a lot of time and effort trying to put together additional fuel supplies and trying to subsidize power and gasoline for their people. Unfortunately, gas tax breaks, national caps on energy prices, and one-time payments to financially hard-pressed residents have only ushered in steady demand. Now, Europe has realized that there are no white knight oil and gas producers who have been waiting in the wings to supply their needs.

The era of austerity is here, and while it might start with oil and gas restrictions, it certainly won’t end there. And age will stay with us for quite some time.

The high cost of diesel is already beginning to be passed on to the end users of the products being transported. In the United States, the CPI for food, for example, has increased by 7.9% from February 2021 to February 2022 according to the USDA. The UK has seen grocery prices rise at the fastest rate in 8 years, rising 4.3% last month. Germany, which has seen a 39.5% increase in energy prices since a year ago, has seen consumer prices increase by 7.6%. There are rumors of an impending recession. European Central Bank President Christine Lagarde has warned that Europe is now entering a difficult phase. Considering the chart below, it’s hard to disagree.

Consumer

It was originally assumed that there would soon be some increase in production from some of the world’s largest oil producers. It was also assumed that, with the exception of the United States, Russia’s oil would not actually be taken off the market in the absence of real sanctions.

US shale and OPEC, however, have failed to meet those production hopes. US production is stagnant and OPEC+ is holding firm with its quota increases of 400,000 bpd per month.

Meanwhile, Cushing inventories are low, US crude inventories have lost 80 million barrels since the beginning of last year and distillate inventories are down to just 25.9 days of supply, a level not seen since 2008.

It is fair to acknowledge that inventories have been low in the past and did not cause as much of a panic in the market as we are seeing now.

cushing

Cushing inventories were close to this low in early 2019. For distillate inventories, while it’s been a while since they’ve been this low, it’s certainly hit 26-28 day supply levels several times over the past few years. as recently as 2019, in fact. But the reality is that the world is only now realizing that there doesn’t seem to be any more capacity available. Low inventories combined with a lack of additional capacity is a recipe for disaster. Whether this “ability” does not actually exist in the physical sense or exists but is deliberately withheld is irrelevant.

The reality is this: Oil prices are at the level the market dictates, and only higher supply or lower demand will cure it. On the supply side, there are only a handful of large producers that have potential additional capacity. We hope to see Russia’s oil, thanks to self-sanctions, find another outlet (Asia). But it would take some serious shipping gymnastics to get all that oil to market and it will add months of lead time to oil that used to find a home in a couple of weeks.

Neither Saudi Arabia nor the United Arab Emirates are willing to increase production at a rate higher than that agreed by OPEC+, and with Russia in the group, the group will not accept additional supplies. For the rest of the deal, we will almost certainly see monthly increases of 400,000 bpd in OPEC+ quotas. If history is any indication, actual production will be less than that quota. The United States will continue to invest and add rigs at a moderate pace according to what companies have predetermined, no matter what the current price is. They have said so much. We may see small private drillers in the US increasing production at a higher rate, but this will not be the millions of barrels per day that the market expects. Even if investments increased substantially today, it would be at least six months before oil hits the market. The only other contenders are Iran and Venezuela. Although there too, it would take some time to ramp up production, and certainly not millions of barrels more per day. This is the reality of the offer.

Then there are the realities of demand. Subsidies, tax holidays and stimulus are temporary measures that do not improve fundamentals. Instead, it will only encourage more demand. Rising demand without additional supplies will, of course, push inventories even deeper. People who have been in lockdown during the Covid era are eager to resume life and travel, and they will. Until prices or lack of inventory exhaust demand.

The oil industry has made its fair share of mistakes over the past decade, but no mistake would be greater than underestimating the consequences of reductions in demand, whether through austerity measures like rationing, due to higher prices, or even due to exhaustion. The other side of the coin, of course, is that if the oil industry could come to the rescue and act now to increase production, they would almost certainly once again find themselves the dirty outcast they were just two months ago as soon as crisis is avoided, which could make your investments obsolete in a short time.

For the oil industry, it’s a no-win scenario.

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