Saudi oil logic is sound

Dec 14, 2016 11:37:18 AM EST

Oil prices are lower today, as focus shifts from optimism of the market balancing in the future, back to current oversupply. With today's US inventory report helping crude to pare losses with a solid draw to crude stocks, hark, here are five things to consider in oil markets today.

1) While the market can pontificate about all the economic reasons which have caused Saudi Arabia to push for a production cut from OPEC and NOPEC, a simple back-of-an-envelope calculation is justification enough. 

At the end of last month, immediately prior to the OPEC meeting, the OPEC oil basket was just below $44/bbl. As of yesterday, it has risen to over $52/bbl.

For simplicity's sake, if we consider that Saudi Arabia is exporting 7 million barrels per day, they would earn $308 million per day at $44/bbl. If they already removed 500,000 bpd from their exports today, taking them down to 6.5mn bpd, at a current OPEC basket price of $52/bbl, the kingdom would still be earning $30 million a day more than back in late November, while exporting 500,000 bpd less. Hence, the logic of higher prices versus higher exports is plain to see. 

(As an aside, it is interesting to see Saudi loadings to Asia and North America clambering above 6mn bpd last month, hark below).

Saudi to US and Asia Clipperdata dec 2016.jpg

oil demand IEA 2017.jpg

2) Yesterday on CNBC's Squawk Box we highlighted how the biggest threat to oil demand growth next year is slowing purchases from China. The leading emerging market has accounted for a sizable chunk of oil demand growth in the last two years, taking advantage of price dips to undertake momentous bouts of bargain-hunting, to fill its strategic reserves. Our analysis indicates that when Dubai oil prices dip, imports into China increase some six weeks later.

As long as prices continue to hang around in fifty-dollardom, Chinese purchasing could well be dampened. This is something affirmed in this piece today, as well as by the IEA monthly numbers yesterday: despite the agency raising oil demand growth expectations to 1.4mn bpd for this year, 2017 growth is projected at 1.3mn bpd, the slowest pace in three years.

3) OPEC has completed the usual triumvirate of monthly reports, joining the acronymtastic IEA and EIA.

Production numbers reported by secondary sources didn't surprise too much, although Saudi's output was still projected at over 10.5mn bpd for last month. Direct communication, however, pegged it at 10.72mn bpd, up 95,000 bpd versus last month - a new record level.

To put this in context, it is over a million barrels per day higher than its average production in 2014. According to direct communications, both Nigerian and Angolan production rebounded strongly last month.

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4) In terms of other key takeaways from the monthly OPEC report, similar to the IEA's report yesterday, OPEC has increased its demand growth expectations for this year - to 1.24mn bpd; growth is expected to moderate to 1.15mn bpd next year. On the supply side, there are two contrasting key areas of non-OPEC which the report sheds light on. 

It has drawn (more!) attention to Kazakhstan's oil production, which is up to 1.38mn bpd, after recovering from maintenance, and as Kashagan production comes onstream. We discussed here on Monday how Kashagan volumes are on the rise; OPEC suggests that Kazakh oil supply will grow by 210,000 bpd next year to average 1.77mn bpd. This is somewhat at odds with the NOPEC agreement last weekend, at which the country committed to cut by 20,000 bpd (apparently under duress).

kazakhstan and China OPEC Dec.jpgIn contrast, OPEC expects Chinese oil production to continue to shrink next year, but at a slower pace. As highlighted in the chart above, it expects it to sequentially drop through the first three quarters of the year, before leveling off.

5) Finally, looking at today's EIA weekly inventory report, the combination of higher refinery runs and lower imports have encouraged a draw to crude inventories. Implied demand for gasoline and distillates has continued its flip-flopping this week, firmly rebounding for both to mean a modest draw to distillates and a minor build to gasoline. 

While the report is being interpreted as bullish for crude, helping to pare some losses on the day, the drop in imports and a tick higher in refining activity was not wholly unexpected. 
 
Also of note, the EIA made a hefty upward revision to domestic production, boosting production from the lower 48 states by 101,000 bpd. This boosts production on a weekly basis to nearly 8.8mn bpd; we fully endorse this revision - it puts them right in line with our own model! 
 
Refinery runs are rebounding after a counter-seasonal drop two weeks ago. They are up 57,000 bpd last week to 16.474mn bpd:
 
refinery runs 121416.jpg

About the Author

Matt Smith

deciphers and distills what is most relevant across the energy complex into cohesive and pithy knowledge you can use. The belly laugh is a bonus.

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