Oil bulls can't catch a break. The escalating U.S.-China trade war and the potential U.S.-Mexico trade war have fueled speculations about a global oil demand slowdown. On top of these trade tensions, EIA has announced builds in crude oil over the last weeks, which has exacerbated the situation. As a result, the United States Oil Fund (USO) has fallen from approximately $14 last April to approximately $11 today.
Nevertheless, we do believe that the oil market is tight, oil's selloff is overdone and trade war fears are being overstated while supply risks around the world are high.
We don't want to speculate whether the Fed will make one, two or three interest rate cuts this year, which are bullish for oil, since they weaken the dollar increasing the crude price.
We don't also want to repeat that the U.S.-based oil shale players will have to cut back their spending because the vast majority of them can't make money at the current oil prices.
But we want to focus on the infrastructure bottleneck and the ongoing sale of the Strategic Petroleum Reserves that have significantly affected both the demand and the supply side over the last weeks.
The Persistent Builds During The Last Few Weeks
When it comes to the U.S. crude oil inventories, weekly drawdowns or builds are the result of factors affecting supply and demand.
And it seems that supply has been exceeding demand over the last weeks, so we have experienced a series of weekly builds that have averaged approximately 4.5 million barrels since late March 2019, as illustrated below:
|Jun. 05, 2019||10:30||6.771M||-0.849M||-0.282M|
|May 30, 2019||11:00||-0.282M||-0.857M||4.740M|
|May 22, 2019||10:30||4.740M||-0.599M||5.431M|
|May 15, 2019||10:30||5.431M||-0.800M||-3.963M|
|May 08, 2019||10:30||-3.963M||1.215M||9.934M|
|May 01, 2019||10:30||9.900M||1.485M||5.479M|
|Apr. 24, 2019||10:30||5.479M||1.255M||-1.396M|
|Apr. 17, 2019||10:30||-1.396M||-1.200M||7.029M|
|Apr. 10, 2019||10:30||7.029M||2.294M||7.238M|
|Apr. 03, 2019||10:30||7.238M||-0.425M||2.800M|
|Mar 27, 2019||10:30||2.800M||-1.100M||-9.589M|
|Mar. 20, 2019||10:30||-9.589M||0.309M||-3.862M|
|Mar. 13, 2019||10:30||-3.862M||2.655M||7.069M|
|Mar. 06, 2019||11:30||7.069M||1.203M||-8.647M|
|Feb. 27, 2019||11:30||-8.647M||2.842M||3.672M|
|Feb. 21, 2019||12:00||3.672M||3.080M||3.633M|
|Feb. 13, 2019||11:30||3.633M||2.668M||1.263M|
|Feb. 06, 2019||11:30||1.263M||2.179M||0.919M|
Source: EIA and Value Digger's database
The average weekly build of approximately 5.5 million barrels during the last few weeks means that supply has exceeded demand by approximately 800,000 barrels per day (bpd), so we will analyze this imbalance in the next paragraph.
As a result, USO has dropped almost 30% from its recent highs, as illustrated below:
The Ingredients To The Supply And Demand Mix
The demand side is dependent on refinery inputs and exports while the supply side is dependent on the U.S. production and imports. Specifically:
1) Supply: U.S. production has averaged approximately 12 million bpd since January 2019, while the U.S. has imported on average at least 7 million bpd since January 2019, as illustrated below:
It's also worth noting that imports hit 7.93 million bpd for the week of ended May 31, 2019, up by 1,065,000 barrels per day from the previous week while crude oil imports have averaged about 7.3 million bpd over the past four weeks, as linked above.
In other words, supply has been at least 19 million bpd since March 2019.
2) Demand: Refineries typically plan maintenance in the spring and autumn in order to gear up for stronger fuel demand in the summer and winter months.
This was the case again this year when U.S. oil refiners began a heavy slate of plant overhauls, so it's estimated that an average of 1 million bpd of crude oil refining capacity was offline through the second quarter of 2019.
Therefore, volumes went down to 15.85 million bpd in the last week of March when refineries operated at approximately 87% of their operable capacity, compared to 17.5 million bpd in the first week of January, as linked above.
However, refineries are gradually returning to normalcy, so refineries operated at 91.8% of their operable capacity and U.S. crude oil refinery inputs averaged 16.9 million bpd during the week ending May 31, 2019, which was 171,000 bpd more than the previous week’s average.
As a result, since March 2019, refineries have operated at approximately 88% of their operable capacity, which translates into approximately 16 million bpd.
Let's now check out the U.S. oil exports which is the second component of the demand side. In one week in February 2019, U.S. oil exports reached a record 3.6 million bpd while both the four-week and twelve-week averages in February 2019 and Q1 2019, respectively, were approximately 3 million bpd, as illustrated below:
But as mentioned above, the persistent weekly build of approximately 5.5 million barrels (average) means that supply has exceeded demand by approximately 800,000 bpd (average) since late March 2019.
Therefore, with supply being at least 19 million bpd, we draw the conclusion that demand has not exceeded 18.2 million bpd (average) since March 2019.
Given that refinery demand has been approximately 16 million bpd, it's safe to conclude that weekly exports must have been approximately 2.2 million bpd (average) over the last weeks, which is what we will analyze in the next paragraph.
U.S. Crude Oil Exports And The Infrastructure Bottleneck
In early 2018, the Louisiana Offshore Oil Port (LOOP) in the Gulf of Mexico (GoM) was refurbished to enable the loading of vessels for crude oil exports. Currently, LOOP is the only U.S. facility capable of accommodating fully loaded Very Large Crude Carriers (VLCC). The VLCC are the largest and most economic vessels used for crude oil transportation because they can carry approximately 2 million barrels of crude oil.
This increase in cargo scale was the key reason why U.S. exports of crude oil rose to 2.0 million bpd in 2018, which was almost double the 1.2 million bpd rate in 2017. Actually, U.S. crude oil exports surpassed 2 million bpd for 25 weeks in 2018 compared with just 1 week in 2017.
However, EIA notes that:
"All U.S. ports in the Gulf Coast that actively trade petroleum are located in inland harbors and connected to the open ocean via shipping channels or navigable rivers. Although these channels and rivers are regularly dredged to maintain depth and safe navigation, they are not deep enough for the safe navigation of deep draft vessels, such as fully loaded VLCCs.
Currently, most U.S. Gulf Coast petroleum ports are capable of accepting vessels with capacities of approximately 500,000 barrels of crude oil (AFRAMAX) while the number of ports that can to accept vessels with capacities of approximately 1 million barrels (SUEZMAX) are limited. Therefore, four AFRAMAX sized vessels or two SUEZMAX vessels are required to carry the same amount of crude oil as a single VLCC.
The inability to fully load larger and more cost-effective vessels has pricing implications for U.S. crude oil exports. Using a number of smaller ships requires a wider price spread between U.S. crude oil and international crude oil prices to compensate for the lower economies of scale and costs associated with reverse lightering and partial loadings. The costs associated with using a smaller vessel are less of a factor for exports over shorter distances such as within the Atlantic basin than exports over longer distances such as to Asia. As exports to Asia are a growing share of total U.S. crude oil exports, these costs will grow in importance."
Moreover, EIA says in the previous link that:
"However, LOOP lacks access to the areas experiencing growth in crude oil production such as in the Permian Basin of West Texas and Southeastern New Mexico.
In addition, LOOP is still used primarily for imports of medium-sour crude oil preferred by refineries in the U.S. Gulf Coast.
MARAD, the agency charged with permitting deepwater offshore ports, currently has no pending applications for new deepwater ports similar to LOOP. Instead, trade press and company announcements have indicated the most likely crude oil export projects with the intention to fully load VLCCs will be located near the port of Corpus Christi in southern Texas. Corpus Christi has access to increased domestic production of light-sweet crude oil from the Permian Basin and Eagle Ford and regularly exports crude oil from the Oxy Ingleside Energy Center and other facilities."
In other words, there are currently shipping limitations that don't allow the U.S.-based oil producers to export much more than 2 million bpd on a sustainable basis. To achieve this target, the U.S. needs more terminals near the port of Corpus Christi that will be able to accommodate VLCCs due to congestion limits in the Houston Ship Channel.
So Corpus Christi is an emerging export hub where there are currently five proposed terminals for VLCCs. The first ones are expected to be ready in 2020 and largely rely on the new Permian pipelines coming online in 2019.
Actually, the Permian Basin was overpiped a few years ago, so the pipeline projects slowed down. But they are now catching up, so we project that the Permian Basin will be fully de-bottlenecked in the first half of 2020 thanks to a number of pipeline projects such as the Gray Oak pipeline adding 800,000 bpd, Epic adding 600,000 bpd and Cactus 2 adding another 600,000 bpd, as shown in our article here.
Thus far, a handful of companies have proposed terminals with the edge going to Carlyle Group LP (CG), privately-held Trafigura and Enbridge (ENB) through its proposal for Freeport, which is about 175 miles northeast of Corpus Christi. The other companies proposing terminals for the Corpus Christi area include Magellan Midstream Partners LP (MMP), Buckeye Partners LP (BPL) and Flint Hills Resources LLC.
After all, we forecast that U.S. crude exports are poised to rise significantly exceeding 2.5 million bpd effective 2020 upon completion of the Permian pipelines and the first terminals in Corpus Christi area.
Strategic Petroleum Reserves
In our opinion, this is the second key factor that has significantly contributed to the recent weekly builds and has weighed on the oil prices over the last weeks. It has to do with the supply side.
Specifically, we are talking about the sale of U.S. Strategic Petroleum Reserves (SPR) into the commercial market, which was 600,000 barrels and 3.8 million barrels in April 2019 and May 2019, respectively, as illustrated below:
On that front, it must be noted that:
"Under Section 5010 of the 21st Century Cures Act, the Secretary of Energy is directed to draw down and sell a total of 25 million barrels of crude oil from the SPR, over 3 consecutive fiscal years, beginning in FY 2017. Of this amount, DOE is selling 6 million barrels in FY 2019. Under Section 403 of the Bipartisan Budget Act of 2015, the Secretary of Energy is directed to draw down and sell a total of 58 million barrels of crude oil from the SPR, over 8 consecutive FYs, commencing in FY 2018. Of this amount, DOE is selling 5 million barrels in FY 2019. A total of 10.87 million barrels of crude oil was mostly delivered in October and November 2018 (with the final deliveries taking place in December 2018), raising a total of $745.7 million in revenue for the U.S. Treasury, for an average of nearly $69 per barrel."
We don't know whether Department of Energy (DOE) will finally sell 5 or 6 million barrels in FY 2019. However, DOE has already sold 4.4 million barrels, so it seems that there are not significant volumes available for sale in the remainder of FY 2019.
The sheer domination of trade wars (U.S.-China, U.S.-Mexico) on the global markets narrative coupled with weekly crude oil builds have been driving the recent surge in negativity in the oil markets over the last weeks. As a result, USO has dropped almost 30% in just two months.
Meanwhile, global oil demand remains strong and is expected to approach 100 million bpd this year, so we believe that the physical global oil market is tight, although this has not yet been reflected on the U.S. oil inventories and the oil prices primarily due to two key factors.
Specifically, shipping limitations in the GoM along with the ongoing sale of the Strategic Petroleum Reserves have significantly distorted the picture.
However, the infrastructure bottleneck in the GoM is expected to be resolved in 2020 while the SPRs will have to be replenished sooner or later. Given also that the oil demand fears due to the trade wars are based on speculation, we recommend energy investors buy now well-selected energy names that tick all the right boxes while having a 12-month investment horizon.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in USO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.