Saudi’s fear of economic impact from new Africa Covid mutation causes them to unilaterally cut back crude production by 1.0Mb/d. Production increases by Libya, Russia, Kazakhstan, Iran, Iraq and Venezuela will likely offset this. Clearly OPEC+ is in disarray. The Expected spike to US$50+/b has occurred. Downside now ahead. We expect WTI to fall below US$45/b in February and below US$40/b in March before we see the next important bottom..

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OPEC Supply Meeting: The two day (Jan 4-5) virtual OPEC+ meeting derailed as the Saudi’s wanted at first to have no increase in February quotas as they worried about the economic impact of more OECD lockdowns due to the new Covid mutations. The rest of OPEC wanted a second monthly 500,000 b/d increase as they looked at the demand growth in China and India. This disarray in OPEC is a weakness as last seen in February when the Saudis and Russia fought a market share war just as the pandemic got underway. In the end OPEC+ granted Russia and Kazakhstan an increase of 75,000 b/d together in each of February and March. The Saudis then unilaterally cut 1.0Mb/d for February and March to help hold back an expected increase in worldwide crude oil storage levels during Q1/21. Oil prices spiked on this surprise offer with WTI rising over US$50/b. We had been expecting a move up into the US$48-52/b level so this jump gets us into this peaking range. We see this price spike taking crude prices into the high part of the range for Q1/21. The problem we see is that some OPEC members, with and without quotas, will increase their volumes anyways as they are desperate for funds to sustain their collapsing economies. Libya, Iran, Iraq and Venezuela have been finding ways to move more oil, (some clandestinely, like Iran and Venezuela). The failure of OPEC to reach a consensus means more disruption and cheating is likely. As long as prices stay firm then cheating makes sense.

EIA Weekly Data: The EIA data on Wednesday January 6th was mixed. Commercial inventories fell 8.1Mb on the week versus the forecast of a 2.1Mb decline. The miss was due to refinery runs rising to 80.7% from 79.7% in the prior week and resulting in Distillate inventories rising by 6.4Mb and Gasoline Inventories by 4.5Mb. Overall Stocks rose by 1.7Mb on the week to 1.34Bb. Crude inventories are now 54.4Mb or 12.6% above last year’s level of 431.1Mb. US domestic crude production was unchanged at 11.0Mb/d, but is down 1.9Mb/d from last year’s 12.9Mb/d.

Consumption fell sharply last week. Total usage fell by 2.26Mb/d to 17.05Mb/d. Gasoline consumption fell 687Kb/d to 7.44Mb/d while Jet Fuel consumption fell 300Kb/d to 917Kb/d. Total product demand is now down 11.9% from last year. Gasoline Demand is down 8.5% from the 8.1Mb/d consumed last year and Jet Fuel is 43.1% below demand of 1.61Mb/d last year.

Cushing Oil Inventories rose by 800Kb to 59.2Mb compared to 35.5Mb last year at this time. If Cushing inventories exceed 60Mb then there will be concern about excess inventories in the domestic market. When this occurs crude prices should come under pressure.

Baker Hughes Rig Data: The holiday week data for last week came out on Wednesday December 30th. The Baker Hughes Rig Survey showed an increase in the US rig count. It rose by three (up eight rigs in the prior week) to 351 rigs working, but remains down 56% from 796 rigs working a year ago. The US oil rig count rose by three (up five rigs the prior week) to 267 rigs but is down 60% from 670 rigs working last year. The Permian saw an increase of two rigs to 175 rigs working but remains 57% below last year’s level of 403 rigs working. Over US$45/b for WTI seems to be a price point where producers see economic returns from drilling. Yet, so far there has been no corresponding increase in US domestic production now at 11.0Mb/d.

Canada saw a big decrease in the rig count last week, down 23 to 59 rigs working as the industry slowed down for the holiday season. The rig activity level is down 31% from a year ago when 85 rigs were working. The rig count for oil is now at 18 rigs (down 13 from last week) and down 33% from 27 rigs working last year. The natural gas rig count fell by 10 rigs last week to 41 rigs working, down 29% from 58 working at the end of last year. The Canadian rig count is now rising and we should see a strong pick up in the coming weeks as the robust Q1 winter activity occurs.

Conclusion: WTI today is at US$50.46/b (high US$50.71/b) up US$2/b over the last two weeks.

Positive issues for higher crude prices:

• Winter is here in earnest and demand is rising especially for heating oil.
• A war premium is now included in crude prices due to two recent attacks on Saudi oil facilities by Yemen militants and Iran grabbing a Korean tanker. Iran did this in retaliation for Korea responding to increased US sanctions on Iran and freezing US$7B of funds in South Korean banks.
• The Saudi surprise announcement to unilaterally cut back production by 1.0Mb/d for the next two months is expected to slow the projected inventory build.

Negatives issues for lower crude prices:

• OPEC+ cheating is rising as prices and volume demand allows countries to gain more revenues or market share. Russia is producing 100,000 b/d above quota and selling the volumes to energy hungry China. Iran added 39,000 b/d in November to reach 1.99Mb/d, Libya added 656,000 b/d to reach 1.11Mb/d and plan to get to 1.6Mb/d in early 2021 and Venezuela added 25,000 b/d to reach 407,000 b/d.
• The demand for energy is expected to wane in the coming months as the pandemic spread causes more shutdowns of economies. Lockdowns and curfews are occurring across the US, Canada and most of Europe with tightened restrictions. The UK’s speedier mutant variant is worrisome as it has now spread to other countries. The US is seeing an acceleration of cases and deaths despite having two vaccines available. The next 3-5 months could see terrible levels of deaths as many areas have ICU beds fully utilized and are now rationing care. The new Africa mutation is very worrisome as it is even more virulent than the UK mutation, and some epidemiologists worry that this strain may not respond to current vaccines. If so, more work will need to be done to create new vaccines and getting herd immunity, may take into late 2021.

The near-term support level is US$46.25/b. One will need to keep an eye on crude and product inventory levels to determine how low crude oil prices could fall during the coming months. Energy and energy service stocks are overbought and could stay so for a little while longer. We see significant downside risk. The most vulnerable companies are energy and energy service companies with high debt loads, high operating costs, declining production, current balance sheet debt maturities of some materiality within the next 12 months and those that produce heavier crude barrels. A breach of US$40/b will hit these stocks hard.

Continue to hold cash and remain patient for the next low risk BUY window which should occur during late March or April 2021. 

Energy Stock Market: The S&P/TSX Energy Index now trades at 100.8 and is reaching our target for early 2021 of 100-105. The S&P/TSX Energy Index is likely to fall below the low of 61.21 (the low in late October 2020) during Q1/21. A breach of 87.55 should start this downward trend.

In our December SER we introduced a new feature, monthly articles from a guest contributor, Professional Engineer and oil industry veteran, Ron Barmby. He will provide articles on climate change issues and related policies that affect the energy sector. We hope you learn much from this new product offering. In our January SER Monthly edition (to be published on Thursday January 21) he will cover the Federal Clean Fuel Tax Issue.

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