The question: can a daily price swing of $3/bbl in a crack spread value be justified by fundamental developments? The answer: rarely, yes, usually, no. Yet, this is what was observed yesterday with CME Heating Oil gaining $1.32/bbl equivalent whilst WTI losing $1.60/bbl with its front-end structure now firmly in contango whilst the backwardation has deepened in Heat. Their price action was the perfect reflection of the changes in US oil inventories; investors quickly reacted to the headline numbers. Crude oil stockpiles rose by 3.6 million bbls with PADD II bearing the brunt of the increase as Cushing stocks fattened by 1.9 million bbls. This, together with last week’s 13 million bbls rise is indeed a blow to anyone with bullish inclinations but nationwide stocks are far from overflowing; there is a 2% deficit to the seasonal norm. Distillate inventories drew 1.4 million bbls and are 11% under the 5-year average. Throw in the 1.5 million barrels depletion in gasoline inventories and you will get unchanged commercial stockpiles, which are 3.9% higher than during the corresponding week of 2022 and on par with the long-term average.

Clearly, the decline in crude oil prices and the weakening of the structure is an ominous sign, one which implies an oversupplied physical market. This theory, nevertheless, flies in the face of the updated monthly reports from OPEC and the IEA. They both predict, although to varying degrees, global stock draws for 4Q of 2023. The October inflation data from the major economic hubs are also solid: consumer prices rose 2.9% in the euro zone, 3.2% in the US with producer price rise also on the descent and 4.6% in the UK, lower than projected. Chinese industrial and retail sales figures were encouraging, too. The current price drop is taking place amidst a seemingly auspicious backdrop, which suggests that investors simply do not buy into ‘4Q stock draw’ narrative, something that is not backed up by the recent weekly EIA reports either. Consequently, any rally in outright prices ought to turn out to be limited, albeit the state of the global economy could ensure that a prolonged break under least week’s lows would be equally improbable.

The Fictious Case of a Supply War

OPEC heavyweight Saudi Arabia cannot be accused of complacency when it comes to supporting the oil market. On top of the agreed production constraints the Kingdom has voluntarily decreased its output level by 1 mbpd since July and for the time being shows no sign of backtracking on the decision, despite the rising cost of the move.  Front-month Brent stood at $75/bbl at the end of June and is currently around 8% higher so one might argue that the act is paying off. It is, however, blatantly obvious for anyone who follows our market on a daily basis that the $13/bbl drop since October 20 raises questions about the effectiveness of the unilateral cut. The fact of the matter, however, is that 1 mbpd off the market is 1 mbpd off the market and without it oil prices would presumably be even lower.

The critical question is that after counting the cost of this move how long Saudi Arabia is willing to be the principal shaper of the oil balance. The cost of the extra 1 mbpd supply constraint is enormous. In June 2023 the Saudis produced 9.9 mbpd. Its average output has stood at 9 mbpd since then, the Kingdom followed up its pledge with action. Over the ensuing four months this difference of 900,000 bpd amounts to 111 million bbls. Using the average OPEC basket price of $88.70 for the July-October period as a proxy, the monetary loss of the voluntary action stood at nearly $10/billion. It is a staggering price to pay for supporting the market, especially when the burden is not shared. No wonder then that the country’s economy contracted 4.5% in 3Q. For the time being the Kingdom is weathering impressively the self-induced financial storm. Aramco, as pointed out by Energy Intelligence, has maintained its quarterly dividend of $29.2 billion despite a 23% year-on-year decline in its 3Q 2023 profit from $42.4 billion to $32.6 billion and is planning to pay out the same amount in 4Q.

How long the willingness of utilizing its war chest would last is anyone’s guess at this point, especially that Saudi Arabia is ungrudgingly giving up market share within the group (and, of course, globally). Between June 2022 and June 2023, the Kingdom was responsible for 35-37% of OPEC’s total production, something that has fallen back to 32% in the last 4 months. And whilst the price impact of the additional supply cut is muted at best, rising output from fellow members, namely Iran, Iraq, and Nigeria might just lead to a re-think of the current strategy. Surely, the topic will be discussed at the end of November in Vienna.

And then there is Russia. The marriage of convenience shows no signs of trouble, there is an ostensibly harmonious relationship between the two oil producers. Yet, it is impossible not to notice that whilst Saudi Arabia fulfills its promise of reducing its output by 1 mbpd, Russia’s approach to its own pledge to cut exports by 300,000 bpd is flexible. After promising to reduce supply by 500,000 bpd in August it decided to lower exports by an additional 300,000 in September. This trimming was extended until the end of this year in a co-ordinated move with Saudi Arabia. The Russian part of the deal, however, is obscure and untransparent. In his latest statement the Russian Deputy Prime Minister said that the 300,000 bpd restriction applies to crude oil as well as products. It is a convenient re-definition of the original vow because of the recent export ban on products whilst sources tell EI that crude oil exports grew by 100,000 bpd in October to countries outside the former Soviet Union.  The backbone of Russia’s economy is the exports of raw materials and the political and financial support for the war it wages on Ukraine is as strong as the economy itself. For this reason, it is not unreasonable to conclude that Russia’s adherence to its voluntary export cut is as iron clad as its will for peace negotiations.

The consequences of the supply or price war of 2020 are still fresh in memory. At the height of the Covid pandemic Russia refused to cut production amidst falling demand, to which the Saudi reply was to step on the output accelerator, greatly contributing to a price fall, and leading to WTI’s less than tuppence ha’penny worth for a brief period of time. Even though such a scenario is currently not envisaged, one can only contemplate how long the Saudi tolerance will last. And even without a price war the question remains as how the Kingdom can achieve, borrowing words from my colleague, a soft landing in re-adding their barrels to the market. The answer lies in the recent price action – it will be a brave undertaking and unless the ongoing Middle East trauma leads to a significant supply disruption the lifting of production cuts could easily lead to further cheapening of prices.
 

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