The pace at which US production has been brought back online after output was shuttered due to freezing temperatures has caught the oil market a little on the hop and indeed, the recovery is rather impressive. It does appear that of all the areas most affected, North Dakota's return to the US oil matrix not only saw Crude oil inventories rise by 1.2mb against an expected Reuters poll draw of 217kb, but national crude production increased by 700kb, thus taking it back to the record 13mbpd as seen at the back end of last year and into the beginning of this. What is also concerning the market is the reduction in refinery utilisation to 82.9%, the lowest for a year, and while much of this diminished throughput can be put down to the very same freeze, one might have thought this would lead to some significant product draws. However, Distillates only drew 2.5mb with Gasoline actually building 1.1mb and to complete the rather negative data, implied demand was all but a push from the previous week.

Some of the negative waves washing over oil price thinking has this week emanated from China which this morning has eased a little after the private Caixin Manufacturing PMI showed a small increase in activity of 50.8 versus a 50.6 forecast and creeps into expansion. Aiding is yet again more stimulus noises from officials with newswires reporting of chat on structural tax incentives for 2024 in technology and manufacturing, however the gains made in the Hang Seng and the onshore blue-chip CSI300 have been short-lived due to lack of detail in the size of relief and dates of implementation.

Any kicker that investors were seeking from Jerome Powell's post-FOMC, unchanged rate decision, was sadly lacking as yet again the Fed Chair pushed back against naming specific months in which any hallowed pivot in policy might appear. Largely agreeing that the US economy was in good shape and inflation was on the right track, Powell nigh on dismissed a cut at the March meeting offering that the path to sustained 2% inflation is one that has not been won yet. Banks such as Goldman Sachs immediately pushed forecasts of rate cuts and the pricing of a March reduction in markets reduced dramatically to only 35%. Still, Powell's language implies that the market is likely to get interest rate relief at some point this year, which is why the reaction from the likes of yields and the US Dollar have been limited and why oil can now go back to concentrating on its own current affairs.
 

Saudi rethinks capacity extension

Because of the noise and the oil market’s twitch surrounding all that is going on in the Red Sea, significant future drivers of price have been somewhat overlooked this week as the blanket of spreading conflagration smothers important considerations. Notwithstanding last night’s FOMC rate decision, it could be argued that without worry of supply interference from Houthi missile attacks, there is much that might have bulls squirming in their seats. Chinese stimulus in this week’s guise of stock market support has had its positive effect evaporate, not only due to the stagnant National Bureau of Statistic (NBS) Manufacturing PMI reading of 49.2, but the ordering of a Hong Kong court for Evergrande to liquidate, which in our opinion is horrendous not only for the property market but its ramifications will be global-reaching and something we will return to. The late-in-the-day winter snap that shuttered North Dakota’s oil production was predicted to take a month to recover from but has climbed back to near normal levels and the draws that have been seen in US crude inventories are likely to slow down or even reverse at next publication.

Foregrounding these Red Sea bullish antidotes gives a lead into the confusing aspect of Saudi’s decision this week to reverse plans that would enable production capacity to extend to 13mbpd from the current 12mbpd. The initial order to increase capacity by the Ministry of Energy was delivered to Aramco back in March 2020, therefore the abandonment of such a strategic plan that was to be implemented before 2027, does bring into question whether Saudi/Aramco see a change in the fortunes of oil. Initially, markets were rather captivated by the notion that in some way this means a tightening of supply, but capacity is different to production as much as production is as different to exports. Over the last year-and-a-half, Saudi, along with let us say reluctant fellow OPEC members, has embarked on a program of production cuts designed to prop faltering prices and counter the heavyweight presence of US supply among other non-OPEC oil producers.

Currently standing at 9mbpd, Saudi’s production means that the Kingdom’s available excess capacity is  3mbpd, the logic of having 4mbpd capacity, nearly 50% over production cannot make financial sense for the costs are likely prohibitive. According to the Financial Times, Aramco’s CEO, Amin Nasser, has spent the last 2-years making a case for more oil investment because of the fragility of the system if unforeseen interruptions should occur, therefore clearly the designed extra capacity would cover such predicted shortfalls. Last year, Aramco predicted capital expenditure (CAPEX) to be between $45-$55 billion, but recently analysts such as RBC Capital Markets, via Reuters, expect the capex budget could be lowered by $5 billion per annum over the next few years and an easy way to achieve this is the reduction of capacity, which is expensive to finance, particularly if it is only then to sit idle.

GDP is an issue, for the fourth quarter year-on-year it shrank 3.7% largely due to lower oil activity and prices. According to Reuters, Saudi Arabia forecasted budget will be in deficit to the tune of $21 billion for 2024, with the price of crude and oil sales at best steady, the Kingdom has little room in which to manoeuvre. Increasing production would likely send the oil price so much lower that any gains in market share will be neutered in terms of income and further cutting production will see gaping holes in the financing of the grand social projects that Crown Prince Mohammed bin Salman is so committed to in legacy. However, we argue that reducing production capacity is not only logical financially but shows that its forfeit is a change in how OPEC’s kingpin sees the oil market going forward. OPEC, and by default Saudi, may very well continue in lofty demand predictions for oil, but supply remains very much in pace with it from non-cartel sources and if spare capacity from Saudi is sacrificed at the altar of cost without admitting that oil, at least in the short term, has a ‘balanced’ mien going on, then so be it. However, cutting capacity short-term, medium-term or long-term, cannot be viewed as bullish.
 

Overnight Pricing

john.evans@pvm.co.uk

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