Crude Observations

Mexican Standoff

Wow, just when you thought it was safe to get back in the water, along comes Donald J. Trump with another broadside to the global economy, this time in the form of another set of reckless tariffs on an ally and major trading partner. It was hard to miss, but if you did, the gist is that as of June 10th, Mexico will be slapped with monthly increasing tariffs on all exports, starting at 5% and ending at… who knows. These tariffs will remain in place until Mexico takes steps to end the passage of illegal migrants through its territory to the United States. Upon hearing the news, oil traders across the world had a panic attack and immediately started dumping WTI Crude like it was, I don’t know, Western Canada Select.


Never mind the twisted logic that tells a president that it is a good idea to announce a new trade war against an erstwhile ally on TWITTER!!! No, this announcement was made at the end of a day where the Mexican government presented the Trump signature USMCA trade deal to its senate for ratification. How’s that gonna go now? I am guessing not muy bien.


Coincidentally, Thursday also saw the United States issue a completely confusing press release on when, how and to whom Iranian sanction waivers on oil imports would be applied. And the end of a week that saw Robert Mueller (remember him?) deliver a prepared statement wherein he basically said that he didn’t charge Trump with obstruction because he’s not allowed to, and that he couldn’t say there was no obstruction and that in the matter of “real and dangerous Russian election interference in support of a candidate” he couldn’t speak to the collusion question because, as he already said, he wasn’t allowed to charge anyone anyway and that all this was Congress’ job. Put another way – something smells and it’s Congress’ turn to change the diaper. Or something like that.


Keeping up? All this matters because it has to do with the subject of this abbreviated blog.


Finally this week, we saw further escalation in the absurd China vs USA checkers match of tit for tat tariffs as well as some eye-poking escalation, with the US on one side saying it was going to ban Huawei and then China cancelling the few soybean orders it hadn’t already cancelled all the while with tariffs bumping up back and forth. Mix all that with some North Korean executions of Trump Summit participants, Iranian nuclear sabre rattling, dirty Russian pipes and you can say we have had a pretty hectic week.


All this chaos hasn’t been lost on the oil market as the price of crude has been on somewhat of a roller coaster during this whole mess (arguably a malfunctioning parachute jump these past two days). While it had largely held in a “reasonably” narrow $6 band around $60, the volatility is pretty gut wrenching. Today’s moves appear to signal a rough ride ahead. And, depending on which way it breaks, it could spell happy fun times for the Canadian oil patch or a return to the bad old days of year end 2018, early 2016 and late 2014.


So why the confusion? Well the world and the oil market traders can’t seem to make up their minds on which factor is going to win. Is it going to be global trade wars, US production growth and economic turmoil? Or is it going to be geopolitics, physical market fundamentals, Middle-East instability and OPEC+?


Stay tuned as they say!


What, not good enough? Fine. Let’s take a closer look.


A key reason the price of oil is so volatile right now is that all of these factors are pulling in opposite directions and trading their ascendancy on a daily and sometimes hourly basis. Fundamental and exogenous factors are undifferentiated in a skittish and increasingly risk averse market. This creates volatility and uncertainty, hammers stock prices, discourages investment and just generally upends the market. In the vernacular of the office – this sucks.


Interestingly, you can make a bullish and bearish argument for oil and support those with pretty rational arguments.


Let’s take a look at some of them. I am going to call them The Good, The Bad and the Ugly. (I am hoping that at least a few of you saw that coming right from the top BTW)


The Good


These are the factors that support a somewhat bullish view for oil prices once the air clears.


Global Demand – everyone is waiting for global demand growth to fall off a cliff because of a whole host of factors including trade war worries, US dollar appreciation and the ever present advent of “alternative fuels”. Fortunately, a funny thing happened on the way to immediate recession – the pace of growth in demand for oil has actually held up reasonably well. Growth is still there, it isn’t going away and it is absorbing its share of extra production. And the areas of the globe where growth is expected are still the areas where growth is happening. Propping up this growth is a commodity price that has fallen more than currencies are depreciating versus the US dollar. Not stellar, but modestly bullish if it can hold while other global issues get sorted.


What to do about Iran? Iran sanctions are starting to modestly bite. While language out the United States is confusing, and started the current slide in oil prices, the reality is that Iran’s export market has been impacted by US sanctions and the theoretical end of waivers. I say theoretical because recent news releases have been misinterpreted as saying that the US isn’t going to enforce the end of waivers when what they actually said was that they wouldn’t enforce on cargo that was booked and shipped prior to the end of the waivers. A splitting of hairs, however … the US is serious about sanctions but is likely stepping lightly around China – a major buyer of oil from Iran. Taken in the context of trade talks, it is understandable the US would want a flexible position. That said, Iranian exports down? Price supportive.


OPEC+ Solidarity. With the upcoming OPEC+ meeting (I forget, is it June or July now?), a lot of market participants are focused on OPEC+ solidarity and questioning whether the group can stay together. My question to the market is – can OPEC afford not to? If the agreement breaks up, the market sell off will be instantaneous and severe. Look, OPEC (Saudi Arabia) is probably rightly pissed that all their efforts at supporting prices are being undermined by a nonsense tariff war, but they are unlikely to take further steps to destabilize an already tippy market. Iran aside, look for renewed solidarity out of this meeting.


Russian Oil Production. Long a concern when assessing OPEC +, most observers have really glossed over Russia’s casual approach to compliance with the OPEC + cuts. Which of course is absurd given Russia’s elevated production levels. That said, the recent issues that Russia has had with contaminated oil in a major pipeline to Europe is an actual “big deal”. This will take up to 8 months to clean up. The net result is that Russia is finally producing in line with their OPEC+ commitment.


Delta Avengers. Instability within OPEC starts and stops with the next three points. The first being Nigeria which is a major OPEC producer. Most of the production occurs in the Niger Delta and the network of pipelines and off shore rigs that populate that area are a constant target for militants, rebel groups and criminal enterprises that seek to disrupt production in any way possible. The Delta Avengers (not a Hollywood movie) have indicated that they are about to ramp up their summer campaign and we have no reason not to believe them, because they do it every year. Force majeure anyone? Tell me again why Canada is such a scary place to invest.


Libyan chaos. Not to be outdone, the internal upheavals and civil strife in Libya continue as insurgent forces battle government forces for dominance and control of the country’s oilfields and export capacity. Meanwhile, production suffers.


Venezuela Called, they want their production back. This is the broken record part of the conversation. Venezuelan production has collapsed. Hello oil markets. Venezuelan production has collapsed. Can no one hear me? Venezuelan production has collapsed.


Crude Quality Matters. If there was a way to summarize a lot of the above into one statement, it would be “crude quality matters”. Most of the production outages outlined above are heavy oil. Most of the production gains that will be described in the next section are light oil. Guess which market is undersupplied and which is oversupplied. And guess which market is the headline price people trade.  That’s right. At some point the financial market will wake up to the 2 million bpd shortfall in the heavy market and get over the 300 some-odd thousand oversupply of light oil and price and react accordingly. Where are those heavy barrels going to come from? Mexico? Declining. Saudi? Curtailed. Canada? Landlocked. Shall I go on? So, is the day of reckoning tomorrow? Unfortunately not. But it is coming.


Investment. The lack of significant upstream investment was a whole 3000 word blog about six months ago. Aside from a couple of headlines, nothing has really changed.


The Bad


These are the factors that are holding up a meaningful move up in the price of oil


US Production. US production is the big stick holding oil prices back. The inexorable rise in light tight oil production feels like an inevitable surge that will dampen prices for years to come. But this supposition comes with a price. First it assumes that all that LTO can displace other production when we know that it just can’t. It also assumes that there is a limitless supply of funds to support debt-addicted over-production when the M&A market (Anadarko aside) is saying the opposite. US production growth is underwhelming YTD, DUCs appear to be way overstated, Weatherford has declared Chapter 11 and Halliburton and Schlumberger are reallocating assets out of the US into the Middle East and North Africa. If this isn’t a big flashing warning sign, I don’t know what is. Are we finally seeing the top of shale? Maybe. What the heck, I’ll make the call right here – shale hits 13 million bpd in average production in 2020 and that’s it.


Storage. This of course is a major factor suppressing oil prices. The storage number is indeed high and is well above last year, but then so is demand and for a variety of reasons (floods, hurricanes, storms), consumption hasn’t accelerated as it typically does this time of year. But give it time. Memorial Day is the usual start of summer driving season and it was late this year. I hold out hope for the next month. Dear Americans – fuel up and drive the open highway. You may as well do a staycation anyway, because your usual trips abroad may be more problematic this year because, you know, trade wars.


Chinese Demand Slowdown. Much was made this week about some statistical data showing that demand for diesel/fuel was down in China and that this was evidence that the Chinese economy was rapidly decelerating or suddenly switching every vehicle to electric or some such nonsense. While certainly unnerving, this drop in demand was actually calculated incorrectly, and didn’t account for drawdowns in diesel inventory. With the market failing to note this, the price of oil dropped some $2 and never really recovered. I call this “OK maybe, but…” hedging.


The Ugly


Donald Trump and Trade Wars – Look, it needs to be said. It is unbelievable to me that one individual can be such a destabilizing influence in the world and the China/US trade war is the epitome of the Trump madness. A completely useless and unnecessary trade enforcement escalation that could upend the global trade system for years to come. Remember that infamous tweet on May 5? Where Trump said China was bad and had unreasonable demands and that he was moving to ratchet up tariffs? Well since that time, the NASDAQ is off by about 8%, the Dow by 7%, the S&P by 7%, the price of oil by 16% and the yield curve has inverted, reigniting recession fears. This is true economic damage to the savings of Americans (and Canadians), another kick in the teeth to the oil patch and a tax on Americans (it is estimated that pretty much the entire burden of the China tariffs will be borne by American citizens via higher prices – current estimates are about $840 per capita).


And what has this achieved? Not much. Unless you like global economic uncertainty, reduced global growth, stunted trade and high prices. The markets are genuinely worried and the risk trade is on. Investors are concerned that Donald Trump is taking a US economy that was running on all cylinders and is going to leave it a smoking wreck, just like he did with his casino and other businesses. Track records don’t lie.


At any rate – certainly not bullish for oil and the longer the standoff continues, the worse it will get.


Factor in the Mexico escalation and unreasonable demands that need to be met to have those tariffs off and the burden on the American consumer grows. The Trump administration is now engaged in a tariff war with 2 of its 3 largest trading partners including one that is a party to comprehensive continental free trade agreement.


Mexico accounts for some $370 billion in imports into the United States and the proposed tariffs account for, at 5%, close to an $18 billion tax on American consumers, rising to close to $90 billion at the “full freight” 25% tariff. Exports to Mexico are about $300 billion. Tariffs had just come off steel and aluminum and the US agriculture sector was hoping its good friend Mexico could help with a China trade war induced soybean problem.


Don’t even get me started on the impact on millennials with the avocado trade.


It’s truly bizarre to me. I mean if Trump is looking to actually get re-elected, wouldn’t the path to victory be easier if the US wasn’t in the midst of a recession he caused in 280 characters or less?


Regardless, add it all up and it is chaos for energy markets, which truly don’t know which way to go.


It’s ugly.


Resolution of Mexican Standoff (no pun intended)


There is too much short term noise to solve this decisively without a significant de-escalation of the trade war drama. At some point as well, the markets will settle down and sort the noise from the fact. On the Mexico front, the self-assessment for action on immigration is so vague that the tariff threat could easily come off is Mexico rounds up a few caravans and sends them home. China is the wild card.


On the energy front, my own view is that we are in a bifurcated oil market – oversupplied with light tight oil and undersupplied with heavy and medium grades. The parties that matter get this and are pricing their product accordingly. Eventually the physical market messages get picked up by the financial market – it rarely goes the other way. Oil is oversold on a tsunami of negative factors that just aren’t reflected in the actual, real world. Aside from this, the political will of OPEC+ combined with ongoing instability in the Middle East trump trade wars. For now.


Don’t hold me to it, but whatever happens in the next few weeks is probably the floor. Expect prices to start re-inflating gradually as the dust settles. Until the next round of random tariffs of course. Which could happen tomorrow. They could even be happening now. Unless Trump is golfing. Who knows right?


Have a nice weekend.


Prices as at May 31 (May 24), 2019 

  • The price of oil was got hammered this week on renewed trade war fears
    • Storage posted a slight decrease
    • Production was up marginally
    • The rig count in the US was down, slightly
  • Injections to storage were above expectations for gas. The market was unmoved
  • WTI Crude: $53.37 ($59.02)
  • Western Canada Select: $36.77 ($42.67)
  • AECO Spot *: $0.22 ($2.07)
  • NYMEX Gas: $2.452 ($2.594)
  • US/Canadian Dollar: $0.7401 ($0.7465)


  • As at May 24, 2019, US crude oil supplies were at 476.5 million barrels, a decrease of 0.3 million barrels from the previous week and 42.0 million barrels above last year.
    • The number of days oil supply in storage is 28.7 compared to 26.0 last year at this time.
    • Production was up for the week at 12.300 million barrels per day. Production last year at the same time was 10.769 million barrels per day.
    • Imports rose to 6.943 million barrels to 6.862 million barrels per day compared to 7.631 million barrels per day last year.
    • Exports from the US fell to 3.347 million barrels per day from 2.922 million barrels per day last week compared to 2.179 million barrels per day a year ago
    • Canadian exports to the US were 3.186 million barrels a day, down from 3.688
    • Refinery inputs rose marginally during the during the week to 16.767 million barrels per day
  • As at May 24 2019, US natural gas in storage was 1.867 billion cubic feet (Bcf), which is about 12% lower than the 5-year average and about 9% higher than last year’s level, following an implied net injection of 114 Bcf during the report week
    • Overall U.S. natural gas consumption was up 1% during the report week
    • Production for the week was up 1%. Imports from Canada decreased 2% from the week before. Exports to Mexico were up 5%
    • LNG exports totaled 41.4 Bcf
  • As of May 31, 2019, the Canadian rig count was up at 85 (AB – 56; BC – 10; SK – 17; MB – 0; Other – 2). Rig count for the same period last year was 97.
  • US Onshore Oil rig count at May 24, 2019 is at 800, up 3 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States was down 2 at 184.
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was unchanged at 22.
    • Offshore peak rig count at January 1, 2015 was 55

US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 68%/32%


  • Canadian Natural Resources announced that it has acquired to acquire the heavy oil and thermal assets of Devon Energy for about $3.5 billion. These assets had been put up for sale earlier in the year as Devon reallocated assets towards light oil and short cycle projects. With the acquisition of these assets, CNRL’s production is expected exceed 1 million boepd which puts it in the top 10 non-NOC global oil producers.

Trump Watch: Trade War! Trade War! Trade War! What’s that? Mueller? Nothing to see there.

Kenney Watch (new!): Bills. bills, bills! Carbon tax repeal? Red Tape reviews? Lowered taxes.? Check, check and check. Lower minimum wage for students? Check!

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