The GERM Report

-Brent rally continues, but will it hold?

-OPEC has a lot on its plate.  

Crude oil prices continued the bullish trends from the previous session, rallying hard on the back of data showing a big drain on US crude oil inventories and the threat from Hurricane Sally. The price for Brent broke out Tuesday even though the IEA, OPEC and British energy company BP all suggested crude oil demand was waning. Crude oil prices could come under pressure from the supply side too as weak economics incentivize a tacit battle for market share. Meanwhile, trading house Trafigura said it was expecting momentum to eventually return to the US shale patch. Elsewhere, and we assess the response to the warming of several Arab states to Israel and continue to believe the poles of alignment spell trouble.

The threat to the energy-rich PADD 3 region in the United States from Hurricane Sally helped put wind the sails of the price for Brent crude oil in the previous session. Data late Tuesday on US crude oil inventories and the threat from flooding along the US Gulf Coast supported an extension of the rally on Wednesday. The price for Brent was up some 2.1% to hit $41.39 per barrel at 8 a.m. ET.

The American Petroleum Institute reported total US crude oil inventories declined by 9.5 million barrels during the week ending Sept. 11. Distillates, which include diesel, fell by about a million barrels, though gasoline levels rose by 3.7 million barrels. Those gasoline levels are indicative of the end of the summer-holiday season in the United States. Formal data from the US Energy Information Administration are expected to show a 2 million barrel build in US crude oil inventories and a hit or miss on API levels will support momentum for the rest of the trading day.

The price for crude oil will also be influenced by the impact of Hurricane Sally. The storm made landfall as a Category 2 hurricane and is expected to bring life-threatening storm surge and heavy flooding to the southern US coast. The storm’s path avoids much of the refining and production centers inland, though offshore production remains constrained. The US Bureau of Safety and Environmental Enforcement estimates about 27%, or some 500,000 barrels per day, and 28%, 760 million cubic feet per day, is offline because of Sally. That’s far less than last month’s Hurricane Laura, though the region is still dealing with the impact of that storm event. Keep all this in mind when reading EIA data today.

On the supply side, the relatively low price of crude oil has sidelined some of the smaller companies working in a US shale patch. Only a handful of shale basins, such as the Permian, stand a chance in terms of break-evens at current prices. Trading firm Trafigura stated from a virtual conference organized by S&P Global Platts that shale was not dead, but only on “sabbatical.” Production could increase, but it likely won’t happen until next year. Apart from rig counts, which could be a rough snap shot of spending, the firm is watching DUCs; drilled but uncompleted wells. DUCs are turnkeys of sorts, where operators can turn on and turn off based on the market. Those ready-to-go wells may be exhausted, however, so US shale output will remain under pressure for some time. Though it will recover, Trafigura estimated.

The balance between supply and demand will be under review when parties to OPEC+ curtailments meet online later this week. For all intents and purposes, it looks like OPEC+ has work to do to erase the supply-side strains that came from a relaxation move in August. Compounding the issue is the pursuit of exemptions from the likes of Iraq, signs of slow recovery in Venezuela and lower selling prices for October loadings from Saudi Aramco and Qatar Petroleum. Russia, not exactly the most disciplined among the restrainers, too may be incentivized to put more oil on the market. A dive into Russian industrial production figures from ING found the entire 0.8% gain from July to August came, thanks to OPEC’s easing back on restraint, from the recovery of oil and gas production. Elsewhere, and it looks like the Abu Dhabi National Oil Co. plans to play catchup on its lack of past discipline by trimming loadings from October. Mirroring movements in US storage levels, stockpiles of oil and petroleum products off the Emirati coast in Fujairah are close to five-year lows. Adding to the mix, though, and it looks like some of the demand signals are off-kilter. Even with some signs of growth in the continental economy, jet fuel demand could come under further pressure in Europe, adding to a glut of refined products.

Susan Rice, the national security advisor to former US President Barack Obama, observed during the Arab Spring movements at the early part of this decade that the explosion of social demands for democracy were tantamount to the “birth pangs” of political evolution in the Middle East. In hindsight, much of her enthusiasm was misplaced, particularly when looking at developments in Egypt. Now it’s President Donald Trump’s turn to try to reshape the architecture in the Middle East by offering military goodies in exchange for Arab support for Israel. Hosting delegates from the United Arab Emirates and Bahrain for the signing of normalization agreements with Israel, Trump said this was “the dawn of a new Middle East.” Behind in the race against former US Vice President Joe Biden, Trump is trying to court favor from his pro-Israel base. Like the comments from Rice, however, Trump’s declaration smacks of hubris. We’ve wrote at length that the consolidation of an anti-Iranian bloc invites adventurism from both sides of the demarcation line. With the question over what to do with the Palestinian territories brushed aside in the latest diplomatic salvo, Israel may feel like it can do what it wants. Arab endorsements of Israel only add to its confidence. As high-ranking diplomats celebrated the Arab warming as a sign of peace, it was ironic then that the Israeli military was bombing targets in Gaza. Continued harassment will only encourage a reaction from Iranian proxies.