A MARKET IN CHRONIC DEPRESSION
Oil prices experienced their worst week since February 2022, before the Russian invasion of Ukraine. It is normal, if such a thing exists in this market, that market players seek the exit in response to the questioning of the health of the two largest economies in the world. Especially, if they already were in a bearish mood, as has been the case since July of this year.
The focus is on the broader macroeconomy and the negative impact that a faltering global economy could have on oil demand growth. This gloomy sentiment leads to the assumption that demand will only grow a fraction of what has been forecast. The information on subnormal economic growth in China and the recent indicators of the US economy could be interpreted as the prelude to a recession. It would not be surprising if this sentiment is reflected in the next demand forecasts of the International Energy Agency (IEA), which will take advantage of the situation to present an even more pessimistic demand estimate than the current one; it is also not surprising that OPEC will try to counter-argue, in the confusing counterpoint of these two important organizations.
We will contrast the recent price trend with our estimates and propose an alternative interpretation to the one that has settled in the market.
Fundamentals
That the Chinese economy has lost the growth capacity that led it to become the second-largest economy in the world is undoubtable. China's problems are multivariable, but it is not difficult to argue that at the center of them is over-centralization, which undoubtedly contributed to its growth, but today it is inflexible. China, in the search for growth, promoted large investments in many sectors, some of them were not necessarily profitable, decisions that are beginning to show their fragile base. For example, the over-investment in housing has resulted in what has been called a "real estate bubble", keeping the economy on the edge of a crisis; housing construction accounts for around 30% of the Chinese economy, that is, almost twice as much as in other industrialized economies.
On the other hand, investment in the manufacture of goods for exports that either lack sufficient demand or have generated protectionist reactions in the market also shows the cracks in the planner’s vision in Beijing. As if this were not enough, there is growing concern that the Chinese bureaucracy is beginning to cover up or hide economic figures, either to avoid contradicting the leadership's vision or to avoid scaring off foreign investors.
The effect on oil demand due to the lack of Chinese economic growth is quantifiable. Demand reduction is estimated at 300 to 500 MBPD vs. current 2024 and 2025 forecasts, respectively, including demand destruction due to the accelerated deployment of electric vehicles.
The concern about the state of the US economy seems less reasoned to us. It is based fundamentally on the recent figures for non-farm job creation, which were more anemic than expected. However, it does not seem enough to persuade the Fed, at its September 18 meeting, to implement a rate cut higher than the expected 25 basis points. In August, total non-farm payrolls increased by 142,000, while the unemployment rate stood at 4.2%.
We believe that the global economic situation does not indicate an imminent recession on the horizon, as apparently imagined by the oil market and reflected in the collapse of prices, particularly this past week. On the contrary, supporting the argument of robust demand, we observe that US commercial crude oil inventories continue their decline. The Energy Information Agency (EIA) reported a reduction of 6.8 MMbbls during this last week, far exceeding the expected 0.96 MMbbls by analysts, and maintaining the trend that keeps inventories at levels not seen since the end of last year. Meanwhile, as is normal at the end of the season, gasoline inventories increased by less than 1.0 MMbbls.
The pessimism about the future and the feeling of inevitability of the imagined destiny seem to have converged on the market and have cooperated to reinforce the perception that the future of oil demand is gloomy. These symptoms, if you will, depressive, are the ones the oil market has recently exhibited, which have also been contagious from the doubts shown by the stock markets in general (Dow, S&P and Nasdaq all fell between 3% and 4% during the week).
In addition to the nervousness regarding demand, the oil market also chose to self-flagellate by assigning to the supply levels of growth that are even difficult to achieve in theory. The market considers in its calculations the eventual openings of “closed crude” by OPEC+, and the production increases in the US, Canada, Brazil, Guyana, and Argentina. According to some analysts, this would represent a growth in global supply of 1.7 MMbpd in 2024, which would exceed the deteriorated demand levels currently envisioned by the market. If those predictions materialized, the market would become oversupplied with crude throughout 2025.
However, we believe that the demand/supply balances that have depressed the market have, on the supply side, an aspect that has not been properly considered: instability. The current global supply is 101 MMbpd, and if we just look at this week, several events have adversely affected production: the internal dispute in Libya, despite news of an eventual agreement, keeps more than 0.5 MMbpd closed; in Brazil, as a result of major maintenance and greater decline than estimated, crude production is around 250 Mbpd below the level at the beginning of the year; in Colombia, protests over the increase in the price of diesel, generated production shutdowns in various fields, the protest was brought under control, but the barrels closed have no replacement. All these events will be overcome, but they illustrate the reality of the market in that disruptions occur and are generally unpredictable.
The production increases forecast by the IEA for 2024-25, we have adjusted for our internal forecast, based on the announced revisions of floating production and storage unit (FPSO) entries and their corresponding “ramp up”, as well as the latest information from the producing companies, and our own estimates of production capacity decline. Based on these premises, the charts illustrate the high probability that the supply forecasts will be substantially lower than those factored in by the market.
Furthermore, the reductions and the overall decline that we factor in will cause the increase in supply to hardly exceed demand, even discounted, during the period under consideration.
On the other side of the coin, the uncertain OPEC+ in the short term, agreed on Thursday to delay by two months the gradual dismantling, scheduled for October, of its production cuts; this after oil prices fell this week to the lowest levels of 2024. The announcement caused the price to rebound, but on Friday they continued their fall to new annual lows after investors ignored the decision of the expanded cartel.
In an orthodox market, the weekly inventory reports in the US, and the high-impact decisions of OPEC+, would trigger significant movements in the oil markets, but not on this occasion. The pessimistic sentiment is so prevalent that the collapse of US commercial inventories and the cartel's decision to postpone the return of barrels to the market barely resonated. This reinforced the oil market's belief that next year the balances will tilt strongly towards an oversupply. This dynamic may not necessarily prevail.
Here is the English translation of the document:
Geopolitics
Eleven months have passed since Hamas' incursion and the massacre perpetrated in Israeli territory, with skirmishes and deaths of terrorists and civilians in Gaza, as well as hostilities in the Golan Heights and the West Bank. Negotiations for a ceasefire do not seem to be heading towards an imminent agreement. But, no large military action is foreseen from any of those involved, pointing to a relatively low probability of escalation that would put oil supply at risk. Meanwhile, Israeli Prime Minister Benjamin Netanyahu is facing pressure after it was revealed that 6 Israeli hostages were executed when Hamas sensed they were about to be rescued.
In the Russia-Ukraine war, the Russians have continued doing the same thing they have done for most of the three-year invasion: launching numerous drones and missiles against civilian targets and energy infrastructure, but without material progress in terms of moving the initially invaded borders — a kind of 21st-century trench warfare. The creativity and innovation have come from the Ukrainian army, taking by surprise a good part of the Russian region of Kursk, including important gas dispatch infrastructures. Additionally, Ukraine has managed to damage bridges that prevent the Russian army from defending or recovering the area. Furthermore, due to the shortage of international armaments, Ukraine is using locally manufactured flamethrower drones to attack fuel depots in the regions around Kursk, as well as attacks on refineries, even near Moscow. These new strategies have affected Russia's product inventories and refining capacity, resulting in failures in the army's supply chain, and weakening its internal fuel market and indirectly hydrocarbon exports.
Price Behavior
Thus, prices continued to fall to the lowest levels in the last two years, completely erasing the accumulated gains so far this year. A hard blow for the oil market and producing countries, but also a possible opportunity to position oneself in this market, if the readings that the market is making represent an exaggeration of the real conditions. But always with the warning that the "market is the market" and it is what determines prices. As an example, current prices represent a weekly loss in oil revenue of almost $300 million for Saudi Arabia and savings of $130 million for India.
The benchmark crudes, Brent and WTI, at the close of markets on Friday, September 6, were quoted at $71.06/bbl and $67.67/bbl respectively. A loss of value of almost 8% compared to the previous week.
VENEZUELA
Distraction And Repression
After its electoral fraud, the Maduro regime, far from trying to find solutions to the crisis it has manufactured, insists on its strategy of repressing without much regard for human rights. They seek to distract the country and the international community from its old and new failures. Thus, faced with the power outage that the country suffered, it chose the fable that the blackout was a sabotage programmed by opposition politicians seeking asylum in the Argentine embassy in Caracas, currently in charge of Brazilian diplomacy.
On the other hand, and in apparent retaliation for critical statements by President Lula, the regime withdrew the approval it had granted to Brazil to take charge of Argentina's diplomatic headquarters. In parallel, the political police, SEBIN, surrounded the embassy and cut off the electrical service to the diplomatic headquarters facilities, violating international diplomacy rules. It is speculated that they may have plans to kidnap the asylum seekers and accuse them of conspiracy, anything to cover up the magnitude of the increasingly proven electoral fraud.
Faced with the facts, Argentina issued a warning statement to the Venezuelan authorities, and the Brazilian Government reiterated its protection of the embassy and those who take refuge in it. "Actions like these reinforce the conviction that in Maduro's Venezuela fundamental human rights are not respected," stated a communiqué from the Argentine Foreign Ministry.
During the week, prosecutor Tarek William Saab made good on his threat to issue an arrest warrant against the elected president, Edmundo González Urrutia, for alleged crimes related to the elections and their results. This Sunday, September 8, it was made public that González Urrutia, who was protected in the embassy of the Netherlands in Caracas, left the country for Spain under the figure of political asylum; the product of a negotiation with the Maduro regime. The effects of this decision on the struggle to defend the electoral result of July 28 are yet to be seen.
For her part, the opposition leader, Mara Corina Machado expressed her support for the elected president's decision. Machado reaffirmed her commitment to the country and her position to remain at the forefront of the fight for the recognition of the popular will expressed in the July 28 elections.
In a surprising announcement, an investigation by The Washington Post revealed that a lawyer representing the Maduro regime is the sister-in-law of the prosecutor of the International Criminal Court (ICC), Karim Khan. She is Venkateswari Alagendra, who has defended the regime before the court for alleged crimes against humanity. This situation would have generated complaints within the entity and, despite the relationship between the prosecutor and the lawyer, Khan has opposed the legal appeals presented, says The Washington Post.
Moreover, this week, former Colombian president Andrés Pastrana, representing 31 former Ibero-American heads of state and government, integrated into the IDEA Group. Pastrana urged this Friday the International Criminal Court (ICC) to issue an arrest and detention order against Maduro and his chain of command for crimes against humanity and state terrorism practices in Venezuela. All this adds to the diplomatic siege that has been growing in the face of the actions of the Maduro regime.
Another news of less relevance, but which has received wide international coverage, is the seizure of one of the planes that provide service to Maduro, which was in maintenance in the Dominican Republic. U.S. authorities consider that the aircraft was acquired illegally, violating that country's sanctions policy. A sample of what can happen with the regime’s assets and its cadre of cooperators.
On the other hand, the individual sanctions that have been mentioned could be imposed by the EU and the US, in response to the electoral fraud, the violent abuses against protesters, and the violation of human rights of dissidents, have been conspicuous by their absence. However, as J.I. Hernández explains, the strict compliance with existing sanctions alone would intensify their effect.
In an attempt to hedge against a change of opinion in the Biden administration, Chevron's lobbying group, headed by its executive president, defended its activity in Venezuela before the White House and the State Department. They claimed that the 200 Mbpd that reached the US from Venezuela helped to keep automotive fuel prices under control; a precarious reasoning in a market of almost 20 MMbpd. They also maintain that Chevron's presence, the only remaining US company in Venezuela, has a strategic value to prevent its absence from being filled by companies from authoritarian countries, China and Russia. This is a curious argument coming from a company that seeks to be a partner of the Chinese in Guyana.
The position of the North American oil company puts to the test the usefulness of the "ESG" (Environmental, social and corporate governance) commitments assumed by multinational companies like Chevron. These criteria are an approach that allows evaluating to what extent a corporation works on behalf of social objectives that go beyond the role of a corporation to maximize profits on behalf of the corporation's shareholders.
The crude reality is that Chevron's arrangement with the regime has a legitimate economic origin. It allows Chevron to recover the bulky debt that PDVSA has with the North American oil company, for expired loans and declared but unpaid dividends. The attached graph illustrates the current and projected debt situation.
Source: Own calculations assuming public information
The other side of the coin is that the regime's economic program is based on the level of tax collection by SENIAT and oil revenues. Tax collection has reached high levels since the introduction of the corporate payroll tax. Oil revenues and access to foreign currency largely depend on Chevron's activities in Joint Ventures with PDVSA. Currently, around 57% of oil sales revenues come from Chevron and Repsol (see graph);Chevron for now represents 85% of that total. The remaining 43% corresponds to commercial sales to China and India by PDVSA.
Source: Own calculations. Projection assumes continuity in licenses
The regime has maintained a high level of public spending, similar to the final stage of the electoral campaign, for which it has had to supplement tax collection with oil revenues in foreign currency. At the same time, it has continued with its policy of anchoring the official dollar, injecting high amounts of foreign currency into the exchange market, and generating a shortage of foreign currency to finance imports. This will be aggravated by the fall in oil prices, opening the gap between the official and parallel dollar.
Oil operations
The month of September has passed to date without any news affecting oil activities, despite power failures.
The new Minister of Oil, Ms. Delcy Rodríguez, visited the Orinoco oil belt, where she was received by workers dressed in impeccable red overalls, a captive audience to the minister/vice president's political harangue.
Crude oil production during the week was 827 Mbpd, geographically distributed as follows:
• West 190 (Chevron 87)
• East 140
• Orinoco Belt 497 (Chevron 103)
• TOTAL 827 (Chevron 190)
It has not been confirmed, but the start-up of the second drilling rig in PetroIndependencia is either delayed or canceled. In any case, Chevron should be able to complete the seventeen wells programmed for this year.
The crude export figures are regularly published in the media, but due to their diversity can confuse the reader, but ultimately are the product of the methodology and nomenclature that each source uses and which is not always stipulated. For the sake of transparency, we will briefly explain below the methodology we use in this report.
As a base case for crude oil exports, the monthly exported volume can be estimated starting from the production not dedicated to national refining, currently 612 Mbpd, adjusted for losses in upgrading. If we add the use of imported diluent, it would result in a volume available for export of 619 Mbpd. This base volume, in turn, would have to be adjusted for increases/decreases in inventories to arrive at the volume exported. Another matter is the export of refined products, petrochemical products, or petroleum coke, which adds to the figure,
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