Best in Energy – 28 June 2022

France calls for easing sanctions on Iran, Venezuela

Australia’s coal miners seek higher contract prices

G7 summit defers price capping of Russia oil

OPEC production close to maximum capacity

China’s northern grid regions hit record load

China probes coal price manipulation (trans.)

Triple La Niña event possible in 2022 (trans.)

EU28 GAS INVENTORIES are accumulating at a relatively rapid rate of +5.2 TWh per day, notwithstanding the recent interruptions of pipeline supplies from Russia, compared with an average rate of +4.8 TWh per day over the previous ten years: 

CHINA’s central-northern region stretching from Ningxia and Gansu in the west to Henan and Shandong in the east, but not including Beijing and the wider Jīng-Jīn-Jì metropolitan region, has been experiencing temperatures well above normal, leading to record electricity consumption in recent weeks. The map also shows below normal temperatures in the south where the monsoon rains have been unusually heavy:

JAPAN has called for electricity conservation especially in Tokyo as temperatures have risen more than +6°C above the long-term seasonal average in recent days and the strong air-conditioning and refrigeration demand has strained the availability of power supplies:

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Best in Energy – 22 June 2022

U.K. energy supplier failure has cost £2.7bn

India urges refiners to buy Russia oil ($WSJ)

China’s northern heatwave and southern floods

OPEC’s spare capacity decision ($BBG)

Thailand reduces LNG imports ($BBG)

Xilodu hydropower station (trans.)*

Xiangjiaba hydropower station (trans.)*

* The Xilodu (13.9 GW) and Xiangjiaba (7.8 GW) mega-dams on the Jinsha River between the provinces of Sichuan and Yunnan have almost as much combined generation capacity as the much more internationally famous Three Gorges hydropower station (22.5 GW). Hydro generation on the Jinsha plays a critical role in power supply for the southern export manufacturing hub around the Pearl River delta (including Guangzhou, Shenzhen and Hong Kong) as well long-distance power transmission to Shanghai. Southern rainfall and reservoir levels are therefore critical for electricity availability and the region’s demand for coal from the north.

EU28 GAS INVENTORIES increased by an average of +5.6 TWh per day over the seven days ending on June 20, decelerating from more than 7.4 TWh per day in the middle of May. But storage has filled at a record rate this year and the pace of injection was clearly unsustainable; some slowdown in the rate of injection was therefore anticipated. Inventories are +35 TWh (+6% or 0.25 standard deviations) above the ten-year seasonal average. The impact of Russia’s supply reductions to Europe cannot (yet) be identified in the data:

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Best in Energy – 9 June 2022

Freeport LNG explosion to shut facility for at least 3 weeks

OPEC spare capacity set to fall to lowest for over a decade

Battery shortages hinder wind and solar grid integration

Asia’s jet fuel refining margins hit record high

U.S. PETROLEUM inventories increased by +4 million bbl to 1,685 million bbl last week. The one-week increase was the largest so far this year. But stocks are still at the lowest seasonal level since 2008:

Best in Energy – 1 June 2022

The United Kingdom has a two-day public holiday on Thursday and Friday to celebrate the sovereign’s platinum jubilee, so Best in Energy will resume on Monday.

OPEC ⁺ explores suspending Russia allocation ($WSJ)

Russia prepares to re-route oil from Europe to Asia

India’s private refiners benefit from cheap Russian oil

India’s record renewables output eases coal shortage

Africa pushes back against emissions hypocrisy ($FT)

U.S. retailers attempt to resist price increases ($WSJ)

Global diesel and gasoline shortage raises prices ($FT)

U.S. residential use of air-conditioning reaches 88%

OPEC’s spare capacity and market stabilisation

EUROZONE manufacturers reported a further slowdown in growth last month as rapid inflation and the war between Russia and Ukraine took their toll. The manufacturing purchasing managers’ index slipped to 54.6 in May (65th percentile) from 55.5 in April (74th percentile) and 63.1 in the same month last year (100th percentile):

EUROPE’s gas futures summer-winter calendar spread from July 2022 to January 2023 is moving deeper into contango as inventories rise at the fastest rate on record alleviating some concerns about filling storage sites:

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Do we need OPEC to stabilise the oil market?

Extreme cyclical volatility has been the defining characteristic of the modern petroleum industry. The influential economist Paul Frankel was convinced the industry would always need what he called eveners, adjusters and organisers to dampen the boom-bust cycle, with a group of leading producers acting in the interest of the industry as a whole (Essentials of petroleum: a key to oil economics, Frankel, 1946 and 1969):

“The basic feature of the petroleum industry is that it is not self-adjusting … All these facts make for continuous crises: “the problem of oil is that there is always too much or too little”. Hectic prosperity is followed all too swiftly by complete collapse, and redress can only be hoped for from the efforts of the “eveners”, adjusters and organizers, whose success derives from the very peril to which the industry must succumb if they were not to lay down the law.” (p. 67)

“Unless my reading of the oil industry’s structure and history is altogether wrong, there is no question that there has been, always and everywhere, an overwhelming tendency towards concentration, integration and cartelization … It is, as I hope I have proved, due to the very fact that all-out competition, where it is allowed to prevail in the oil industry, leads either straight to general bankruptcy or to the monopoly of a survivor.” (p. 127)

“As there is always too much or too little oil, the industry, not being self-adjusting, has an inherent tendency to extreme crises; this fact has called forth the ingenuity of planners within the trade. As no individual unit can evolve a rational production policy on its own, some sort of communal organization is almost inevitable. Paradox though it may appear, oil, competitive par excellence, is usually controlled by some “leading interests”. The major companies have in the past played a vital part, with the independents as an indispensable corrective …” (p. 144)

“In this book the word Cartel is not only used to cover international combinations of big companies. Cartels are, as far as my arguments are concerned, all “associations based upon contractual agreement between enterprises … which, while retaining their legal independence, associate themselves with a view to exerting a monopolistic influence on the market.” (p. xv)

In the last 150 years, the role of eveners and adjusters has been played by a series of organisations and combinations, including Standard Oil (1870s-1910s), the Achnacarry “As-Is” Agreement (1920s-1930s) between the oil majors, the Seven Sisters (1940s-1970s), the Texas Railroad Commission (1940s-1970s), the Organization of the Petroleum Exporting Countries (OPEC) (1970s ―) and most recently an expanded group including Russia and  Mexico (OPEC+) (1990s ― ).

OPEC as a cartel

OPEC’s commitment to act as a market and price stabiliser is set out in its founding statute, approved in 1961, which commits the organisation to three objectives:

  • coordination and unification of the petroleum policies of member countries;
  • stabilization of prices with a view to eliminating harmful and unnecessary fluctuations;
  • securing a steady income to the producing countries; an efficient, economic and regular supply of petroleum to consuming nations; and a fair return on their capital to those investing in the petroleum industry.

OPEC dislikes being called a cartel, but its behaviour is similar to other cartels at other times and other markets, for example coal cartels in England between the 1580s and 1840s, so the characterisation is accurate (Monopolies, cartels and trusts in British industry, Levy, 1927).

Since 1982, OPEC has set production quotas (called “allocations”) for members to share out available market demand (the “call on OPEC”) fairly and avoid destructive competition for market share leading to over-production, excess inventories and slumping prices.

OPEC has never controlled all global petroleum output; its share of worldwide production peaked at 50% in 1973 and has generally been around 40-45% in recent decades.

But OPEC has controlled a higher share of the export market and its share has been enough to give it significant influence if not complete control over prices in the short and medium term (periods lasting up to 2-4 years).

Since the 1980s, OPEC has repeatedly sought to associate other producers with its production policy, with more or less formality and with mixed success.

OPEC has formally and informally reached out to Britain and Norway (1980s―), Mexico and Russia (1990s―) and U.S. shale firms (2010s―) to make its policy more effective and bring them within the market-sharing system.

Like other cartels, OPEC’s main impact has been to reduce production compared with the free-market alternative, keeping prices higher than they would have been without the cartel.

Low-cost producers in the Middle East have restricted output compared with a laissez-faire scenario, leaving some market share for higher cost producers in Alaska, the Gulf of Mexico, the North Sea, ultra-deepwater off the coast of Africa and Latin America, and U.S. shale.

Voluntary production restraint by the lowest-cost producers keeping some high-cost producers in business is characteristic of cartel behaviour.

As in other industries, cartelisation has kept prices higher across multiple cycles, but it has also supported a greater diversity of producers geographically and in terms of technology.

According to OPEC’s former secretary-general Francisco Parra  (Oil politics: a modern history of petroleum, 2010):

“One of the industry’s central features, the huge disparity between costs and reserves in the Middle East on the one hand, and everywhere else on the other, remains what it was in the late 1940s when U.S. Interior Secretary Harold Ickes was wondering how to fit low-cost Saudi Arabia into a structure dominated at the time by high-cost Texas” (p. 335)

“the essential dilemma, with the emphasis on security rather than protectionism, remains: to reconcile diversity of supply with price. You can have high prices and ample diversity of supply, but they, both supply and price, must be managed; or you can have competition, low prices, but supply, dangerously, in the hands of a few – who would drive out high-cost diverse sources and might then not continue competing among themselves.” (p. 335)

“non-OPEC producers are of course delighted with the OPEC price umbrella and keep as quiet as church mice about it”. (p. 336)

“The West has never wanted free, competitive markets in international oil” (p. 337)

Price stabilisation

OPEC’s statute commits it to stabilising prices, presumably by increasing output when there is a shortage and reducing production in a glut.

But there is limited evidence the organisation actually operates like this, with policy generally aimed at short-term revenue maximisation rather than price stabilisation.

OPEC’s often-cited spare capacity is the result of past forecasting errors when it comes to investment and its attempts to keep prices high by restricting production rather than a commitment to price stabilisation.

If OPEC has tried to stabilise prices, it has not succeeded: prices have been more volatile since the 1970s and 1980s than in prior decades.

The standard deviation of annual prices has been much higher in the five decades since 1970 than it was in the previous 50 years.

OPEC fought price/production wars in 1985-86, 1998-99, 2014-16 and 2020, increasing rather than reducing price volatility.

Prices or inventories

For political, diplomatic and legal reasons, OPEC frames its decisions in terms of balancing production, consumption and inventories rather than achieving a particular price target.

By avoiding overt discussion of prices, the organisation’s members aim to deflect criticism from consumers and minimise the risk of antitrust litigation.

As a practical matter, however, production, consumption and inventories are connected inextricably by prices, so this is a distinction without a difference.

Setting an explicit target for production and inventories is inevitably the same as setting an implicit target for prices (in terms of desired direction if not level).

OPEC and sanctions

OPEC has generally been more effective at limiting output and raising prices when output from one or more major producers inside or outside the organisation has been disrupted.

Economic collapse, mismanagement, corruption, civil conflict, war and sanctions have all played a key role restricting competition at various times.

In particular, U.S. and international sanctions on Iraq, Iran, Libya, Venezuela and Russia have reduced competition at different times and given OPEC more scope to raise prices.

In every case when OPEC has successfully lifted prices, at least one major producer was under sanctions, making it easier to reach an output agreement and reducing the scope to cheat.

As a practical matter, OPEC and sanctions have been inextricably linked. OPEC policy cannot work without sanctions, while sanctions have generally assumed compensating output increases from OPEC to limit the price impact on consumers.

OPEC and consumers

OPEC policymakers often claim to seek “stability” and a “fair” outcome in the interest of producers and consumers.

For their part, oil importing countries have displayed confused and confusing attitudes towards the cartel and its production strategy.

After the oil embargo and price shock of 1973/74, the major western consuming countries created the International Energy Agency (IEA) as an anti-OPEC.

OPEC has been strongly criticised by consumer countries led by the United States during periods of high prices in 1973-75, 1979-1981, 2000-2001, 2007-08, 2012-2014 and 2018.

But the United States has also appealed to OPEC to cut its production, limit the accumulation of excess inventories and halt downward pressure on prices during slumps in 1985-86, 2015-2016 and 2020.

The United States is one of the world’s largest producers as well as its biggest consumer, so in recent decades its internal political and economic balance has favoured moderate prices around $70-80 in real terms.

Real prices around this level are high enough to ensure the profitability of producers in Texas and other states but low enough to keep fuel affordable for motorists.

The White House tends to intervene when prices diverge too far from this level by pressuring OPEC to reduce or increase production.

Bloomberg columnist Javier Blas argues OPEC has been a useful foil for U.S. policymakers and the U.S. oil industry (U.S. politicians can’t handle the truth about OPEC: the cartel beats the alternative of oil producers pumping at will, Blas, May 12):

“U.S. politicians must secretly love the cartel. When oil prices are high, as they are now, they can hide behind OPEC, deflecting any responsibility. When oil prices are low, as they were in 2020, they can ask it for help to bail out America’s high-cost petroleum industry”

Stockholm syndrome?

Over the years, many economists, commentators and policymakers have argued OPEC’s production strategy has served the interest of consumers as well as producers.

Without OPEC market management, prices would have been even more volatile, creating even greater problems for consumers, in this view, which has also been promoted by OPEC itself.

The argument rests on a counterfactual, which is always difficult to test, but the evidence in favour of it is limited.

Prices have been higher in real terms in the OPEC era because of the limits on output growth, which has clearly been in the interest of all oil producers.

OPEC has been indirectly responsible for initial development and later protection of higher-cost producing areas (the North Sea, Alaska, Gulf of Mexico, China and U.S. shale).

Like other cartels, the case for OPEC being in the interest of consumers as well rests on the claim it has reduced damaging volatility.

But prices have been much more volatile during the OPEC era than they were in the decades previously.

OPEC members have worsened volatility by fighting several fierce price/volume wars (1985-86, 1998-99, 2014-16 and 2020).

They have also contributed to volatility by delaying output increases when prices are rising and allowing inventories to fall critically low (2007-08, 2011-14, 2018-19, 2021-22).

Other capital-intensive industries such as gas have developed without an international agreement or cartel to stabilise their markets.

The argument that consumers as well as producers benefit from OPEC has always struck me as an instance of “Stockholm syndrome”.

OPEC looks after the interest of its members by maximising the revenues they earn; non-OPEC oil producers also benefit from the tendency for higher prices.

OPEC’s benefits for consumers are less clear and there is no evidence it has made prices less volatile.

John Kemp

22 May 2022

Best in Energy – 13 April 2022

WTI’s negative price – inside story ($BBG)

India faces coal and electricity shortage

OPEC/IEA tensions break into the open

OPEC reduces oil consumption forecast

German economists downgrade outlook

CNOOC to exit U.S./U.K./Canada assets

India’s refiners buy Russian oil ($BBG)

Jet fuel supplies are tightening ($BBG)

Energy crisis ousts climate policy ($FT)

U.S. petroleum product exports in 2021

U.S CONSUMER PRICES are increasing between two and four times faster than the central bank’s target of a little over 2%. Core prices for items other than food and energy have increased at a compound annual rate of 4.0% over the last two years and were advancing at an annualised rate of 5.8% in the three months from December to March. Services prices, which are normally more stable but also more labour-intensive, increased at a compound rate of 3.4% over the last two years and were rising at an annualised rate 7.1% between December and March. The rapidly rising cost of energy, raw materials, manufactured products, freight and labour is becoming more deeply entrenched in the rest of the economy:

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Best in Energy – 12 April 2022

Retail gasoline prices: rockets and feathers

EU’s proposed carbon tariff moves forward

U.S./India talks about Russia oil

OPEC warns EU about oil shock

U.S. households’ energy security

BRENT spot prices and especially calendar spreads have softened significantly and are now trading at or below levels prevailing immediately before Russia’s invasion of Ukraine. China’s coronavirus outbreaks and lockdowns, signs of a business cycle slowdown in Europe and North America, and the massive offer of 240 million barrels from strategic stocks by the United States and its allies have all weighed on futures near to expiry:

BRENT futures for delivery in July 2022 – the impact of the business cycle and epidemic waves on oil prices:

U.S. GASOLINE and diesel prices at the pump are still elevated despite the reduction in crude futures prices as fuel inventories remain low:

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Best in Energy – 28 March 2022

Commodity traders keep Russian exports flowing

OPEC+ officials call for increased understanding

EU carbon market operations – regulator review

IEA defers decision on energy data subscriptions

Germany’s dependence on Russian oil ($BBG)

Japan nuclear restarts win more support ($BBG)

Russia sanctions threaten LNG ship orders ($FT)

U.S. shale output limited by supply chain ($FT)

Freight costs rise in response to diesel ($WSJ)

Middle East diplomatic negotiations ($WSJ)

Shanghai financial district in lockdown (trans.)

Shenzhen relaxes coronavirus controls (trans.)

Battery storage: grid-service and load-shifting

Hedge funds position for yield curve inversion

RECESSION signals are intensifying with the two-to-ten year segment of the U.S. Treasury yield curve within 12 basis points of inverting and in the 88th percentile for all months since 1990. The U.S. economy has been in a formal end-of-cycle recession as defined by the National Bureau for Economic Research for just over 9% of the time since 1990:

U.S. OIL producers have added drilling rigs at a rate of just over 4 per week since the start of the year, essentially the same rate since August 2020, but slower than during the previous recoveries after price slumps in 2015/16 and 2008/09:

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