Energy

<p><strong>After coming under pressure through August and early September, Brent crude prices have steadily crept back up towards the $75/barrel mark since mid-September. These levels were last seen at the end of July, just before the Delta variant led global Covid resurgence spooked the markets and pressured oil prices lower. </strong></p><p><strong>But the big question is, are the major economies hit by the Delta wave in recent months, prominent among them the US and China, firmly back on the recovery track? And related to that, is global oil demand recovery past its Q3 setback and poised to resume a rebound in the fourth quarter?</strong></p><p><strong>The International Energy Agency and OPEC appeared sanguine in their September monthly market outlook reports. The former stuck to its 2021 global oil demand forecast made last month, while the latter even upgraded it marginally.</strong></p><p><strong>The US Energy Information Administration made a modest downward revision to its outlook for 2021 global consumption, but was outweighed by the IEA and OPEC&rsquo;s optimism, which became a supportive element for crude.</strong></p><p><strong>The IEA and OPEC jacked up expectations for global oil demand in the fourth quarter of this year, but we would take that with a pinch of salt. We don&rsquo;t know to what extent data- and modelling-based forecasts are vulnerable to human emotions. But a pattern has emerged this year, of demand expectations being downgraded for the current period after they prove too optimistic, while carrying over the bright scenario into the approaching future, only for the cycle to be repeated, down the road.</strong></p><p><strong>We can see the argument for economic and oil demand recovery regaining momentum in Q4 on the basis that the Delta wave has receded, and vaccination rates continue to climb (with some developed economies even embarking on booster shots). But that picture misses crucial downside risks.</strong></p><p><strong>It doesn&rsquo;t take into account the very real danger of more debilitating variants emerging on the tails of the Delta, especially in the northern hemisphere winter flu season, just as the protection offered by the first round of vaccinations begins to fade.</strong></p><p>&nbsp;</p><p><strong>VACCINE BOOSTERS A TRICKY TURN IN THE ROAD</strong></p><p><strong>Pfizer told the US Food and Drug Administration this month that the efficacy of its Covid vaccine drops by 6% every two months after the second dose. Fellow pharma giant Moderna concurred, recommending booster shots to avoid &ldquo;breakthrough infections&rdquo;. The need for a booster shot puts the rich, highly vaccinated countries back at square one in the fight against Covid in a way, even as the poorer nations struggle to reach the first round of immunisation for their populations.</strong></p><p><strong>Second, we doubt that the reassurance injected into the financial markets by strong August retail sales and weaker inflation data reported in the US will sustain. Global economic recovery remains highly uneven and on a national level, one month&rsquo;s data is too flimsy to banish all worries over inflation and the tough juggling act awaiting central banks in tapering the flow of easy money.</strong></p><p><strong>Finally, one needs to avoid extrapolating from the current market mood and price levels, especially if they are under the influence of transitory factors.</strong></p><p>&nbsp;</p><p><strong>NOT ALL BULLISH PROPS WILL SUSTAIN</strong></p><p>Crude&rsquo;s gains around mid-September mainly rested on a troika of factors: Plunging US commercial oil stockpiles as the post-Ida upstream and downstream recovery remained slow, delayed crude loadings at Libyan terminals due to blockades by protestors, and data showing that OPEC+ fell far short of raising August output by 400,000 b/d over July, as pledged.</p><p>The disruptions caused at the Libyan ports of Es Sider, Ras Lanuf and Hariga had ended as of September 17. Trouble could erupt again, but the immediate threat of diminished or even severely curtailed Libyan supply has receded.</p><p>Restoration of oil production in the US Gulf of Mexico has been slow, as also the restart of the refining capacity in Louisiana shuttered by Ida, but the pace is now baked into crude prices.</p><p>With the US Gulf outages petering out over the coming weeks, the big draws across US crude and product stockpiles should also ebb. US crude and gasoline inventory levels are below the lower end of their five-year average ranges for this time of the year, while distillates are close to the bottom of the range. That would continue to support oil market sentiment, as would US oil consumption trends.</p><p>Demand in the world&rsquo;s biggest consuming nation is firmly on rebound trajectory, having proved mostly resilient to the Delta wave, and we expect it to remain so. Total fuel demand in the country on a four-week average was 21.13 million b/d as of last week, 99% of the corresponding 2019 levels. Gasoline use was at 99% and distillate at 101% of 2019 levels.</p><p><strong>OPEC+ FALLS SHORT BUT COULD CATCH UP TO NEW CEILING</strong></p><p>OPEC/non-OPEC production falling far short of the alliance&rsquo;s new ceiling in August was bullish at first blush but it would be wrong to assume it is par for the course.</p><p>The 19 OPEC and non-OPEC members bound by production quotas collectively pumped around 35.88 million b/d of crude in August, 860,000 b/d shy of their new ceiling.</p><p>The shortfall versus the agreed ceiling has increasingly widened since May.</p><p>The vast majority of OPEC members have been producing below their individual quotas in recent months, prominently&nbsp; including the relatively bigger ones, Iraq and Nigeria.</p><p>Iraq had over-produced its quota for most months until May this year. Nigeria had a tough time bringing its production down over May-July 2020, the first three months of the current output cut pact, but output has languished well below quota since.</p><p>Interestingly, even Saudi Arabia and Kuwait under-produced their quotas in August, according to figures from independent agency surveys published by OPEC. The two countries, along with their Arab neighbour UAE, have the capacity to ratchet output back to levels before the start of the production curb agreement in May 2020.</p><p>Meanwhile, it is now a well-accepted fact that the remaining mid- to small-sized producers in OPEC will struggle to squeeze out much more production in the coming months, despite getting higher limits under the alliance&rsquo;s tapering plan.</p><p>The same story is playing out across the non-OPEC bloc. Russia exceeded its quota by about 170,000 b/d in August but of the eight others in the group, Bahrain and South Sudan were close to their quotas, with the remaining six well below their limits.</p><p>OPEC+ forged an agreement to raise output by 400,000 b/d each month starting in August and going into next year on July 18, after a fortnight of wrangling over the UAE&rsquo;s demand for a higher baseline, which triggered an impasse.</p><p>The deal missed the window of the first 12 days or so of a month when the Middle Eastern producers typically allocate crude volumes for the following month to their buyers under long-term contracts. That could have been a reason the August volumes did not rise as expected under the new agreement.</p><p>Going forward, while there is every possibility that a majority of the small and mid-sized OPEC+ members may have lost the ability to sizeably raise output, perhaps even permanently, we expect the bigger ones with the capacity to ramp up, such as Russia, Saudi Arabia, Iraq, Kuwait and the UAE, to step in to fill the void.</p><p>How that gets sorted out from a quota-compliance perspective remains to be seen. The five producers already have an agreement within OPEC+ to raise output based on higher individual baselines from May 2022. That could be brought forward.</p><p>Alternatively, the Saudi-Russian leadership of OPEC+ could de-emphasise individual quota discipline, which would be manageable from an internal dynamics as well as a market optics perspective when the collective output is well within the agreed ceiling.</p><p>&nbsp;</p><p><strong>DEMAND VIEW: THEN AND NOW</strong></p><p>In its September short-term market outlook, the EIA downgraded global oil demand projections for the second through the fourth quarter of this year compared with its August report.</p><p>The IEA revised down its demand forecast for the second half, while OPEC did so only for Q4, and that too, marginally.</p><p>Even organisations with an army of analysts at their disposal are in uncharted territory with regard to predicting demand and the growing divergence between them is hardly surprising.</p><p>The latest consensus expectations are for global oil demand to reach (and slightly surpass) pre-Covid levels in the third quarter of 2022.</p><p>OPEC sees the milestone being reached through growth in the use of transportation fuels and Covid being brought under control in 2022.</p><p>The IEA expects the average global demand for LPG, ethane and naphtha to surpass 2019 levels as early as this year.</p><p>Deficits against pre-Covid levels will be wiped out in 2022 for residual fuel oil and narrowed for gasoline and gasoil, leaving the jet fuel behind with the slowest recovery, according to the Paris-based agency.</p><p>&nbsp;</p><p><strong>US DATA CHEER MAY BE PREMATURE</strong></p><p>US retail sales rose 0.7% from a month ago in August, in contrast to a 1.8% slump in July, encouraging the view that the Delta wave did not dent its economic recovery.</p><p>Annual consumer price inflation cooled down &mdash; albeit marginally &mdash; to 5.3% in August from a rate of 5.4% in July. But it may be premature to conclude that inflationary pressures in the US have levelled off.</p><p>Container freight rates from east Asia to the US have been on a tear and are not expected to cool down any time soon. Meanwhile, soaring natural gas prices because of a severe shortage building up just ahead of the northern hemisphere peak winter demand season in Europe could ripple over to the US too.</p><p>The August retail sales pick-up may not signal the start of another spending surge. Americans shifted from spending on goods to services through the summer reopening but continued momentum hinges on the absence of fresh Covid waves.</p><p>On the other side of the globe, retail sales in China rose by an anaemic 2.5% on-year in August, versus an 8.5% jump in July. Industrial production, which takes into account manufacturing, mining and utilities, cooled off to a 5.3% on-year rise in August from 6.4% in July. The deceleration in Chinese economic activity is not in doubt.</p><p>&nbsp;</p><p><strong>BEIJING HOLDS A NEW WILD CARD</strong></p><p>China&rsquo;s National Food and Strategic Reserves Administration said it will auction the maiden batch of crude from state reserves, amounting to 7.38 million barrels, on September 24.</p><p>The barrels will come from tanks in the northeastern Liaoning province and will include the sour grades Qatar Marine, Oman, Murban and Upper Zakum and the sweet North Sea crude Forties.</p><p>The news failed to sway crude prices, probably because the volume is less than three-quarters of a single day&rsquo;s crude imports by China in a good month.</p><p>But the significance of China&rsquo;s new strategy can hardly be overstated. It is not known what price levels or domestic inflation rates may trigger future releases, but this is a new bearish surprise that Beijing can spring upon the market at short notice.</p><p>In short, in the hundreds of millions of barrels of state and commercial reserves at its disposal, Beijing has a powerful tool to cool down overheated crude prices, at least over a short period, and clearly intends to use it. Those calling for $80 crude may want to pay heed to this new wild card in the oil market.</p><p>&nbsp;</p>