Oil – If Demand Drops, Exports Drop

Welcome to the export edition of Oil Markets Daily!

People keep thinking about the oil market in a vacuum. They are imaging the global oil trade like a faucet to a bucket.

Oil produced – oil consumption = delta

But what’s not being said is about the function of the oil market and how oil is traded and flowed across the world.

If a refinery is cutting throughput, then the demand for crude drops. There’s a reason why you see a seasonality pattern in global exports during maintenance-heavy months and high throughput months. OPEC’s exports in the month of April, May, and June (if the price war persists) will be a battle of market share for a shrinking pie.

If the Saudis are cutting OSP by $10 to $12/bbl on Brent, other producers can either match it or be left completely behind. This is the reason why we published our flagship weekly report on Sunday titled, “Global Production Shut-In Is Needed To Fight The Coronavirus, Not OPEC+.

Now let’s take Brent at today’s price for example:

  • Brent is $27/bbl
  • Saudi OSP cut implies a price of $15 to $17
  • Nigeria announces a cut of $6/bbl to pricing. This equates to a discount from $30 previously to $24/bbl. Nigeria still can’t compete against Saudi crude.

Nigeria will have to keep cutting its pricing until it eventually matches the Saudi discount. If it doesn’t, then it won’t be able to sell any of its crude resulting in a shut-in. But at what price point does Nigeria stop competing with Saudi crude?

Simple, the cost of producing each barrel.

Nigeria – $28.99/bbl

Source: Rystad Energy

Now if you exclude the capital spending of $13.10 (large implications for future reserves if this capital is not spent, but we will cover that another day), Nigeria’s cash cost breakeven is $15.89/bbl.

Any price below $15.89/bbl means that it will be cash margin negative to produce every barrel of crude. Nigeria would not want to go into a price war below that price.

The problem, however, is that the mechanism of the Saudi OSP cut combined with a shrinking demand pie inevitably forces high-cost producers like Nigeria to cut prices down to the levels offered by the Saudis, and if it can’t, then there won’t be any buyers for the crude.

This is why we keep focusing on the idea of demand displacement. If refinery X has the option to buy Saudi crude but only intends to run 3 million bbls in May, for example, then it will buy only Saudi crude. And given gasoline cracks are negative for global refineries, the incentive to stockpile crude goes down the drain.

Instead, what we think will happen is that refined product storage is more likely to hit tank top in certain regions where demand has drastically fallen. And in that scenario, the refineries in that region will reduce throughput to match the decrease in demand, which in turn impacts how much crude it will buy in the months to follow. This is the real residual effect, so the crude impact will be felt on the producer end at the well head via discounted prices. And if prices fall too low, those barrels will never make it into an export.

Finally, the last analogy we will give is to take Canada for example. Oilsand production cost including condensate puts pricing at negative now. This means oilsand producers are operating at not just negative cash margins, but negative barrel realized pricing. The producers are then doing the analysis of how much it costs to shut down production versus eating the losses. Once the cost of production exceeds the cost of the restart, Canadian oilsand production will be shut-in. Watch for Canada wide announcement of shut-ins to take place in April.

We are now entering one of the craziest periods in the energy sector. Valuations have gotten so out of hand that we believe this is the final washout. We are now offering a 2-week free trial and if you wish to read our WCTWs this week, please see here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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