20/4/20: Oil

The madness of Oil (see an explainer below):

As I said a few minutes back: at this rate, within a couple of days, it will make sense to start re-injecting the stuff back into the wells, as opposed to storing it.

An explainer:

Quite a number of folks - including journalists - have confused the above data and the 'reported' price of oil today for the actual price of oil. It is not as simple as that. Actual price of oil did not fall below zero, though for some grades it has been below zero before and is still staying there now. So what all of this really means?

Q1: Is price of oil below zero? The answer is "it depends on what price of oil one takes". Let me explain.

First, there are several major grades of oil. The two most popular are:

• Brent North Sea Crude (commonly known as Brent Crude). Brent originates in Brent oil fields and other sites in the North Sea. Brent is a benchmark price for African, European, and Middle Eastern crude oil producers, covering, roughly two-thirds of the world's crude oil production.
• West Texas Intermediate (commonly known as WTI) and this is a benchmark oil for North America.
• Urals grade oil is Russian oil
• Fateh grade oil or Dubai Fateh is the most important crude oil benchmark for Asia
• Iran Heavy and Iran Light are benchmarks for Iranian oil.

The percentage of sulfur in crude oil varies across the grades and fields of extraction, and this percentage basically determines the amount of processing required to refine oil into energy products. "Sweet crude" is a term that refers to crude oil that has less than 1% sulfur: Brent at 0.37% and WTI at 0.24%. And both Brent and WTI are "sweet". So, "sweet" oils carry a market premium, as refineries can process these at lower cost. 

Fateh sulphur content is around 2%, Urals at 1.35%, and other grades are described here: https://en.wikipedia.org/wiki/List_of_crude_oil_products. Higher sulphur content oil trades at a discount on WTI - or used to, roughly, prior to 2008 GFC. Since GFC, U.S. supply of WTI oil has been growing more robustly than Brent supply, so the relationship reversed (see chart below).

Now, notice the above table also shows "Port of Sale". This is an important feature of trading and pricing of oil and it matters in today's oil price determination too. Bear with me.

So, let's focus on WTI and Brent. 

• Brent is traded at a discount on WTI because it is harder to process
• WTI is traded in the futures markets - with contracts signed and priced today for future delivery. The NYMEX (New York Mercantile Exchange) division of the CME (Chicago Mercantile Exchange) trades futures contracts of WTI. Physical delivery for WTI futures occurs in Cushing, Oklahoma. Futures are contracts that must be delivered in physical delivery if held to maturity. In other words, futures are NOT options. Options can be left to expire and the bearer does not have to take a delivery of the commodity on which the option is written. With futures, if you bough June 2020 delivery of oil contract for 1,000 barrels at, say $22, and you hold it to expiration (at the end of May 2020), you will have to take physical delivery of 1,000 barrels of oil in Cushing, OK, no matter what. 
• Brent crude oil futures trade on the Intercontinental Exchange (ICE), and are traded with delivery internationally. In other words, Brent futures contracts are deliverable to specific country, not to one location globally, as is the case with WTI.

So, now, what happens if your hold a contract for oil, deliverable in May 2020, at 8:00 am EST today? You have two actions you can take. Today happens to be the day when May 2020 contracts mature for WTI. You can: (1) let contract mature and take delivery of oil in Cushing, OK in May, paying the price of the contract - say $22 per barrel. Or (2) you can sell the contract today, before it matures, to someone else who will then face a choice of (1) or (2) herself. 

If you opt for (1), you will need somewhere to store 1,000 barrels and a transport from Cushing, OK to wherever that storage facility is. Both cost money. And, worse, the former is not available, since we are experiencing a glut of oil. You can pay to store your oil on board transport - e.g. on board a tanker sitting in the Gulf of Mexico, or on-board railroad cars. This is hellishly expensive, even if you own the said tanker or railroad cars. So you will not do this. Worse, yet, there is so much crude out there in storage already, that short-of-demand refineries are not buying oil today. Which means you will be paying high costs of storing this stuff for weeks to come.

If you opt for (2), you need a buyer of the contract that can do (1). And these are not available, because everyone is short storage and everyone is facing a market with no buyers for this stuff for weeks. 

So you dump your May futures contracts at a negative price just to get rid of the obligation to take physical delivery of oil in May. And this is exactly what happened today with May futures (charts above) for WTI.

Now, the same did not happen today in the Brent markets. Why? Because Brent, as noted above, is deliverable across a number of countries, not just Cushing, OK. Which means you can shift location of delivery to find a more-likely-available storage facility for it, or a more-ready-to-buy refinery. In chart 2 above, top red line did not fall as much today - these are Brent futures for May contracts.

Here is the spot price of oil for Brent and WTI:

And here it is over the last year:

Today's prices are not in the chart. So here they are:

Observe negative prices on some lower quality (high sulphur - ugly) stuff in the above. These are down to the lack of refineries willing to take low quality crude when there is a glut of higher quality key stuff available. And note that Brent is nowhere near $0 today. 

Blend of WTI and Brent is another way to look at oil prices. And here is a table from the CME showing different month contracts for the blend:

Yes, may delivery is ugly. June and on, however, is well above $20 per barrel. 

15/4/16: Of Breakeven Price of Oil: Russia v ROW

There has been much confusion in recent months as to the 'break-even' price of oil for Russian and other producers. In particular, some analysts have, in the past, claimed that Russian production is bust at oil prices below USD40pb, USD30pb and so on.

This ignores the effects of Ruble valuations on oil production costs. Devalued Ruble results in lower U.S. Dollar break-even pricing of oil production for Russian producers.

It also ignores the capital cost of production (which is not only denominated in Rubles, with exception of smaller share of Dollar and Euro-denominated debt, but is also partially offset by the cross-holdings of Russian corporate debt by affiliated banks and investment funds). It generally ignores capital structuring of various producers, including the values of tax shields and leverage ratios involved.

Third factor driving oil break-even price for Russian (and other) producers is ability to switch some of production across the fields, pursuing lower cost, less mature fields where extraction costs might be lower. This is independent of type of field referenced (conventional vs unconventional oils).

Russian Energy Ministry recently stated that Russian oil production break-even price of Brent for Russian producers is around USD 2 pb, which reflects (more likely than not) top quality fields for conventional oil. Russian shale reserves break-even at USD20 pb. In contrast, Rosneft estimates break-even at USD2.7 pb (February 2016 estimate) down from USD4.0 pb (September 2015 estimate).

Here is a chart mapping international comparatives in terms of break-even prices that more closely resembles the above statements:

Here is another chart (from November 2015) showing more crude averaging, with breakdown between notional capital costs (not separating capital costs that are soft leverage - cross-owned - from hard leverage - carrying hard claims on EBIT):

Another point of contention with the above figures is that they use Brent grade pricing as a benchmark, whereby Russian oil is priced at Urals grade, while U.S. prices oil at WTI (see here: http://oilprice.com/Energy/Crude-Oil/Will-Russian-Urals-Overtake-Brent-As-The-Worlds-Oil-Benchmark.html). All three benchmarks are moving targets relative to each other, but adjusting for two factors:

• Historical Brent-Urals spread at around 3.5-4 USD pb and
• Ongoing increase in Urals-like supply of Iranian oil

we can relatively safely say that Russian break-even production point is probably closer to USD7.5-10 pb Brent benchmark than to USD20pb or USD30pb.

Another interesting aspect of the charts above is related to the first chart, which shows clearly that Russian state extracts more in revenues, relative to production costs, from each barrel of oil than the U.S. unconventional oil rate of revenue extraction. Now, you might think that higher burden of taxation (extraction) is bad, except, of course, when it comes to the economic effects of the curse of oil. In normal economic setting, a country producing natural resources should aim to capture more of natural resources revenues into reserve funds to reduce its economic concentration on the extractive sectors. So Russia appears to be doing this. Which, assuming (a tall assumption, of course) Russia can increase efficiency of its fiscal spending, means that Russia can more effectively divert oil-related cash flows toward internal investment and development.

During the boom years, it failed to do so (see here: http://trueeconomics.blogspot.com/2016/02/10216-was-resource-boom-boom-for.html) although it was not unique amongst oil producers in its failure. 

Note: WSJ just published some figures on the same topic, which largely align with my analysis above: http://graphics.wsj.com/oil-barrel-breakdown/?mod=e2tw.

Update: Bloomberg summarises impact of low oil prices on U.S. banks' balancesheets: http://www.bloomberg.com/news/articles/2016-04-15/wall-street-s-oil-crash-a-story-told-in-charts.

Update 2: Meanwhile, Daily Reckoning posted this handy chart showing the futility of forecasting oil prices with 'expert' models

6/1/16: It's Christmas Eve... and Ruble is Getting Socks...

Anyone wondering about Ruble's next move from here:

 Source: @Schuldensuehner 

should take a look at the third chart here: http://trueeconomics.blogspot.ie/2015/12/301215-2016-better-be-kinder-to-old.html.

As oil stays around USD35 mark, the duration of slump will be weighing on Ruble, with oil/USDRUB spread compressing on re-valuations of the Russian budget and fiscal position. Current spread appears moderately optimistic to me...

As an aside, c Рождеством!

30/12/15: 2016 Better Be Kinder to the Old Ruble... or...

The never-before mighty Ruble started the last day of 2015 trading on a shaky ground:

And it ended the year on a shaky ground:

And for all the pain, there is little gain. As oil tanks, Ruble will keep sinking. Per recent report from Bloomberg (emphasis mine):

"The currency would need to tumble more than 20 percent to at least 90 against the dollar to tip the
country into a full-blown crisis, according to 17 of 20 respondents in a Bloomberg survey. Should such a threat emerge, the Bank of Russia has an array of tools at its disposal, including verbal and market interventions, an emergency interest rate increase and capital controls, they said. “It would take more than 90 rubles per dollar to provoke significant repercussions,” said Sergey Narkevich, an analyst at Promsvyazbank PJSC in Moscow. “In 2015, Russian monetary authorities managed to mostly avoid spillovers from the foreign currency market and keep the financial system afloat and broadly functional.”

Except, here's a problem, per BAML:

Source: Bloomberg

Now, connect the dots... At above 90, we will have 'significant repercussions' and oil is already at around 37. What is more, all of the above references Brent prices. But Urals-Brent spread has been pretty awfully 'unfair' to Russian energy suppliers, and with the glut of eager and ready substitutes producers in the markets, the spread is unlikely to improve. Which means that 'above 90' can be 91 or it can be 95 or it can be 88... go figure.

Then again, may be, by some miracle, the New Year will be a happy one for the Ruble.

Update: Russia is hardly unique in linking currency valuations to budgetary / exchequer balances, as argued in this post - all commodities-dependent economies do that. And there is, of course, that added dimension of recessionary pressures, as shown in the chart below (taken from Bloomberg article covering Chinese growth woes):

20/12/15: Of those Russian GDP 2016 forecasts

In my recent column for Slon.ru (see: http://trueeconomics.blogspot.ie/2015/12/151215-russian-outlook-for-2016-slon.html) I quipped that in the case of the Russian economy, forecasts for 2016 growth rates might just as well be taken from the fortune tellers, as there are too many moving factors driving the economy, all of which are virtually impossible to forecast.

Now, h/t to @JoMichell, we have a picture of 'predictability' of one key driver of the Russian economy - oil prices. Please, keep in mind: these are Brent prices (Urals grade predictability is even lower, as Urals-Brent spread is subject to further uncertainty, including geopolitical risks and substitution risks, as discussed in my Slon.ru column).

So here is a chart showing IMF forecasts for Brent prices issued back in June 2015:

 Note that in the above, least probable downside scenario is for oil above USD40 per barrel through 2015. Alas, the least probable forecast is not exactly the lower bound for reality:

So here we have it: less than 6 months forecast out, and the least probable worst case scenario has been breached already. Good luck pinning Russian GDP forecasts down...

17/12/15: Re-aligning Ruble with Oil: Fed Hiccup...

Two casualties of the Fed's rate jitter: Oil & Ruble

Source: @Schuldensuehner 

Ruble is now nearing August 2015 lows on a continued trend that realigned with oil prices.

And while we are at it, another pairing:

Source: @Schuldensuehner 

Note: as of yesterday's closing Russian CDS 5 year spread was at 308.91 with implied probability of default of 19.15%. A week ago, same stood at 291.64 with implied probability of default at 18.26% and at the end of Tuesday, at 305.91 with implied probability of default at 18.99%.

But as a reminder, watch not only Brent, but also Urals-Brent spread. Hawkish dove of the Fed has less to say on that than Russian energy substitution ongoing in Europe and Turkey via Saudi's and Iranian contracts.

15/6/15: Long Run Oil Price Chart

Quite a wonkishly fascinating chart (I love long time series, even if much of them are imaginary numbers): via http://uk.businessinsider.com/oil-is-cheaper-than-it-was-in-the-1860s-2015-6?r=US we have oil prices from 1860s on, though, sadly, not updated to most current, which is just around 1970s decade average.

Draw conclusions at your own peril. I chance to say: post 1900 price trend is all steady, until Governments mess up (the 1970s crisis - Governments-led, the 2000s lift-off - also Governments-led). So here you have it... boring commodity that is occasionally over-politicised into a bizarre beast.

12/1/2015: Falling... falling... still... falling: Oil Prices in Time

With WTI just flying past USD45.99/bbl price marker and Brent fell through USD47.47, here's the best visualisation of the 'Plight of Oil' (courtesy of @EdConwaySky):

Note: Above is Brent, but, hey... anyone cares at that stage?..

And here's one in a more historical perspective (courtesy of @Convertbond):

Note: Above is through December 2014. Which means that by now, we are down at the levels of October1990-April 1991 crisis and heading further South.

And in case you are keen on celebrating the above as a definitive Western victory over the Bad Russkies, as Reuters is reporting - Standard Chartered might need to raise USD4.4 billion in capital to cover losses due to commodities-related loans exposures (link). 

11/1/2015: Ending 2014 with a Bang: Russian Inflation & Ruble Crisis

Couple footnotes to 2014, covering Russian economic situation. Much is already known, but worth repeating and tallying up for the full year stats.

Ruble crisis with its most recent up and down swings took its toll on both currency valuations and inflation. Over 2014, based on the rate tracked by the Central Bank of Russia, the ruble was down 34% against the euro and 42% against the USD. The gap reflects depreciation of the euro against the USD.

Virtually all of this relates to one core driver: oil prices. In 2014, Brent prices lost 48% of their values and Urals grade lost 52% of its value. Urals is generally slightly cheaper than Brent, but current gap suggest relatively oversold Urals. It is a bit of a 'miracle' of sorts that Ruble failed to completely trace Urals down, but overall, you can see the effect oil price has - overriding all other considerations, including capital flight and sanctions.

Ruble valuations took their toll on Moscow Stock Exchange - RTS index, expressed in USD, lost 43% of its value, reaching levels comparable to Q1 2009 (791 at the end of 2014, from 1,388 at the start of January 2014).

And ruble crisis pushed inflation well ahead of 5% short term target from CBR set for 2014. Preliminary estimates for December put inflation at 11.4%, with food inflation at 15% (7.3% in 2013), goods (ex-food) at 8% (4.5% in 2013) and services at 10% (8% in 2013). M/m inflation hit 2.6% in December 2014 - the highest since January 2005). Overall inflation was 6.5% in 2013, 6.6% in 2012, 6.1% in 2011 and 2010 and 8.8% in 2009. Last time Russian inflation hit double digit figures was in 2008 - at 13.3%.

Comment via BOFIT: "The pick-up in inflation at the end of the year reflected the ruble’s sharp depreciation and the ensuing frenzy of household spending. Following the ban on certain categories of food imports last autumn, food prices have risen even if no food shortage has actually emerged." Most of this is pretty much as reported. One point worth highlighting - lack of shortages, which is contrary to some of the hype paraded in the media about Russians suffering greatly from diminished supplies and stores running out of goods.

Again per BOFIT: "Representatives of food producers and retail chains committed in September to a government initiative that their members would not raise prices without good reason or create artificial shortages in the market. There has been no move by the government as yet to impose price controls as in 2010. The agreement could have limited price increases somewhat."

And a chart from the same source illustrating pick up in inflation:

Update: Some more numbers on inflation: Meat prices were up 20.1% in 2014, having posted deflation of 3% in 2013; fish prices were up 19.1% in 2014, a big jump on 7.6% inflation in 2013. Cereals are up 34.6% against 3.2% in 2013.