Answering Your Oil & Energy Investor Questions
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Answering Your Oil & Energy Investor Questions

by | published September 20th, 2019

Today is a good day to take a breather from all the heavy topics, like the attacks on Saudi oil, analyzing investment moves arising from recently completed Persian Gulf meetings, or considering the next technical advances in energy efficiency.

Today is Friday, it’s nearly the weekend, and I think we’re all ready for something lighter. I know I am.

You have been sending in some excellent inquiries on all sorts of topics recently, and now seems like a good occasion to dip into the mailbag and answer some of your questions.

So, let’s get started…

Robert J. writes in and asks, “How do the recent refinery outages at Philly and Bay City impact your ‘index?'”

Robert’s mention of the “index” refers to my proprietary ECP (Effective Crude Price) system to calculate genuine market pricing levels. Actually, ECP is not really to do with what one pays at the pump when filling up or finds as the bottom line in a heating bill.

The ECP algorithms allow a determination of artificial pressures on crude oil prices. For example, the success of short plays on reducing the price from where market pressures would have set it otherwise.

When it comes to determining the state of refined product, crack spreads are decisive. These determine what percentage of a refinery run is devoted to which end product. Market makers also use crack spreads to trade crude oil futures contracts against equivalents for gasoline or low-sulfur heating oil (sitting also as a proxy for low-sulfur diesel since it is a distillate coming from the same refinery cut as heating oil).

It is here that an interruption in refinery capacity may have an impact. The time of year is also important. At this point, refineries have moved production from gasoline (summer) to heating oil (winter), a primary crack spread switch. When there is an interruption in expected production flow, therefore, the crack spreads can create spot shortages.

The other main factor is one arising only recently. U.S. refineries are now leading the world in the exports of finished product, that is, more gasoline, heating oil, and diesel moves out of the country than ever before.

As a result, any prolonged interruption in product flow from major refineries may well mean an emphasis on serving the domestic market first. This will avoid a local supply interruption but will reduce refinery profitability (since the exports move to foreign markets commanding higher prices).

Don’t be surprised if this also results in a higher consumer price as refineries attempt to recoup some of the lost export earnings. Unless the refinery outage is longer-term, this will tend to balance out.

William B. asks, “Please address the effect of the recent “tweetage” on the likelihood of Asian LNG sales to which we were so recently looking forward.”

Well, William, we continue to see the effect here of trade politics. The U.S. export of liquefied natural gas (LNG) to China had been widely regarded as the linchpin in a rapid advance of American exports to the expanding Asian market.

That has been called into question by the ongoing trade fight between Washington and Beijing. In this tariff battle, the U.S. imports more from China than China does from the U.S. The result allows more leverage for U.S. than for China.

Currently, China has applied a small tariff on U.S. crude, oil product, and LNG imports. The recent decision to delay full application of new increased tariffs by the U.S. has brought a temporary respite on the Chinese side as well.

Beijing is between a rock and hard place on this. The Chinese authorities need to finalize import contracts within the next several weeks or face huge price rises later should the winter be harsher than usual, and users need to move back into the spot market. That was the problem last year, resulting in some of the largest expense overruns in recent memory.

“Tweet politics” has probably cost U.S. LNG exporters sales now well into the spring, even if a breakthrough in trade negotiations occurs quickly. But this is shaping up as a reduction not an elimination of market penetration.

We are probably a year away from American LNG producers being able to offset Asian and European costumers. There is also the option opening for increasing LNG sale to South Korea, although this has been the main LNG consumer worldwide (along with Japan). That has resulted in a market that is pretty much saturated.

However, U.S. LNG is still a lucrative market. Fact is, U.S. LNG companies are smack in the middle of one of the biggest energy sectors there are, and as more facilities come online in the next few years, they’re very well-positioned. I’ve put together an entire briefing on just this subject, so click here if you’re interested.

B.B. sent along the following: “What percentage of the tariff money went to large corporation farmers?”

Good question. The issue here is the federal bailout money paid to domestic farmers for lost sales to China resulting from the reprisals to U.S. tariff impositions. Many smaller growers were also hit with another whammy. To receive the government aid, a crop had to be laid by a certain date. Unfortunately, heavy rain and flooding made that impossible in several Midwest areas.

Bottom line, estimates put the total sent along to large industrial farming enterprises at more than 60% of all funds paid out.

The Jolly Green Giant, apparently, has something else to “Ho, Ho, Ho” about.

Finally, Pete E. asks: “What do you think is the (percentage) probability of China attacking a U.S. warship within the next year, resulting in a very strong but limited U.S. counterattack? What about China invading Taiwan in the next five years? And if so, will U.S. declare war on China?

As I have noted on several occasions, the escalating situation in the South China Sea is a major crisis point that is likely to drag the U.S. and China into confrontation (I have a full briefing on the tensions in the region; just click here to read it).

To date, both sides have been exceptionally careful to avoid a direct clash of naval vessels. But as I have learned from personal experience in places throughout the world, putting military hardware too close to the other side in confined spaces carries the risks of unintended consequences and mistaken judgments.

Putting these highly contentious questions into percentages: (1) Chinese attack on a US naval vessel within the next year (10%); (2) limited American counterattack from a deliberate military strike (60%), less if the attack can be construed as a mistake; (3) China will not invade Taiwan unless it has concluded that the U.S. will stand down in response.

This last matter is very much an issue of deliberate American diplomatic posturing. There is no firm bilateral defense arrangement between Washington and Taipei. All of this is going to require a careful assessment by all sides. The absorption of Taiwan is a major objective of both mainland Chinese officials and public sentiment. Taipei knows that. So does Washington.

I will not give a likely percentage on this one. If Taiwan is attacked and the U.S. responds, this will be a full-blown war in which China has a decisive regional advantage. At that point, questions like the price of crude oil will be decidedly on the back burner.

At this juncture, all of this appears unlikely. Provided, of course, that each party understands the clear positions of others.

Sincerely,

Kent

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