Targeting Upstream Flows

Last week two large oil producers decided to extend previously announced — and largely implemented — production cuts. Motivations for the cuts are varied. But pushing higher per unit prices for what is produced is one shared goal.

This goal has been achieved, see chart below. An April decision by OPEC-plus countries to reduce production had rather limited price impacts, even once Saudi flows substantially slowed in early July. Constrained global demand and robust non-OPEC flows softened the market reaction.

But last week’s extended production cuts coincided with accumulating signals of improved global demand (more and more) for fossil fuels… and some reduced US capacity for both production and refining. The demand component in pricing was super-charged by this week’s release of China’s August refinery data. According to Reuters, “China’s oil refinery throughput in August rose to a record, data showed on Friday, as processors in the world’s second-largest crude consumer kept run rates high to meet summer travel demand and capitalise on strengthening export margins. Total refinery throughput was a record 64.69 million metric tons last month, data from the National Bureau of Statistics (NBS) showed, up 19.6% from a year ago, the fastest annual growth since March 2021… Additionally, refiners have been incentivised by additional government fuel export quotas to maintain higher runs to ship fuel overseas and cash-in on stronger profit margins from processing crude amid tighter regional supplies of diesel fuel.”

The persistence of August demand in China and elsewhere is uncertain. But movement either way will significantly impact future prices… especially if supply continues to be intentionally constrained.

On September 12 the US Department of Energy released the following:

We forecast global liquid fuels production will increase by 1.2 million b/d in 2023 despite recent voluntary decreases in production from OPEC+. Global production in our forecast increases by 1.7 million b/d in 2024. Non-OPEC production is the main driver of global production growth in our forecast, increasing by 2.0 million b/d in 2023 and 1.3 million b/d in 2024, led by the United States, Brazil, Canada, and Guyana. We expect Russia’s production will decline by 0.3 million b/d on average this year and remain relatively unchanged in 2024. We forecast that OPEC crude oil production will fall by 0.8 million b/d in 2023 and increase by 0.4 million b/d in 2024.

For some time Russia’s oil production capacity has been expected to decline. This century Venezuela’s operating capacity has fallen significantly. But this is not — yet — the case for most other major oil producers. The last decade’s recovery of US operating capacity also demonstrates how technological advances and other shifts can transform capacity. It is meaningful to differentiate upstream source capacity from upstream extraction capacity from upstream processing capacity from upstream storage capacity from upstream distribution capacity.

Reduced OPEC-plus production does not reduce upstream capacity. Rather this is a policy-constraint imposed to obstruct available operating capacity. The argument can be made that this is active “demand management” which supports more sustainable capacity. This is not an argument likely to be offered by price-sensitive consumers. For these consumers the intentionally reduced supply is an artificial chokepoint in flows. (More)

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