It is more likely that oil prices will fall below $50 per barrel than that they will continue to rise towards $70. Prices have increased beyond supply and demand fundamentals because of premature expectations about the effects of an Opec production cut on oil inventories.
Last week’s 13.8 million barrel addition to US storage was the second largest in history. It moved US crude oil inventories to new record high levels. Meanwhile, 130 horizontal rigs have been added to tight oil drilling since the Opec cut was first announced in September. That means that US output will surge and will continue to be a drag on higher prices.
Comparative inventory analysis suggests that the current $53 per barrel WTI oil price is at least $6 per barrel too high. Don’t hold your breath for $70 oil prices.
Most analysts believe prices will increase steadily now that Opec has decided to cut production. Their logic is that over-production caused lower oil prices and lower output should bring markets into production-consumption balance.
The problem is that production is not the same as supply and consumption is not the same as demand. Inventories lie in-between and modulate the flows from both sides of the production-consumption equation.
Inventory is clearly part of supply but is also a component of demand. Excess production goes into inventory when demand is less than supply. When consumption exceeds production, oil is withdrawn from inventory reflecting increased demand.
The International Energy Agency (IEA) reported last week that global liquids markets would move to a supply deficit by the first quarter of 2017 if Opec production cuts take place as announced.
Yet the OECD inventories on which IEA’s forecast is based have increased and are now more than 400 million barrels above the 5-year average.
In order for a supply deficit to develop in the first quarter of 2017, those stocks would have to be drastically reduced over the next 6 weeks. Comparative inventory analysis provides some context for the necessary magnitude of that reduction.
Comparative inventories index current storage levels against a moving average of values for the same calendar date over the previous 5 years. This provides the most reliable way of understanding oil-price trends by normalizing stock changes for seasonal variations and comparing them with 5-year average values.
Current OECD comparative inventories (CI) are at an all-time high level of more than 300 million barrels (absolute inventories are 3.1 billion barrels). CI values around zero (+/- about 50 mmb) correspond to periods of high oil prices (>$80 per barrel) over the past decade. That suggests that comparative inventories need to fall approximately 200 to 300 million barrels to support $70 to $80 per barrel oil prices.
What IEA is apparently showing as a “demand/supply balance” is really a demand/production balance.
If Opec cuts move forward as announced, consumption will exceed production in the first two quarters of 2017 and withdrawals from storage will occur. That is a legitimate demand increase.
[Arthur Berman – OilPro.com]