The apparent cause was a larger-than-expected 8.2 million-barrel (mmb) addition to U.S. crude oil inventories.
Based on history, we can see that this was an over-reaction. WTI has fallen below the $50 to $55 per barrel range in which oil futures have traded for the last 3 months (Figure 1).
Figure 1. Oil prices have not exceeded $55 per barrel since early 2015. Source: EIA, CBOE and Labyrinth Consulting Services, Inc.
An 8.2 mmb addition to crude oil storage is actually fairly normal during the annual re-stocking season that we are in now (Figure 2). Inventories increased 10.4 mmb during this week in 2016 and the 5-year average for this date is 5.3 mmb.
An 8.2 million barrel addition is fairly normal for re-stocking season. Source: EIA and Labyrinth Consulting Services, Inc.
The fact that inventories have been in record territory since the beginning of 2015 has not kept oil futures from going through several rallies or from trading near $55 per barrel since November. The 13.8 mmb addition to storage a month ago was larger than yesterday’s amount yet prices barely responded.
Comparative inventory–the crucial price indicator-only moved up 2.4 mmb (Figure 3). That is because we are in the re-stocking season and compared with previous years, this addition to storage is not that big. Other key measures of gasoline and diesel volumes fell by more than 1 mmb each.
Figure 3. Comparative crude oil plus refined products inventory increased only +2.4 mmb. Source: EIA and Labyrinth Consulting Services, Inc.
And there was some very good news this week that the markets ignored. EIA’s Short-Term Energy Outlook (STEO) showed that the global market balance (production minus consumption) moved to a deficit last month. The world consumed almost a million barrels more than it produced in February (Figure 4).
Figure 4. The world liquids market balance (production minus consumption) was -1 mmb/d in February 2017. Source: EIA March 2017 STEO and Labyrinth Consulting Services, Inc.
This is a one-month data point and should not be seen as a trend. Still, it is a positive sign that seems to have been overwhelmed by an otherwise normal addition to U.S. storage.
The March STEO also had good news about world demand. The average liquids consumption growth for 2016 was 1.5 mmb/d and 1.6 mmb/d for the first two months of 2017 (Figure 5).
Figure 5. 2016 global liquids consumption growth: +1.5 mmb/d, early 2017: +1.6 mmb/d. Source: EIA March 2015 STEO and Labyrinth Consulting Services, Inc.
In mid-2016, there were indications that consumption was only growing at only about 1.2 mmb/d but particularly strong year-over-year performance from August through January have brightened that outlook.
Although yesterday’s price plunge may have been an over-reaction, it may also represent a turning point for prices to adjust downward.
I have written for months that global oil inventories must fall before prices can make a sustainable recovery, yet they remain near record levels. OECD inventories fell 15 mmb in February but are nearly 550 million barrels above December 2013 levels (Figure 6).
Figure 6. OECD incremental liquids inventories are near record high levels. Source: EIA and Labyrinth Consulting Services, Inc.
Brent was probably $10 over-valued at $55 and WTI was at least $6 over-valued at $54 per barrel as Figure 1 shows.
The other negative weighing on oil prices is the increase in U.S. crude oil production. Output has increased 420,000 b/d since September and EIA forecasts that it will exceed 10 mmb/d by December 2018 (Figure 7). That is higher than 1970 peak production and 1.1 mmb/d more than current levels. In short, this would more than cancel the U.S. decline since oil prices collapsed in late 2014.
Figure 7. EIA U.S. crude oil forecast is 10.1 mmb/d and $59 WTI by December 2018. Source: EIA March 2017 STEO and Labyrinth Consulting Services, Inc.
Over-Reaction or Turning Point?
This week’s price downturn reflects waning confidence that OPEC production cuts will result in higher prices. Much of the discussion until now has centered on whether OPEC will deliver on the announced cuts or if output increases by Libya and Nigeria will offset those cuts.
There seems to be a growing awareness that global oil markets are incredibly complex, and that there are so many moving parts that a single, simple solution is unlikely.
The problem may be about expectations. Many believe that the OPEC cuts will increase prices but the cuts may be more about establishing a floor under those prices.
There is no good reason why a normal addition to U.S. inventory should affect prices so much. The timing of this price adjustment may be an over-reaction but the direction may also represent a turning point.
The larger issue is the inexorable relationship between stocks and prices. It’s not so much about this week’s change in inventory. It’s about how much inventory needs to be reduced and how long that will take in the most hopeful scenario.
If OECD stocks must fall by approximately 550 million barrels to support $70 prices, it will take more than a year to get there if production is cut by 1 mmb/d. If the production-consumption balance fluctuates, it will take even longer.
For more than two years, the industry has believed that higher prices are possible without extreme reductions in stocks. That is a dream. Perhaps markets have woken up from that dream.
The United States Oil Fund LP ETF (NYSE:USO) fell $0.01 (-0.09%) in premarket trading Friday. Year-to-date, USO has declined -10.15%, versus a +5.96% rise in the benchmark S&P 500 index during the same period.
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