When discussing supply and demand, it is often more important to figure out whether the person doing the analysis is looking at the oil market, or balancing their own opinion to fit the market. This problem is exacerbated by the small size of the industry. Don’t get me wrong, it is quite large, but it has relatively few participants. If I asked you to name true oil trading houses, you’d be hard pressed to get to a dozen. So if you are an analyst, and you need to find customers, you may often be tempted to resort to sensationalism. I have lost count of how many times OPEC has been pronounced dead, oil has run out, or alternative fuels were supposed to take its place. It is important at to one’s cool and look at things objectively. Things are improving, but don’t go making one way bets to US$ 100 just yet.
First I should tell you the bad news… Thankfully, there is no real “News” there… The market is still oversupplied, and we still have the same old issues looming over the horizon. Libya is creeping back into production, and everyone is waiting for Iran to start exporting at full speed. The Obama administration seems to be on course to push through the Iran deal, and we should soon see the result in the market. Meanwhile OPEC is continuing to produce as much as it can, although we think it appears to have reached capacity. There are also signs OPEC intends to stick to its strategy of putting market share above price. Venezuela’s president Maduro recently attempted to convince other nations to help him with low prices… From Russia to Qatar he was rebuffed. Saudi Arabia is cutting down its state budget in a sure sign it intends to fight to the bitter end. Mexico doing the same is a sure sign it believes the Saudis mean business. Both believe relief isn’t around the corner.
OPEC is motivated by their strategy starting to work. Not only have most oil majors confirmed they would be reducing investments, it has also been estimated that capital outflows in the Shale Oil industry have passed the US$ 30 billion mark. US production is continuing to decline and is now around 9.1 million barrels from a 9.6 million barrel high. It is important to note, however, that we have only returned to the levels of December 2014, so we still have quite a long way to go. Add to that worries about North Sea oil, you can see the situation beginning to change.
Now it is important to take a deep breath and remember what I wrote earlier. Do not succumb to sensationalism. I am not saying the surplus has disappeared and that you should prepare for a stampede upwards. To steal a line from Winston Churchill, this is not the beginning of the end of oversupply, but rather the end of the beginning. We now need a few months of low prices to drive home the point and bring US production closer to 8 million barrels a day. Provided Iran and Libya do not outdo themselves in terms of exports, we should see prices improve sustainably by the second half of 2016. (I mean of course that we would be on a sustainable uptrend and not a temporary dead cat bounce like earlier this year which only served to delay the inevitable).
It is important not to ignore the effects of demand on our little analysis. Although things are not as good as they should be, they have not worsened. Demand has increased, but considering prices have almost halved, you may have been justified in expecting more than the 3 to 6% increase reported across the OECD. This is because demand for oil is relatively inelastic. If you drive to the office every morning, you will usually continue to do so even if prices rise by 50%. Similarly, if prices drop by 50%, you will not start driving to the office twice every morning, or take the longer route just to consume more gasoline. Again, it will take time for the decrease to have a wider effect.
In the short term, we continue to believe things will appear gloomy, and everyone will continue to lower their price predictions. The driving season officially ended with the Labour Day week-end, and the hurricane season is about to be renamed the “Slightly Windy Season”. To make matters worse, the maintenance season is upon us, and we should soon see regular crude oil stock builds. By this stage I hope I have used the word season often enough to remind everybody that oil is a seasonal business. It is a cycle, and we are about to enter one of the low periods. Be very careful if you think this is the time to be long, because we think you will be wrong!
The good thing for people like me is that volatility is alive and well, and married to the price of oil. Recent massive price moves have played havoc with those who are purely directional, but have helped those who understand oil is mostly about relative values.
The firs “post summer” EIA report was disappointing for the bulls, as continued refinery upsets have led to a new increase in stocks of 2.57 million barrels. This likely to be the first of many more increases to come, and could even be one of the smallest. If refining maintenance reaches 1 million barrels a day, things could get crowded in a hurry. We think that oil prices are making a valiant stand in the 40’s, but they will go test the 2008 lows at US$ 32.20 for WTI and US$ 36.40 for Brent. If they hover there for a few weeks, it will surely force many non-state producers to cut production or go bankrupt. November Brent-WTI has crept down close to US$ 3 per barrel, but we think it may soon reverse as US stocks increase. We would buy this if it reaches US$ 3. We are also sellers of Nov-Dec WTI which is now up to US$ 0.60 in contango. We think it will head back to at least US$ 1 per barrel. Brent spreads are still in no man’s land and we will leave them be for now.
Distillate stock building for winter is continuing with a 952,000 barrel increase this week. Demand is still down, but the maintenance period should reduce the pace of builds. The margin has declined US$ 1.5 per barrel, to US$ 20, but we are still wary of selling this right before refineries shut down.
Gasoline stocks have added 384,000 barrels right before Labour Day week-end which is indicative of ample supplies. Here too the margin has declined US$ 1.5 to US$ 12.5, and the 2015 summer gasoline season will go down in history as the one no one remembers.
Refining has declined 279,000 barrels and is no longer at a five year high. This is due to refining mishaps, but there may be a bit of maintenance starting to creep in. Refiners will be quite satisfied with their summer and it will be interesting to see their approach to the maintenance period.
You will find below our usual graphs. These represent the evolution of stock levels for Crude oil, Gasoline and Distillates (heating oil, diesel and Jet fuel) as well as refinery crude runs. The graphs show the current year against the High/Low range of the preceding five years. These are published by the EIA on a weekly basis, and are used by traders the world over to try and assess Supply and demand. The scale is in thousands of barrels over the 52 weeks that make up the year.
US CRUDE STOCKS
US Commercial Crude Stocks… is a trend forming? (Source: EIA)
US CRUDE RUNS (Refining)
US Refining… finally out of breath? (Source: EIA)
US DISTILLATE STOCKS
Distillates Stocks… Growing (Source: EIA)
US GASOLINE STOCKS
Gasoline Stocks… The summer is over. (Source: EIA)
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