WTI futures fell $2.86 from $53.14 to $50.28 per barrel, and Brent futures dropped $3.81 from $55.92 to $52.11 per barrel. WTI is trading below $49 and Brent below $52 per barrel at the time of writing.
The apparent cause was a larger-than-expected 8.2 million-barrel (mmb) addition to U.S. crude oil inventories.
Over-Reaction
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).
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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.
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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.
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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).
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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. Related: Will Exxon’s New $20 Billion Strategy Pay Off?
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).
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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.
Turning Point
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).
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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. Related: Why It Isn’t Game Over For Canada’s Oil Sands
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.
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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.
By Art Berman for Oilprice.com
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The simple fact is that there is a lot more of crude and gasoline in storage tanks than there was last year, while the production keeps increasing. Even the Saudis are increasing the exports - while reducing the exports of crude they have more than offset it by exporting gasoline.
The speculators have amassed well over one billion barrels of crude and now have to find the suckers to take it off their hands, while the US producers have hedged their production and now the real pros have started selling the crude short.
Fasten your seat-belts - the avalanche is turning loose,
This was a one hump camel. As the back end of the future curve continued to fall, it eventually eroded the front end peak about 8 months out for WTI, 4 months out for Brent. And the system broke down yesterday.
In a way this is exactly the expectation that OPEC had created. You had a 12 month commitment to cutting production, followed by wait and see. So naturally speculators would want to buy up the first 12 months of futures, but little past that. So you get a one hump camel for a futures curve.
What should oil producers be doing instead? Well we need to clear out that 550 mmb excess. So what is needed is a futures curve that is very flat or declining 12 to 24 months out. This will purge the inventory. Producers are in a unique position to make this adjustment to the futures curve. They simply need to write futures on the bulk of what they intend to produce over the next 36 months. Yes, this will put downward pressure on the spot price in the near term, but producers who have written these futures will be protected, even as inventories draw down. Producers who resist hedging will be rightly punished for their foolishness. So it turns out that this is a strategy that a few large producers like Aramco could deploy unilaterally. Once there is enough selling pressure on futures, all producers would be advised to hedge as well, and speculative longs would be driven out of the market.
It's tough medicine, but the proper way for a free market to restrict production is to sell down the futures curve. I only wish that OPEC understood this. They could dispense with collusion if they would only use the futures curve the same way central bankers use the yield curve.
Excellent analysis, as always. But, I don't believe that fundamentals have mattered much for many months -- as is witnessed by the many, even larger inventory builds over the past many months which resulted in rallies in oil prices.
Ever since Feb 11, 2016 in particular, oil has been an important component of algorithms which are, in turn, increasingly responsible for driving stock prices on a day-to-day basis. In fact, I called a bottom for oil on that day because stocks were in danger of breaking down through long-term support.
There is a limit to how much "good" higher oil prices can do, though. As you know, oil/gas are important components to CPI. And, as CPI crept up to and beyond 2%, higher oil prices were suddenly problematic again.
Bottom line, they had to come down -- just as they did in Aug 2014 when they broke down through long-term support at virtually the same time that USDJPY (another equally important driver of stock prices via the yen carry trade) broke out through resistance.
I believe we'll see oil prices stabilize only after CPI is back down to an acceptable level (one which doesn't require higher interest rates.) February's CPI is already in the books and is likely to exceed January's 2.5%. So, now it's up to March's YoY comparison to provide central bankers a pressure relief valve.
I understand this seems like gobbly gook, tin-foil hat nonsense. It's certainly not what I learned in business school, and you will never, ever see it in a mainstream publication. But, this thesis has helped me identify several tops and bottoms in oil over the past year or two.
Several of the charts referred to above may be seen at http://pebblewriter.com/a-changing-of-the-guards/
Michael
So better not to be boast and not to increase much in production and cooperate with those who cut in production .
This is only a input from market analyst by watching the market for so many years