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Are Crude Inventories Falling Fast Enough?


Friday August 18, 2016

In the latest edition of the Numbers Report, we’ll take a look at some of the most interesting figures put out this week in the energy sector. Each week we’ll dig into some data and provide a bit of explanation on what drives the numbers.

Let’s take a look.

1. Shrinking ambitions for OPEC cut

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- The IEA revised some of its projections for the oil market in its latest report, estimating that the global market will need much less OPEC supply than previously thought. The IEA said that it had previously overestimated demand from developing nations.

- That means that the market will need 400,000 bpd less from OPEC than previously thought.

- But a smaller “call on OPEC” does not mean that OPEC will produce less. The result will be a much narrower decline in global inventories in the third and fourth quarters, and an inventory build in 2018.

- On the flip side, the IEA upgraded its total global demand figure to 1.5 mb/d, up from 1.4 mb/d in its July estimate.

2. Inventories have moved back into the (radically different) five-year range

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- The chief objective for OPEC with its production cuts is to bring inventories back to average levels. Specifically, back into the “five-year range.”

- Recently, they have made significant progress on that goal, with U.S. crude inventories dipping below the upper end of the five-year range – crude inventories currently stand at 466.5 million barrels.

- The problem is that the five-year range is radically different than it used to be, inflated by the massive buildup in storage levels in 2015 and 2016.

- The Bloomberg Gadfly chart shows the 2012-2016 range vs. the 2010-2014 range. In short, the more recent average is significantly higher than even the upper bound of the previous five-year range.

- The upshot is that today’s “average” is dramatically higher than it used to be, which sort of undermines the value of OPEC’s goal as it seeks higher prices.

- On the other hand, demand is also higher than it used to be, somewhat justifying larger inventory levels.

3. EVs could erase 1 mb/d of oil demand by 2025

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- The forecasts for EVs have become steadily more bullish over the past few years, and data from Bloomberg New Energy Finance predicts that EVs will erase 1 mb/d of oil demand by 2025.

- Today’s fleet of EVs is cutting out an estimated 100,000 bpd of oil demand.

- Next year, that figure will rise to 155,000 bpd before growing to 290,000 bpd by the end of the decade.

- The figure seems small, but erasing 1 mb/d of oil demand by 2025 could be enough to push global demand from growth into contraction. In other words, “peak oil demand.”

- It is a seismic shift. So much happens at the margins – the supply glut that crashed prices in 2014 only ever reached a little over 2 mb/d.

- Thus, destroying 1 mb/d of oil demand is a big deal. And crucially, that figure will only grow as the years go by.

4. Cheap gasoline undercuts natural gas in cars

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- Natural gas is only used in small amounts in vehicles, as the technology and infrastructure required is more complex than that of gasoline or diesel.

- In places like Iran or Pakistan or parts of South America, natural gas plays a relatively large role.

- In the U.S., the push for natural gas in vehicles gained a lot of currency after the shale gas revolution. Natural gas was cheaper than gasoline, and it became a political issue as a way of reducing U.S. oil consumption.

- But that urgency is long gone. Plunging oil prices mean that running a car on gasoline or compressed natural gas (CNG) is roughly equal.

- After factoring in the trouble of converting vehicles and building out CNG refueling infrastructure, there is no longer much of a business case for natural gas in the transportation sector.

- The market is moving on – Tesla (NYSE: TSLA) has 455,000 reservations for its Model 3, more than the total fleet of CNG vehicles on U.S. roads in 2015, according to Bloomberg New Energy Finance.

5. Pipelines narrow natural gas differentials

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- The surge in natural gas production, particularly in the Marcellus Shale, happened so rapidly that pipeline companies are still struggling to keep up.

- The dearth of pipeline capacity led to a wide disparity in pricing depending in location. Henry Hub prices, based in Louisiana, traded at a premium to the Dominion South benchmark, with tracks gas in southwestern Pennsylvania.

- But the buildout of new natural gas pipelines, particularly last year, has sharply narrowed that difference.

- In 2016, 11 interstate pipelines came online in the Northeast, opening up new markets for Marcellus shale gas by adding 4 billion cubic feet per day of pipeline capacity.

6. Oil price volatility low

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- Oil prices have been stuck in a relatively narrow range for nearly 3 years, between $25 and $50. But for the past year, it has traded in an exceptionally narrow range between $45 and $55.

- That is not typical historically. But the rapid response of shale has put a ceiling on prices, as new supplies come online when prices rise. Meanwhile, OPEC has put a floor beneath prices by taking barrels off of the market.

- The result is muted trading between $45 and $55.

- Volatility is at some of its lowest levels in years. Oil futures are on track to trade at its tightest range since August 2003.

- Hedge funds have grown “bored”” on the lack of movement.

7. Hedge funds more bullish, but downside risk grows

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- While oil has been stuck within a tight range, they can move up and down quickly on a day-to-day basis.

- Some of this has to do with speculative movements by hedge funds. For example, big traders became profoundly bearish on crude in June, which corresponded with a liquidation of bullish bets and a steep rise in shorts.

- Since then, they have become a lot more bullish, helping to pull oil prices back up close to $50.

- However, the risk now is that without a change in the fundamentals, hedge funds are on the verge of overextending themselves once again.

- Whenever they rein in their bets after going too far, the result is a correction in oil prices back in the other direction.

- There is now a bit of downside risk as summer ends, with peak summer oil demand waning. If hedge funds start to liquidate their bullish bets, oil prices could fall in the next few weeks.

That’s it for this week’s Numbers Report. Thanks for reading, and we’ll see you next week.

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