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Dan Hassey

Dan Hassey

Dan Hassey’s passion for investing started at the UCLA Graduate School of Management where he earned his MBA. After UCLA, Dan started his investment career…

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Have Oil Markets Grown Numb To Supply Disruptions?

Most of the articles, reports about oil in the financial media since mid-2014 have been bearish, and oil prices more than reflect the bearishness.

This article looks at the contrarian view on what could cause oil prices to recover and even spike. All we need to do is to look at the historical causes of oil price increases and spikes, as these causes could be repeated. Below are some of the causes of a potential recovery in oil prices.

• Saudi Arabia and other OPEC nations cry uncle, or realize enough damage has been done to Canadian, U.S., Mexican, Venezuelan, Russian energy industries and they get back to producing at their normal levels. If the Saudis dropped to their normal levels of production, supply/demand equilibrium could occur in the oil markets.

• Supply disruptions due to terrorist attacks on Middle East production could occur at any moment. Oil production in Nigeria and Libya are down because of disruptions to oil supplies due to attacks on their oil supplies. Related: The Forgotten Shale Boom Towns

• Supply disruptions due to weather (e.g. hurricanes in the energy rich Gulf of Mexico).

• Oil spills (remember the British Petroleum Gulf of Mexico oil spill in 2010), labor strikes, and maintenance issues could cause oil supply disruptions.

• Normally oil prices have a risk premium because of the above reasons. If supply disruption risks increase, the oil risk premium could cause oil prices to move higher.

• Storage issues are causing some upward pressure on oil prices. Some articles report that the potential for storage shortages proves there is an oil glut. There are often reports that global oil demand is falling, worsening the oil glut. This is basically wrong. Below is a chart of world oil demand for since 2013:

(Click to enlarge)

Source: International Energy Agency

As the chart above corroborates, oil demand is increasing; world oil demand is expected to grow close to 97 million barrels a day by the end of the year. Some energy analysts are forecasting that oil demand will increase to about 100 million barrels a day by the end of the decade. Although demand and supply have grown consistently, oil storage has not kept up. Oil storage facilities need to be increased. Once storage facilities are built, storage issues should abate. Related: After Years of Fracking, What do We Know?

• Oil supply and demand could achieve equilibrium by the end of 2016. The chart below shows how global supplies have gone from surpluses to shortages over the last dozen years.

(Click to enlarge)

The chart shows the oil surpluses and deficits since 2003. The chart overlays oil prices.

In 2005 there was a surplus of oil of over 3 million barrels of oil, and oil prices were around $70. At that time, production and demand were about 84 million barrels a day, about 12 million barrels less than today. In 2012, the surplus was over 2 million barrels a day, and oil prices were over $100, again oil prices did not collapse because of the surpluses.

The idea that there is a major glut in oil supplies has been overstated. Surpluses in the past have been higher, and oil prices did not collapse.

• Oil price discovery is basically made in the oil futures market. The oil futures market is highly leveraged and attracts speculators. These speculators exaggerate oil price movements on the upside as well as the downside.

Just as fast and dramatic prices fell because of the speculators in the futures market, they could drive prices up. We saw that recently when prices went for $26 to about $41 in about one month, a move of more than 50 percent.

Admittedly, if the global and U.S. economies go into a recession, oil prices could stay low until the global economy recovers. Related: What Happens When Oil Hits $50?

Summary

The catalysts to cause oil prices to increase and even spike include:

• Saudi Arabia and other OPEC members produce at normal levels.

• Oil supply disruptions due to wars and terrorist attacks.

• Oil supply disruptions due to weather.

• Oil supply disruptions due to oil spills, maintenance issues, and labor strikes.

• The normal oil supply risk premium is added to oil prices.

• Supply, demand equilibrium is established by the end of the year.

• Oil futures speculators cover their shorts, and enter long positions.

Oil supply disruptions could occur at any moment, and oil prices do not reflect these possibilities.

By Dan Hassey for Oilprice.com

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  • Jessica on March 24 2016 said:
    Thank you for this article. Where did you get the data to determine surplus in the prior years? IEA data suggest there was a much smaller surplus than the 2MMb/d you suggest in article in 2012.

    It's closer to 200Kb/d in excess of demand that year.

    Thank you,
    Jessica

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