Oil Inventories Fall, But OPEC’s Problems Persist

Friday July 14, 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. Oil inventories decline counter-seasonally

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- As Bloomberg Gadfly points out, the U.S. posted a highly unusual drawdown in crude inventories in the March through June period, with exceptional declines in June.
- The declines rescued oil prices from cratering below $40 per barrel, a rout that began after disappointment of OPEC's May meeting.
- But inventories are still high and follow a strong build in the first quarter. Also, as Goldman Sachs said in a recent note, the drawdowns are still early.
- Moreover, a lot of the oil has been exported, as U.S. oil exports surge to record highs. As a result, the drawdowns are not clearly a sign of a tightening market, as the crude could simply end up exacerbating supply problems elsewhere.
- Bloomberg Gadly notes: "The U.S. exported 149 million more barrels of crude and refined products in the four months through June than it did in the same period of 2016. Had those barrels not been exported, U.S. inventories would have risen by another 129 million barrels."

2. Oil inventories coming down…slowly

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- OPEC's goal with its production cuts is to bring the OECD oil inventory balance back down to the five-year average.
- When the initial deal was announced, inventories were 306 million barrels above that five-year average.
- Inventories increased sharply in January, as OPEC ramped up production in late 2016. Since then they have decreased.
- The drop in May was the largest of the year, falling by 33.8 million barrels, cutting the surplus to 266 million barrels above the five-year average.
- Another factor helping OPEC is that the five-year average, over time, will increasingly encompass the surplus years, which means the five-year average will increase.

3. Saudi Arabia cuts oil exports to U.S.

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- Part of the effort to drain oil inventories is to drain them specifically in the U.S., where transparent data has a heavy influence over market thinking.
- According to the EIA, U.S. imports of Saudi crude sank below the 1 mb/d mark in the four weeks ending on July 7, averaging just 900,000 bpd.
- That is the lowest level since 2015, and the least amount of oil imported for the specific time of year in over five years.
- Saudi Arabia is reportedly hoping to cut exports to the U.S. to under 800,000 bpd in August.
- The reduction will likely help accelerate the inventory drawdowns.

4. Oil fields depleting at fastest rate in 25 years

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- The three-year bust in oil prices has not only led to a drying up of investment in new drilling, but it is clearly inflicting damage on older oil fields.
- According to Rystad Energy, output at older fields contracted by 5.7 percent in 2016, the fastest rate since 1992. China saw fields decline by 9.5 percent, and U.S. fields fell by 8.3 percent. So even as U.S. shale grows strongly, older fields are depleting.
- These older fields represent 30 million barrels of oil per day (mb/d), or almost a third of global supply. As they deplete, the market is left more dependent on relatively higher cost sources of production.
- Depletion will accelerate to 6 percent this year unless oil prices rebound, a drop off of about 1.8 million barrels per day, which incidentally, is equivalent to the OPEC/non-OPEC cuts.

5. OPEC may try to cap Libya and Nigeria output

- Libya and Nigeria have added well over 400,000 bpd in recent months as production is restored following attacks on energy infrastructure.
- The resurgence in output from the two countries is undermining the OPEC deal. Now, there are rumors that OPEC could try to take away the two producers' exemption from the OPEC cuts.
- Libya and Nigeria are aiming for 1.25 mb/d and 1.8 mb/d of production, respectively. If that comes to pass, OPEC would be producing 1 mb/d more than it expects demand for its oil to be.
- That is why capping their production has been raised. But that probably won't cure the oil market woes.
- First, it won't be easy to bring them on board. Second, it could require changing the quotas of other members, which would be difficult as well. Third, it wouldn't take place until the end of this year at the earliest.

6. OPEC supply is up

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- Saudi Arabia increased oil production in June by 120,000 bpd from a month earlier, taking output above 10 mb/d for the first time this year.
- The increase led the IEA to conclude that the rebalancing would take much longer than expected, and the agency even wondered if any progress was made in the second quarter, after previously predicting the supply/demand balance had already dipped into a deficit.
- OPEC supply stood at 32.6 mb/d in June, the highest volume in 2017 and nearly as much as a year earlier.
- The return of Libya and Nigeria, combined with the Saudi increase, led to an additional 340,000 bpd in June from OPEC, knocking its compliance rate down to just 78 percent, compared to the 95 percent compliance rate from May.
- If the cartel's resolve weakens and compliance dips further, oil prices could fall further.

7. Investors sour on oil

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- Oil prices collapsed in June, corresponding with a sharp liquidation of net-long positions from money managers.
- The ratio of long-to-short bets in the futures market from money managers declined from 7:1 at a peak earlier this year down to just 1.8:1 in June, a huge shift towards a more pessimistic outlook.
- The long-run average is about 3.5 long positions for every short.
- The net-long position is now at its lowest level since January 2016, and June was the fourth consecutive month of a more bearish positioning.
- The upshot is that investors are pessimistic about the trajectory of oil prices. The flip side is that there is now more room to bid up prices than in previous months.

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