Posted by Art Berman - The Petroleum Truth Report
Comparative inventory: The most important approach to oil & gas price formation
Comparative Inventory (C.I.) is the difference between current stock levels of crude oil & select refined products, and their 5-year average.
C.I. has accurately predicted most of the changes in oil pricing since the 1990s when inventory data first became public.
C.I. explains the 2014 oil-price collapse and subsequent recovery.
Over-supply and weakening demand for oil led to lower prices and a build up of oil in storage.
As C.I. fell, prices increased and eventually led to the present C.I. deficit.
That appears to be ending as C.I. moves back toward the 5-year average.
This is the context for understanding the near- to medium term direction for supply, demand and prices.
Comparative inventory ordinarily correlates negatively with price
The C.I. vs oil-price yield curve intersects the y-axis at the 5-year average & is called mid-cycle price.
It is the market clearing price of the marginal barrel needed to maintain supply thru the price cycle.
Mid-cycle price for 2014 to mid-2017 was ~$75-$85 but a new yield curve has developed with mid-cycle price of $60-$70 but more significantly, with a much flatter trajectory than the previous yield curve.
August OECD C.I. of -56 mmb corresponds to a Brent price of $72.53.
A similar C.I. for June 2014 of -58 mmb corresponded to a Brent price of $111.80.
That represents a 35% price devaluation.
The 1995-2004 price cycle had a flat yield curve trajectory.
Despite very negative C.I. levels, prices remained correspondingly flat.
This was based on market sense of supply security.
Markets devalued WTI and Brent ~35% during the last year
Market devalued price of WTI partly because U.S. tight oil rig count tripled (2.9x) from 193 to 568 rigs at prices less than $60/barrel from May 2016 to Apr 2018.
Producers have been claiming profits at successively lower break-even prices since the 2014 oil-price collapse.
Markets hate to overpay.
Part of price discovery is to see what happens with lower prices.
Tight oil production returned to pre-oil price-collapse peak level (4.1 mmb/d) at WTI prices of $47-$53/barrel by July 2017.
Markets take that as confirmation that adequate supply will be available at relatively lower oil prices than before the 2014 collapse.
Output has continued to increase at prices less than the lowest levels from 2011-2014.
Managed money has been unwinding net long positions
From mid-June 2017 to Jan 2018, net long positions increased +615 mmb for WTI crude + products, and +776 for WTI + Brent.
Brent + WTI net long positions have fallen -335 mmb since Jan 2018.
WTI crude + refined product net long positions have fallen -225 mmb since January 2018 and -104 mmb since the week ending July 10.
Despite high frequency price fluctuation, the overall trend is down.
The U.S. export party seems to be losing momentum
Distillate exports have been the cash cow driving U.S. refined product exports.
Distillates comprise ~17% of product exports
Distillate exports remain strong and above the 5-year average but have declined compared with record levels in 2017.
Big drop off in exports to Mexico and Brazil where refinery expansions have occurred.
Exports may increased again when Latin American refineries begin maintenance toward the end of the year.
Distillate and gasoline inventories have been building
Distillate comparative inventory (C.I.) is -4.3 mmb below the 5 year avg but at the highest level since the week ending Mar 30, 2018.
Stocks & C.I. have increased dramatically since June.
Gasoline comparative inventory (C.I.) is +17.6 mmb above the 5 year average and at the highest level since mid-June 2017.
Gasoline stocks have been flat-to-rising during the normal destocking period.
Crude exports are lower but the Brent-WTI differential sends another message
Crude oil exports remain strong but have fallen sharply from 2-3 mmb/d levels from April through July.
Last week's exports were 1.6 mmb/d, 200 kb/d less than the 2018 YTD average of 1.8 mmb/d.
At the same time, the Brent-WTI premium vs 5-yr average is up from $0.13 to $3.43 (25x) since week ending Aug 17.
Premium increased +$4.46 from $3.67 to $8.13.
These changes reflect increased market concerns about supply security.
This could mean increased U.S. exports on the horizon.
Yet foreign refiners have begun to understand the limitations of high-gravity U.S. crude.
Markets have been sensitive to supply concerns in recent weeks
The price rally that began in mid-August reflected renewed market concerns about tighter world supply.
This is an artificial problem created by U.S. sanctions on Iran but real nonetheless.
Iran, Nigeria, Libya & Venezuela production has fallen 1 mmb/d since January & 0.5 mmb/d since May 2018.
Saudi Arabia, Kuwait & UAE have increased production 542 kb/d since April but there is considerable doubt about true spare capacity.
Maximum output was 16.84 mmb/d just before the 2016 production cuts.
If that represents spare capacity then, there is little left to overcome tighter supplies in the future.
IEA suggests that markets have been more-or-less in balance in 2018 and are likely to move into substantial over-supply in 2019.
OPEC forecasts show 2017 deficits continuing through 2018, and reaching a maximum in Q4.
OPEC indicates over-supply by mid-2019 returning to deficit for the rest of that year.
No wonder investors are confused!
Closing thoughts and observations
Oil fundamentals are only part of the story–the global economy is the main factor going forward.
Current U.S. interest rates of 1.9% are 15 times higher (1483%) than the average 0.12% from 2009 through 2015.
Emerging markets are taking the blows for now & a recent study by Oxford Institute for Energy Studies places global economic growth risks above geopolitical risk or shale growth risks for oil price.
Oil supply threat from Iran probably over-stated: sanction relief likely and Iran will find ways to export crude through Iraq & black market.
OPEC spare capacity may be greater than assumed.
Above all, it is critical to recognize that oil markets remain in a period of secular deflation that begain in 2014.
However things turn out, they are not going to return to the old normal.
I expect prices to remain range-bound near or below current levels for the near term and will probably fall in 2019 (but nothing would completely surprise me!)
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US 28 May 2020