IEA says market “awash with oil” – debunks bullish myths

WTI inventory Feb16Oil markets are the proverbial “canary in the coalmine”.  They are showing us what happens when the rose-tinted glasses provided by stimulus policy are removed.  Now markets have to return to their true role of price discovery, based on the fundamentals of supply and demand.

This makes them very dangerous indeed.  Some large players in the energy markets will go bankrupt as a result, as happened with Enron in the dotcom bubble and GM in subprime. Some of their trading partners will also go bankrupt. Many companies have no contingency plans – they never realised this could, and would, happen one day.

One problem is that fundamental analysis requires investors to think about the reality behind the headlines – rather than just repeat them:

  • Many seriously paid attention when Venezuela and Ecuador called for an OPEC meeting, not realising these countries are increasingly irrelevant within the group.  Why would the Gulf Co-operation Council (GCC) countries, who are the keys to OPEC policy, take any notice of their views?
  • Similarly, why does anyone waste their money buying oil with the idea that Russia is likely to cutback production and work together with the GCC?  Have they not noticed, for example, that Russia and the Saudis are on opposite sides in Syria, or that Russia is a long-time ally of Iran?
  • Equally puzzling is the idea that Iranian calls for production cutbacks are a serious policy statement.  Iran’s priority is to recover its historic market share as quickly as possible – of course, this would be made easier if others cut back, but why would anyone do this?

So all credit to the International Energy Agency for trying to help investors go up the learning curve as fast as possible in their new Monthly Report. As they note:

“Persistent speculation about a deal between OPEC and leading non-OPEC producers to cut output appears to be just that: speculation. It is OPEC’s business whether or not it makes output cuts either alone or in concert with other producers but the likelihood of coordinated cuts is very low. This removes one driver of bullishness

“Another widely-held view is that OPEC production, other than Iran, will not grow as strongly in 2016 as it did in 2015. Although it is still early in the year, Iraqi output in January reached a new record and it is possible that more increases could follow. Iran has ramped up production in preparation for its emergence from nuclear sanctions and preliminary data suggests that Saudi Arabia’s shipments have increased. Thus, another driver might be removed.

“Another driver of bullishness is that oil demand growth will receive a boost from the collapse in oil prices to below $30/bbl. We retain our view that global oil demand growth will ease back considerably in 2016 to 1.2 mb/d – at 1.2% still a very respectable rate – but our analysis so far sees no evidence of a need to revise it upwards. Estimates by the International Monetary Fund that global GDP growth in 2016 will be 3.4% followed by 3.6% in 2017 is heavily caveated with risks to growth in Brazil, Russia and of course slower growth in China. Economic headwinds suggest that any change will likely be downwards.”

These comments are from the world’s leading energy watchdog.  They could hardly be more direct.  And their conclusion is equally blunt:

“On the assumption – perhaps optimistic – that OPEC crude production is flat at 32.7 mb/d in Q116 there is an implied stock build of 2 mb/d followed by a 1.5 mb/d build in Q216. Supply and demand data for the second half of the year suggests more stock building, this time by 0.3 mb/d. If these numbers prove to be accurate, and with the market already awash in oil, it is very hard to see how oil prices can rise significantly in the short term.  In these conditions the short term risk to the downside has increased”.

They describe the market as being “awash with oil” and they do not exaggerate.  The chart above shows record US inventories for oil and petroleum products – these have just reached 500 million barrels for the first time in history- an astonishing 50% more than the 1982-2008 average.  And Q1 is a seasonally strong period for demand.

All eyes are, of course, on Iran and its return to Western markets.  But US producers are equally desperate to sell.  How else can they hope to bring inventories down to normal levels again?  And at the moment, they are paying to store a product whose price is falling day-by-day, which must upset a lot of CFOs.  Plus, of course, the banks are pushing for companies to reduce their debts as quickly as possible.

Companies who intend to be Winners will already be making plans to ensure their survival – whatever 2016 may bring. And they will also be planning to take advantage of the Opportunities that are now available, as we describe in our new 5 Critical Questions Study.  This will be published very soon, and I would be delighted if you wanted to subscribe.

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