Oil stocks at record levels as demand growth slows, supply rises

IEA Sept15OECD oil inventories have never been higher.  They were 2.9mb at the end of July, and are expected to have risen further since then, according to energy watchdog the International Energy Agency:

  • In terms of days of forward cover, they are now at 63 days in the OECD overall
  • They are at 68 days in Europe and well above normal in Asia and the US
  • China has also been filling its strategic reserve at the rate of 380kb/d all year

And of course, it will not be long before Iran returns to world markets as sanctions are eased.  Iran expects to increase its volume by 1.5mb/d by the end of 2016.

Yet media headlines continue to focus on the “noise” around around markets, rather than the bigger picture.  This is great for traders, who know they have at least 3 trading opportunities a week to move prices up or down – the weekly US inventory data from the American Petroleum Institute on Tuesday, and from the Energy Information Administration on Wednesday, plus the drilling rig report on Friday.

But it is really irrelevant for everyone else.  The inventories are so large that they simply cannot be reduced to normal level within weeks, or even months.  And it therefore can’t possibly matter if US production growth is estimated to have risen 100kb/day, or reduced 200kb/d.  For a start, these are just estimates – not final figures.  And even if they were accurate, the impact on the global market is too small to be noticed.

The problem is that a decade of central bank stimulus means a whole generation of analysts have never had to worry about understanding supply/demand balances.  Instead they have made enormous sums of money by using the ‘buy-on-the-dips’ model in oil markets as in other financial markets.  In this looking-glass world, bad news is always good news, as it means central banks will keep interest rates low and print more money to invest in oil futures markets.

Nobody can be sure this won’t happen again.  This is why we have a $100/bbl oil price Scenario in our Study with ICIS, How to survive and prosper in today’s chaotic petrochemical markets: 5 Critical Questions every company and investor needs to answer.  It would be naive not to believe this could happen again, especially as the latest jobless data suggests the recent US recovery is weakening once more.

A Scenario based on a continuation of the $50/bbl price level is clearly also possible – we have, after all, seen prices stay around this level for most of 2015.  But my own view is that the current market is fundamentally unstable, due to today’s record inventory levels.  It only needs a few people to start selling – perhaps because they need the cash for something else, and prices could quickly spiral downwards to $25/bbl.  And this Scenario although seemingly impossible to many, is where prices have been for most of history.

US supply growth may now be plateauing after a period of very rapid growth – US output was up 1.7mb/day last year, for example.  But Russian output is at post-Soviet Union peaks, with its revenues supported by the collapse of the rouble, whilst Saudi continues to pump at high levels.  And at the same time, demand growth is clearly weakening.

Emerging markets  have been responsible for most of the world’s economic growth since 2008 – but they are now seeing major cash outflows – the worst since the 2008 Crisis.  And  China’s New Normal direction for its economy is sending commodity exporting countries into recession.

It seems wishful thinking to imagine these developments will quickly reverse.

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