The U.S. Over-Supply of Oil is Ending

Posted in The Petroleum Truth Report on November 6, 2017

The U.S. over-supply of oil is ending.

Comparative inventory (C.I.) has been dramatically reduced in 2017. Levels have fallen 159 mmb since February and are now approaching the 5-year average for the first time in nearly 3 years (Figure 1).

Figure 1. The U.S. Over-Supply of Oil is Ending. Source: EIA and Labyrinth Consulting Services, Inc.

An interpreted yield curve that correlates C.I. and WTI price is developed by cross plotting the same data without the time dimension (Figure 2). The yield curve may provide price solutions to inventory reduction assumptions in the near term.

Figure 2. Crude + Product Comparative Inventory Have Fallen 159 mmb in 2017. C.I. Could Reach the 5-Yr Avg By & $70 WTI Prices by Early 2018. Source: EIA and Labyrinth Consulting Services, Inc.

Accordingly, if C.I. continues to fall at the 9-month average of 4 mmb/week, oil prices may be approximately $67 per barrel by the end of December. If C.I. falls at the 8 mmb/week average since late September, WTI could approach levels not seen since before the price collapse in late 2014.

Exports and The Brent-WTI Spread

The causes of the U.S. inventory drawdown are clear: increased exports of crude oil and greater domestic consumption.

Crude oil exports for the first half of 2017 averaged 766 mmb/d but rose to 1.8 mmb/d in September and October. Increased exports now average more than 12 mmb/week and contribute substantially to reduced inventory levels.

Higher export levels correlate with the increased spread between Brent and WTI prices that began in late July (Figure 3). Traders can sell U.S. crude oil overseas at less than international prices but at levels higher than domestic pricing allows. Record exports of 2.13 mmb/d occurred during the week ending October 27.

Figure 3. U.S. Crude Oil Exports Reached Record 2.13 mmb/d Week Ending Oct. 27. Higher Export Volumes Correlate With Increased Brent-WTI Price Spread. Source: EIA and Labyrinth Consulting Services, Inc.

Tight oil production levels, crude oil quality and U.S. refinery blending needs are behind the WTI discount to Brent price. Most U.S. refineries are designed for international grades of oil like Brent which is heavier and contains more sulfur than WTI.

The U.S. has had a surplus of light sweet oil since the tight oil boom began, and the Brent-WTI spread reached almost $30/barrel in September 2011 as a result (Figure 4).

Figure 4. Brent-WTI Price Spread Related to Surplus Tight Oil Production. Source: EIA and Labyrinth Consulting Services, Inc.

The spread decreased to about $2.25 with the advent of rail shipments of WTI to East Coast refineries, and associated reduced light oil imports. The transport cost was reasonable when oil prices were $100 per barrel but lower oil prices after 2014 resulted in a progressive decline in rail shipments (Figure 5). East Coast refiners increasingly relied again on imported light oil mostly from West Africa to blend with heavier grades of oil.

Figure 5. Recent Increase in Brent-WTI Spread Related to Replacement of WTI Rail Shipments to East Coast Refineries by West African Light Oil Imports. Source: EIA and Labyrinth Consulting Services, Inc.

A surplus of tight oil returned as production recovered as a result higher oil prices in 2016 and 2017. Surplus supply caused discounted WTI prices, and the recent increase in the Brent-WTI spread. Some of excess oil has been exported in recent weeks but the price spread persists because import levels are so far unaffected.

Consumption

The second major cause of the U.S. inventory drawdown is increased domestic consumption of refined products.

Consumption reached a 10-year record of 21 mmb/d during the summer of 2017 (Figure 6).  August 2017 consumption was 300 kb/d more than in August 2016 and that difference accounts for more than 2 mmb/week of incremental inventory reduction. In fact, the increase in consumption that began in January coincided with the beginning of comparative inventory reduction that in February (red dots in Figure 6).

Figure 6. Record 21 mmb/d Refined Product Consumption in Summer 2017 A Major Factor in Comparative Inventory Reduction. Source: EIA and Labyrinth Consulting Services, Inc.

The greatest portion of consumption is from transportation. The declining growth rate of vehicle miles traveled (VMT) that began in early 2016 reversed in the second quarter of 2017 despite somewhat higher gasoline prices (Figure 7).

Figure 7. Declining Growth Rate of Vehicle Miles Traveled Reversed in Q2 2017 Despite Higher Gasoline Price. Source: U.S. Federal Reserve Bank, EIA and Labyrinth Consulting Services, Inc.

VMT data is only available through July but it is likely that growth continued at least through August based on consumption data that is more current.

The Possible Downside of Consumption

It is reasonable to question the capacity of the rest of the world to continue to absorb U.S. exports. Exports have increased in each of the last 6 weeks except the week ending October 6, and exports that week were still a robust 1.3 mmb/d. It is impossible to get reliable inventory data for most of the rest of the world but OECD data suggests inventory reductions similar to those described in the U.S.

Continued high U.S. consumption is the only area of concern for sustained higher oil prices. September and October consumption were considerably lower than in August. It is normal for consumption to decline after the summer driving season but the magnitude of the decline is disturbing.

October consumption was 1.2 mmb/d (38 mmb/month) less than in August (Figure 8). That is almost as much as the total August-to-January seasonal decline during the previous year (1.4 mmb/d, 42 mmb/month).

Figure 8. October U.S. Consumption Was 1.2 mmb/d (-38 mmb) Less Than Than In August, Almost As Much As Total August-January Seasonal Fall in 2016. Source: EIA and Labyrinth Consulting Services, Inc.

The data may be biased by the effects of hurricanes Harvey and Irma, and two months do not define a trend. It is, nevertheless, a troubling observation despite the fact that it will probably not affect inventory levels or oil prices in the rest of 2017.

Consumption becomes a greater concern if oil prices increase as much as I expect because gasoline prices will increase accordingly–consumption and gasoline price are negatively related (Figure 9). Higher oil price means higher gasoline price and lower consumption.

Figure 9. U.S. Consumption is Inversely Related to Gasoline Price. Higher Oil Price Means Higher Gasoline Price & Lower Consumption. Source: U.S. Federal Reserve Bank, EIA & Labyrinth Consulting Services, Inc.

$70 WTI will result in almost a $1/gallon price increase above the current average retail price of $2.53 and that may depress consumption.

The U.S. Over-Supply of Oil Is Ending

Increased exports of crude oil have reduced U.S. inventories more quickly than I expected a month ago when I wrote Higher Oil Prices Likely in Early 2018. Higher consumption levels were well established at that time but evidence for a trend of elevated export levels consisted of two anomalous data points.

Because of the way that trades are arranged, if the Brent-WTI spread closed tomorrow, continued high export levels are almost inevitable through the end of the year. That means that oil prices will increase at least for the near term.

Comparative inventory is not a predictive methodology.  It is, however,  a powerful tool because it identifies trends that correlate inventory change and oil price. As such, it can provide price solutions to inventory reduction scenarios. Those scenarios suggest that WTI prices in the $60 to $70 range are almost certain in early 2018, and that prices higher than $70 are also possible.

The U.S. over-supply of oil is ending. It is likely that comparative inventory will be near or even below the 5-year average by the end of 2017 or early in 2018. Higher oil prices may be good for oil companies but bad for consumers.

For the first time since the 2008 financial crisis, the U.S. and global economy appear to have some reasonable potential for growth. Economists are generally too preoccupied with monetary policy, interest rates and abstract mathematical models to see the obvious connection between the price of oil, our master resource, and economic growth.

Will higher oil prices smother the weak flicker of economic growth that now seems possible?

Higher prices will unquestionably provoke a new flood of capital to E&P companies. Although demand is important, producer behavior and the impulse for over-production have been the defining aspects of the last decade in the oil industry. Under-investment and limited availability of frack crews have modulated supply since early 2015. That will change probably later in 2018.

The path to price recovery will not be straight. The elegant interplay between higher oil prices, credit and the impending threats of over-supply and under-supply will continue.  In the medium term, we will learn whether tight oil plays in fact have sufficient reserve potential to meet global supply needs. My guess is that they do not.

That means reliance on more costly deep-water projects that have much longer development time lines. Associated reserves are largely know and, while considerable, are insufficient for more than about a decade of demand.

Supply and its alter-ego credit are central to mapping the implications of the topics I have discussed here. Most investors and analysts assume—perhaps unconsciously—that future supply will be more abundant than present supply. What if they are wrong?

**Help from J.M Bodell and Matt Smith are gratefully acknowledged.

 

 

 


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29 comments on this entry


  1. Did you receive the comments I sent you re the reason for high domestic crude oil stocks as reported by EIA. Two major points in brief:

    (1) As domestic shale revolution generated an increase in oil production from new areas, and this created the need for a great deal of additional pipeline supply capacity from field to refinery markets. The MLP industry was happy to accommodate – building much more Pipeline supply with REQIRED Tankage/storage. This action raised the crude stock LEVEL and it will not go down because that crude supply system is required to get crude to market. It is not just Pipeline fill, it’s a lot of storage. In the Summer of 2016, PAA had 80 mm bbls of crude storage capacity and KMI had 130 mm bbls. Go to EIA data site and see how all of the expansion in crude stocks has come from pipeline and Tankage – Reinery Stocks. Hence, oil stocks will NOT go back to prior levels like the lazy paper market thinks. And, EIA leads IEA by the nose.

    (2) As domestic production increased, it replaced foreign waterborne imports. That is very important because those foreign imports are discharged right into refinery tanks or very close. Therefore, they are not counted as inventory/stocks for more than say one week. While the domestic replacement barrels are counted as inventory for say 6 or 7 weeks. I have spoken or emailed the EIA about this and they definitely agree with me. I just could not convince them to make this clear to the market.

    This is very important and the market should be informed. I think inventory will go down further (mainly because of exports of crude). But, importantly it will not go back to prior levels. The “glut is gone and a shortage is starting to develop, IMO. Maybe I’m a few weeks early.

    Good luck and regards,

    Dave Davis


  2. Dave,

    Thanks for your thoughtful comments. I am aware of the issues that you raise namely, that there are many ways to calculate the amount of storage capacity.

    I have published concerns about “unaccounted for oil” and how reported stocks do not square with “implied” stocks determined from field production, net imports and refinery intakes. If anything, however, these calculations suggest that there is less inventory than EIA reports.

    Please help me better understand your concerns.

    All the best,

    Art


  3. Art,
    Please could you provide more color about wti/brent spread dinamic?
    Do you think the spread can return again in the next future to the physiological gap of two dollars due to high wti export and in how many time?
    Thanks Marco


  4. Marco,

    I believe that the WTI-Brent spread is the cause of increased WTI export because U.S. crude oil can be sold for more outside the U.S. than at home. If the spread decreases, the price arbitrage will disappear and discourage export sales.

    The price spread is complex and incorporates many factors including fears of international supply disruption because of political tensions in the Middle East. Oil prices are higher today because of events in Saudi Arabia viewed as potentially disruptive to smooth supply delivery.

    I fully expect the Brent-WTI spread to return to $2/barrel sometime sooner than later.

    All the best,

    Art


  5. Hello Art
    what we would have to see is how the complex global system reacts at prices of 70 dollars, we are talking about huge price variations again


  6. Hi Carlos,

    Oil prices have been range-bound between $40 and $55 since April 2016. My guess is that the boundaries will move upward but that the range will remain similar, around $15/barrel.

    All the best,

    Art


  7. Is production decline or at least the reality of the ratios part of it? I see a lot of crude touted from W. Texas, OK, etc. but it appears wells are producing more gas and less oil (lower ratio of oil to gas) from existing wells as they age. … If so, means bad news for gas prices, better news for oil. Or do you think export demand is simply absorbing the production faster?


  8. Art,
    As usual, thanks for the great data driven articles on crude oil. Have a question on Figure 1.”Crude oil exports for the first half of 2017 averaged 766 mmb/d but rose to 1.8 mmb/d in September and October. Increased exports now average more than 12 mmb/week and contribute substantially to reduced inventory levels.”

    Assume this is just a typo – “averaged 766 mmb/d but rose to 1.8 mmb/d in September …..”. Shouldn’t this be ‘averaged 0.766 mmb/d but rose to 1.8 mmb/d in September and October. Increased exports now average more than 12 mmb/week ….? Thanks again for the great slides with easy to understand data.

    PS- I agree with your work for the primary (sole) reason why crude prices are going up (Compatible Inventory, etc), but I have a hunch that the political heat is increasing in the Middle East (as you mentioned also). Iran has launched a few ballistic missiles into Saudi from Yemen, yet the media has not focused on these events. Plus I noticed a significant uptick in U.S. fighter/attack air wing activity? I sure do not know if that is significant, just hypothesizing (I assume it’s the hard data regarding CI that you have been following and conveying via your articles and frequent Tweets). Regards, Daniel.


  9. […] Art Berman […]


  10. In my latest post I have a graph of US crude exports by destination

    http://crudeoilpeak.info/wp-content/uploads/US_exports_by_destination_2010-Aug2017.png

    Canada still dominates but levels now are lower than before. US crude oil goes to many destinations but in small quantities, suggesting these are either test cargos or blending components. US exports to China have increased substantially but nowhere near providing for China’s demand growth as assumed by former Australian Prime Minister Howard


  11. Matt,

    Thanks for the excellent graph. Exports to Asia and Europe have increased dramatically in 2017 and now comprise 60% of U.S. volumes while Canada has fallen to 33% from almost 100% as recently as late 2015.

    http://www.artberman.com/wp-content/uploads/60-of-U.S.-Crude-Oil-Exports-Now-Go-to-Asia-Europe.jpg

    All the best,

    Art


  12. U.S crude oil production is now up to 9.55 million bpd and the inventories are falling?

    Dave is suggesting that this is due to a counting error?

    As the WTI Brent spread increases, so does exports of U.S domestically produced crude oil. This export is then replaced by imports of foreign crude oil. Due to a switch in counting (domestic crude in transit is counted as inventory, but foreign crude in transit is not counted as inventory) it will just appears as there is a decline in inventories, when in fact there is non. The decline in inventories is just an counting error.


  13. I almost got it right. The inventory “glut” in the U.S was a counting error in the first place. There has never been an inventory increase in the U.S.

    The increase in inventories appeared when U.S domestic crude oil production increased and imports of foreign crude oil declined.

    Since U.S domestic crude oil in transit to U.S refineries counts as inventory, but foreign crude oil in transit to U.S refineries doesn’t count as inventory, it just appears as if there was an inventory increase in the first place in the U.S.


  14. Yoshua,

    We agree that the way EIA counts inventory is flawed. It is based on a sampling estimate and algorithm that stopped working when tight oil production became a factor. I don’t have any quarrel with using a sampling approach but it needs to be adjusted to match reality.

    More importantly, EIA never revises its weekly estimates. It does provide a monthly report with revised data but it is 2 months in arrears.

    I am less concerned than you are about floating oil in transit because it is almost impossible for EIA to know those volumes until the import trade and tax documents are filed in ports. I think it is unrealistic to expect EIA to account for inventory volumes that are not yet on U.S. soil.

    We should never forget that the main purpose of EIA and state regulatory agencies like the Texas Railroad Commission is to ensure that tax revenues are collected.

    All the best,

    Art


  15. […] Petrol fiyatları tekrar yükselişte. Art Berman’a göre, her ne kadar kasırgalardan da olsa, ABD’de Ağustos-Ocak döneminde 1.4 mv/g düşen talep şimdiden Ağustos-Ekim’de 1.2 mv/g düştü. Yüksek fiyatlar ABD tüketicisini de vuruyor, petrol ihracatı da artıyor. […]


  16. 1. Brent is not a heavy crude. It is almost identical to WTI. See chart:

    https://www.eia.gov/todayinenergy/detail.php?id=7110

    2. Bakken trains are not heading to the East Coast refineries because of DAPL. The price realization (close to Brent) is still better in the East Coast, but the difference between cheap pipe toll and expensive train cost makes it better to ship into the Midcontinent even so.

    3. It is not the WTI-Brent differential that drives export but the differential of prices at the US Gulf Coast with Brent. IOW, look at LLS-Brent or WTI (Houston) to Brent. They are both viewable for free on the CME website. A lot of people do not realize that there is a big differential from Cushing to the Gulf Coast. Larger than the difference from the Gulf Coast to Brent.

    4. As far as consumption, it is not only increased US driving but also increased export of products. IOW, refinery consumption is not the same as internal consumption of products.


  17. Anonymous,

    This website is for people who want to help each other learn not for pompous, abrasive know-it-alls like you to take cheap shots at me.

    If you want to disagree with me, that is fine but be courteous. Because you are so smart, perhaps you should start your own website and actually help people understand oil markets rather than criticize me for trying to share what I know.

    I didn’t say Brent was heavy crude. I said it is heavier than WTI and has higher sulfur content. Read the post.

    I know all about LLS but chose not to confuse the readers who are accustomed to hearing about Brent-WTI spread.

    If you read my previous posts, you would know that I know about refined product exports. I chose not to repeat what I had already written.

    Use your real name in the future or I will disapprove your comments.

    Art


  18. Yes it makes sense for the EIA to just count crude on U.S soil as inventory.

    If this “increase” in U.S inventory caused the WTI price to fall and cause the Brent price to fall as well…then we Europeans thank EIA.

    The oil glut did still take place around the world though. Europe experienced a glut as U.S production of crude increased and U.S need for imports declined.


  19. Yoshua,

    The global collapse of crude oil prices in 2014 was because of over-supply and the U.S. was a chief contributor but not solely responsible. The perpetuation of low prices was because of OPEC + Russia over-production.

    http://www.artberman.com/wp-content/uploads/OPEC-NOPEC-Crude-Oil-Prod.jpg

    U.S. imports actually increased in 2016 because it needed heavier oil to blend with its ultra-light. The U.S. continues to import light oil from West Africa. It’s net refined product imports that have fallen so much.

    All the best,

    Art


  20. Agree with every thing you said – there are always basis deltas when it comes to formula pricing. The only minor change I would make is – I think in your very last sentence you meant to say refinery production, not refinery consumption.


  21. The same was true in reverse when domestic production was increasing, and foreign waterborne supply was falling. Domestic crude in transit gets counted say 5 to 7 weeks in the reports. The additional buildout of domestic collection and transmission pipeline and required associated tank storage is still in place. And very simply that in transit supply is still in place and will be as long as production from these fields exists. That makes the LEVEL of domestic inventories higher than prior levels, so inventories will not fall back to the lower levels investors are looking for.


  22. The more I learn about oil, the more complex the matter becomes. Warren Buffet has invested in oil three times and lost money every time.

    Thx


  23. Art,
    How do you explain the huge reduction of us oil export published by eia this week ( 0,869 million bpd) respect to the previous one ( 2 million bpd )
    Thanks Marco


  24. Marco,

    I can’t explain everything. It is one data point.

    I follow the market but do not predict it. I tell readers about the trends that I see. If new data reveals a change in those trends, I change my interpretation.

    Consumption was way up and more than balanced the export decrease and comparative inventory fell > 8 mmb. I say everything is according to what I described in my post but we will see how it unfolds.

    All the best,

    Art


  25. Yoshua..

    That is not true. Warren Buffett made a ton of money on PetroChina.

    “Buffett purchased a stake in PTR between 2002 and 2003 at a cost of $488 million. He sold this stake in 2007 for $4 billion, netting Berkshire a gain of 8 times its initial investment. The capital Buffett put to work in PetroChina compounded at about 55% annually between 2002 and 2007.”

    http://basehitinvesting.com/buffetts-petrochina-investment-finding-large-gaps-between-price-value/


  26. Don

    I didn’t know about PetroChina. A new lesson.

    http://basehitinvesting.com/wp-content/uploads/2014/08/PTR-Chart.jpg

    This time Warren was just lucky?
    🙂


  27. […] and WTI, the US benchmark, to rise significantly as a consequence of oil inventory drawdowns (see here for a  detailed explanation about the interplay between the crude varieties, their uses and trade […]


  28. hola Art

    I keep reading notes that say shale gas and shale oil lead to a world where lack of oil will no longer be a problem


  29. Art,
    Thank you for all your thoughtful and exhaustive posts.

    I have looked all over the internet for the calculation of Comparative Inventory. I see a reference to Bodell, 2009 and I cannot locate that source either.

    I certainly understand the relationship, but what exactly is this moving benchmark?
    How exactly do you arrive at a mid-cycle price at which you oscillate for a year or more (one comment I found from Bodell).

    Can this be produced transparently?

    Also how do you adjust for shifting working capital of inventory as related to a larger US petrochemical complex including new pipelines, field storage, etc and the greater absolute level of demand. Surely a steady state inventory must adjust on an absolute basis for a larger system.

    Thanks for you diligence & appreciate the website. Best!