- April 19, 2017
- Posted by: Art Berman
- Category: The Petroleum Truth Report
Global oil inventories are falling because of OPEC and non-OPEC production cuts but the road to market balance will be long.
Production cuts have removed approximately 1.8 million barrels per day (mmb/d) of liquids from the world market since November 2016 (Figure 1).
Saudi Arabia has cut 619 kb/d (35% of total) and the Gulf States Cooperation Council—including Saudi Arabia—has cut 1,159 kb/d (65% of the total). Other significant contributors outside the GCC include Iraq (12%), Russia (12%) and Mexico (9%) (Table 1). Nigeria’s cuts are probably involuntary since it was exempted from the OPEC agreement. Iran and Libya–also exempted–and both increased production.
Inventories and The Forward Curve
OECD inventories began falling in July 2016, four months before the OPEC production cuts were finalized. Stock levels have declined approximately 107 mmb according to recently revised EIA STEO data (Figure 2). That includes the January 2017 increase recently noted in the April IEA Oil Market Report.
Although this represents progress toward market balance, stocks must fall at least another 260 mmb to reach the 5-year average level to support oil prices in the $70 per barrel range.
Almost three-quarters (73%) of OECD decline was from non-U.S. inventories. Perhaps the intent of OPEC’s November cuts was to stimulate a decrease in U.S. inventories (about 45% of the OECD total). U.S. stocks and comparative inventories were increasing at the time of the cuts and did not start to fall until February 2017 (Figure 3). Since mid-February, U.S. stocks and comparative inventory have each declined 20%.
Still, U.S. inventories must fall another ~150 mmb to reach the 5-year average (Figure 4).
The immediate results of the OPEC cuts were an increase in oil prices and an important change in the term structure of crude oil futures contracts. Before the cuts were announced, the term structure of the WTI oil futures curve was in contango (prices are higher in the near-future). That favored storing rather than selling oil and contributed to growing inventory levels (Figure 5).
In early March 2017, however, oil prices fell as investors lost confidence that the cuts were working. Forward curves moved into weak backwardation (prices are lower in the near-future). Now, prices have increased with outages in Canada and Libya, and the forward curve has moved into stronger backwardation. That favors selling rather than storing crude oil and contributes to decreasing inventory levels.
Market Balance, Supply and Demand
The latest IEA Oil Market Report stated, “It can be argued confidently that the market is already very close to balance.” What does that mean?
Market balance means that production and consumption are approximately equal. That is an important first step for a market in which production has exceeded consumption for most of the last 3 years but it hardly means that $70 oil prices are around the corner.
Market balance must be expanded to be useful: production is not the same as supply, and consumption is not the same as demand. Supply is production plus inventory. Demand is the quantity of oil the market is willing to buy at a certain price–it may be either more or less than production.
Oil prices collapsed in 2014 because demand wasn’t great enough at $100 per barrel to absorb the output from the 2010-2014 production bubble. Prices collapsed to $30 per barrel before a transformed market began a weak and uneven recovery, and production surpluses began to decrease slowly (Figure 6).
Demand did not increase enough until July 2016 to require critical supply withdrawals from inventory–a small subset of total supply. U.S. inventories did not begin to decline until after the OPEC cuts took effect in February 2017.
In the real world, the 5-year average inventory level represents a dynamic proxy for market balance. Comparative inventory is the measure of how far the present market must rise or fall to reach that level. IEA data indicates that inventories are 330 mmb above the 5-year average although revised EIA data suggests that levels are closer to 260 mmb higher than that important benchmark. In either case, it will take 6 months to a year to approach the 5-year average.
Demand Growth
Weakening demand growth is the potential barrier to continued inventory reduction and price recovery assuming that OPEC production cuts hold and are extended. Annual demand growth has declined to 1.25 mmb/d from the comparatively robust 2 mmb/d growth in 2015 and 1.62 mmb/d in 2016 (Figure 7). IEA forecasts continued weak demand growth for 2017.
The problem, of course, is that demand is highly price-sensitive in a global economy that is burdened by unmanageable debt. Demand lags price and demand growth reflects the full spectrum of economic headwinds. In early 2016, oil prices reached the lowest level in a decade-and-a-half. After that, year-over-year demand and oil prices increased through November 2016 and yet, demand growth in 2016 was lower than in 2015. Since then, $45 to $55 per barrel prices appear to have depressed demand growth to annual levels of about 1.25 mmb/d.
The OPEC cuts are accelerating the reduction of global inventories but continued progress toward the 5-year average will push oil prices higher. Higher prices may collide with weak demand growth in a stagnant economy that simply needs less oil. The long road to market balance may be slower and less predictable than bullish analysts predict.
Thank you for another great article on understanding the possibilities of the future price of oil. The increase in the number of drilling rigs in the US and the resulting increase in production, indicates that the supply-demand balance will not be reached as soon as many are hoping for and $70/bbl oil is likely to be further in the future than producers current plans.
But the 5 year average hasn’t really been a shortage, so looks to me like pressure remains to keep prices from floating back much over $80 for a long time??? Right?
Terrell,
When inventories are near the 5-year average, prices are high and vice versa.
It will take quite awhile to get near enough to the 5-year average for me to think about $80 oil prices and there is no reason to expect that prices will even get that high if we reach the 5-year average. Things are clearly different than before 2014.
All the best,
Art
It looks as though we need a new way to value oil. Some sort of equivalent energy marker, perhaps based on the energy value of human labor?
Existing currencies all fail to convey the message.
Art,
Great work on another interesting piece. If they make an Art Berman t-shirt show me where to buy.
Quick question. I’ve been reading about Iran dumping presanction floating storage and possibly using it as faux production. Think it was around 75mb, either way it’s now gone. Any thoughts to a possible impending upcoming cliff in inventories reductions. Seems this is on the way here shortly as floating storages dump and run dry with the backwardations. My belief is OPEC wants US balanced last and is maintaining crude storage here while they reduce their own inventories which makes good sense strategically.
John K.
John,
No T-shirts so far!
I found some new information from ClipperData, a commodity research company, that confirms what you heard about imports in general–not sure about Iran specifically.
All the best,
Art
Thanks. Very useful, timely article.
Could you comment on the definition of “incremental liquids” from Figure 2? Clearly it is showing the opposite trend as crude inventory from Figure 4 since July 2016.
Are the incremental liquids the sum of crude inventory + refined products inventory + NG (boe) inventory ?
Thanks.
PS,
Thanks for your questions.
Incremental OECD inventories are based on all liquids that are included in the EIA/IEA liquids accounting–oil plus refined products. The incremental method that I used takes the minimum value for each data series (U.S. & OECD minus U.S. inventories) and subtracts that value from each series. Incremental is, therefore, relative to that minimum volume that is added back in as “Base.”
The reason for your confusion is two-fold. First, Figure 2 shows crude oil plus refined products and Figure 4 is crude oil inventories only. Crude oil plus refined products inventories have fallen. Below is a graph showing the latter.
Figure 2 shows the U.S. portion of OECD inventories above OECD minus U.S. It reflects the decline of the data series underneath it that I mentioned in the text below “Almost three-quarters (73%) of OECD decline was from non-U.S. inventories.”
The figure below is the same as Figure 2 except I have re-stacked U.S. Inventories and OECD Minus U.S. Inventories so you can see the difference in decline rates.
Another reason for confusion is that OECD data is reported monthly and U.S. inventory shown in Figure 4 and the first image above is reported weekly so there is some difference from averaging. Also, I use a select basket of refined products in my inventory and comparative inventory that is somewhat different from total liquids.
It is confusing!
All the best,
Art
Art
The article and its knowledge surpass my understanding, because my technical level is not so great. But when you talk about inventories it includes biofuels. What is the point of equilibrium for these? I suppose it must be greater than that of conventional and non-conventional oil. Has the production of these been cut?
A greeting for you and for all who participate and I read to all although I struggle to understand some things
Carlos,
Biofuels are part of the world’s accounting of “liquids” even though they are not petroleum. The U.S. produces about 1 million barrels of fuel ethanol per day but used an average of about 300,000 bpd in 2016. The rest sits in perpetual inventory that averaged about 21 mmb in 2016. This is because production is mandated by law. Biofuels production has not been reduced at least not in the U.S.
It is a relatively small percentage (1.5%) of total crude oil plus products stocks (excluding the Strategic Petroleum Reserve). It is impossible to determine the volume of biofuels stocks (oxygenates) for OECD because they are lumped with NGLs and other products but I assume that it is a similarly small but rather silly percentage.
All the best,
Art
Art, I read your blog a lot (and have learned a lot) but have not posted a comment. But, now I am confounded. If the oil production cuts that have been in place manage to get the oil price to eventually rise, what good will that do. When the price rises, production will increase again (as oil exporters need the cash flow and money). But, at the same time the economy stagnates or contracts!!! Then global inventories of oil go up and the price of oil falls again. Rinse and repeat. It seems like a dog chasing its own tail. But, I have had an epiphany – continue reading to see what I mean.
Occasionally we will read some EROEI analysis that says as EROEI drops we will reach a point where oil just becomes useless. I have read that as EROEI approaches a theoretical value of 1:1, oil extraction will require so much energy to extract that all you can do is look at it. At that point there is no longer a net energy gain by extracting oil to burn it.
Now, given those two paragraphs I am confounded: are we reaching the point where all we can do is extract oil and look at it? If oil production cuts lead to increasing oil prices, then gluts of oil, isn’t that exactly what is happening? Is there really not enough net energy left in oil extraction to do anything useful with it other than extract it and grow inventories (look at it)? Now that is an interesting thought.
Greg,
Thank you for your thoughtful questions. I believe that the OPEC/NOPEC production cuts were made more to put a floor under oil prices than to necessarily cause them to increase. OPEC is an unhappy family whose members have different motives and needs. The wealthy members–Saudi Arabia and the other Persian Gulf states–want to sustain a price that they can live with, around $50/barrel. Among the many and complex reasons that agreement among OPEC and Russia was reached in November was fear that prices would fall to $40 or less if action was not taken.
EROI and its variants are important–net energy is an easier way to think about this. Having said that, calculations about net energy are frustratingly imprecise and variable. I do not think that we are close to the 1:1 net energy concerns expressed by some like the Hill Group.
Oil supply, demand and inventories are components of how the market somehow manages supply. The supply bubble that burst in 2014 followed a period dominated by investor belief in peak oil. A market price was set around $100 per barrel to stimulate supply and it worked, too well. Markets always overshoot and undershoot until things equilibrate. Markets are not the hand of God but people trying to make money. The only certain thing is that markets are ruthless.
I worry less about net energy approaching zero than I do about the global debt created to compensate for higher energy costs.
All the best,
Art
Art what do you think about this declaration
The volume of new oil discoveries hit a record low in 2016, the result of severe cuts to exploration budgets amid plummeting oil prices. The number of new conventional drilling projects also dropped to the lowest level in 70 years, according to the International Energy Agency.
Carlos,
Those are true statements and we should be concerned about future supply. Market forces, however, favor return on capital employed (ROCE) and big, expensive, long-payout projects with big reserves cannot compete on ROCE with a series of single wells in a tight oil play. How long will the supply last? That is a moving target. Longer than deniers thought a few years ago but perhaps not so long as promoters claim.
The price is now below the marginal cost of production. Unless and until that changes, there will be supply concerns about the future.
All the best,
Art
Odd looking chart: “Figure 5. The Term Structure of WTI Futures Contracts” which appears to be trying to show the change from contango to backwardation. However the chart seems oddly constructed. If it is illustrating the curve on Mar 9 for example, why does that curve start at Jan ’17? All of the curves start on Jan ’17 but to the best of my knowledge the starting point for each curve should be right above the curve’s starting date on the x-axis. Am I misunderstanding this somehow?
Edward,
The chart is notional and is designed to show that a change has occurred. I should spend more time with the x-axis and where the different curves begin and end. It not change the message but I will be more careful in the future.
All the best,
Art
Thank you for your willingness to answer questions
Perhaps it’s fair to say that energy has always been the economy in modern humans evolution from solar, fire, fossil fuels, nuclear, tools, technology and science, and now we have to reach beyond these energy sources and find a new energy source to evolve ?
Yoshua,
I do not believe that evolution needs any help. In order to survive, humans need to learn how to live without the continuous growth in population, debt and energy consumption that will eventually result in disaster.
All the best,
Art