Another Oil Meme Bites The Dust: Tight Supply Turns to Oil Surplus

Mainstream oil analysts have bombed on their two big calls for 2023.

The first call was for oil prices to soar as China’s economy and oil demand recovered after Covid lockdowns. That idea went down in flames several months ago. It was replaced by a call for prices to soar as global oil supply fails to keep pace with demand, and a huge supply-demand deficit opens.

Goldman Sachs recent statement summarizes this view concisely:

“The main reason for oil outperformance is that the oil market continues to price sizeable deficits”

That now seems ready to flop as new supply from Iran, Iraq, Canada and several other producers is coming into the market

After months of daily drum-beating about tight supply, PVM’s Tamas Vargas made this comment yesterday:

“Whilst the oil balance could obviously deteriorate, currently there is no reason to believe that global oil consumption would approach, let alone fall below supply.”

The big supply-demand deficit probably isn’t happening but at least there won’t be a big SD surplus! Another meme bites the dust.The key element for Vargas is that Iraq may resume Kurdish exports that have been stalled for many months.

Grant Smith made this observation today:

“Since the start of the year, oil watchers have widely predicted that prices would end 2023 on a high note. That forecast is looking more and more precarious.”

How can mainstream analysts get things so consistently wrong? Because they take perfectly reasonable hypotheses and fail to test them against updated production and projections by credible sources.

For example, Canada production is estimated to increase +6% in the second half of 2023 compared with the first half (Table 1). Guyana output is expected to rise +11.2% over the same period and +52% in 2024 compared to 2023.

“Canadian crude output to increase 175,000 bpd this year & another 200,000 bpd in 2024.”
—RBN Energy

What about the OPEC production cuts and other OPEC and non-OPEC countries? Angola, Iran and Venezuela production increased in June and July compared with the first four months of 2023 (Table 1). EIA projects that non-OPEC liquids will be 1% higher in 2H 2023 than in 1H and 2% higher in 2024 than in 2023. Middle East output is expected to be 3.6% higher in 2H than in 1H 2023, and 2.4% higher in 2024 than in 2023.

Of course, these are projections but they do not support that meme that supply will fall.

That’s supply but what about demand? Figure 2 shows both OPEC and EIA supply and demand data, and corresponding projections. At the bottom of the chart, the blended supply-demand balances are indicated. They suggest that the supply-demand deficit in the second half of 2023 is unlikely to be greater than in the same period in 2021 when Brent monthly average price did not exceed $83.54 and WTI did not reach $81.50 per barrel.

I’ve shown in previous posts that supply-demand balance is a terrible indicator of oil price and that comparative inventory does a much better job. Figure 2 shows Brent comparative inventory (C.I.) and the price-inventory volume yield curves for 2021 and early 2022 (orange), and 2022 through the present in blue.

The orange circles and arrow near the text “4Q 2022 excursion” represent the early part of the price-discovery excursion that resulted from the first failed analyst meme about the China oil-demand rebound. The blue circles and arrows near the text “1Q 2023 excursion” mark the second part of that price-discovery excursion including its reversion to the blue yield curve in May and June 2023.

The promotion of the second false meme about global supply deficits triggered a third price-discovery excursion away from the blue yield curve leading to the August 2023 data point at -69 mmb less than the 5-year average and $85 per barrel.

Projecting a perpendicular line from the August data point to the blue yield curve and following a horizontal line to the y-axis indicates a market clearing price of about $75 per barrel for Brent. That means that its $85 average August price is about $10 over-priced. The market is now including a $10 premium based on the failing supply-demand deficit meme that analysts have been pushing for months.

Analysts like to blame their failed calls on broader market trends like a weak global economy, a strong U.S. dollar and rising interest rates.They don’t understand that oil price is the macro indicator because oil is the economy.

They haven’t yet grasped that the oil paradigm that guides them isn’t working, and hasn’t been working very well for at least the last five years. I am sometimes accused of being negative about oil markets but I am neither pessimistic nor optimistic.

I am a scientist. I do not rely on what others say unless the data supports those views. That doesn’t mean that I’m right.

What perplexes me most about mainstream analysts is their certitude about reductionist cause-and-effect axioms that become memes when enough of them repeat what the other said.

Oil markets are complex systems in which uncertainty is given. That said, my sense is that global oil prices will probably fluctuate between $75 and $90 for the rest of 2023, and that the broader trend will be generally lower.