Art Berman Newsletter: April 2021 (2021-3)
Super-Cycle Silliness: Why Oil Prices Will Not Increase Much Further
Monthly oil prices have nearly quadrupled since April 2020 and that has some analysts talking about an oil super-cycle. What nonsense.
We’re near the end of a price increase that began at less than zero back to the where prices were before the pandemic. That’s a recovery not a rally.
Futures price fell to -$37.63 on April 20, 2020 and reached $66.09 on March 5, 2021 (Figure 1). WTI has fallen $6.93 (-10.5%) since then to less than $60 per barrel.
The $66 level on March 5 was higher than after the Saudi refinery attack in September 2019 and after the Soleimani assassination in early January 2020. Why?
The mainstream view is that demand for oil will explode now that Covid vaccines are available. I expect demand to improve but not even the most optimistic forecasts suggest that it will return to pre-pandemic levels any time soon.
Figure 2 shows OPEC’s demand forecast and EIA’s supply projection. Oil demand was more than 100 mmb/d in the final two quarters of 2019. It is about 7 mmb/d lower now at 93 mmb/d. OPEC expects it may rise to 98 mmb/d by the end of 2021. That’s a big improvement but still several million barrels per day less than before the pandemic.
Oil prices have increased to $60 per barrel because markets are concerned about adequate supply. Both supply and demand are important but it’s their balance that matters to markets. Demand is a mysterious force that is beyond anyone’s control. Supply is tangible and markets reckon it can be controlled or at least modulated with price.
So, when demand collapsed in March and April 2020, over-supply was addressed with record-low prices. Now that demand is recovering, supply must increase and price is there to help it. The fact that price increased from -$37 to $66 per barrel doesn’t mean a thing about its future trajectory once it reaches the level needed to ensure future supply.
Figure 3 shows WTI price in March 2021 CPI (consumer price index) -adjusted dollars. The average since 1974 is $62.63. The average price for March 2021 is $62.48. Prices have recovered to the 47-year average. A return to normal is not a call for the next oil super-cycle.
Oil prices cannot be whatever people think they should or might be. They are constrained by storage levels. OPEC knows this. That’s why it targets inventory because lower inventories will result in higher oil prices.
Higher price is not arbitrary or capricious. It is a cheerless and grudging matter for markets and done only when absolutely necessary.
The beauty of comparative inventory (C.I.) is that if you tell me a price that you think oil may be, I can tell you what has to happen to C.I. in order to get there. I have discussed the details of comparative inventory in a recent post.
Figure 4 shows the relationship between WTI spot price and total U.S. petroleum inventory from 2014 to the present. Two yield curves describe different periods of price formation. The red curve fit 2014 through 2016 data based on the market’s sense of supply urgency. The blue yield curve fits 2017 through present price-volume data. It reflects a lower sense of supply urgency than the 2014-2016 yield curve.
The chart suggests that there is no way that WTI can get to $80 per barrel or more at any comparative inventory value unless markets re-value oil to 2014-2016 supply-urgency levels. Although that is possible, it seems unlikely given the amount of spare capacity that OPEC+ has withheld from the market since March 2020.
Some analysts are suggesting that we are at the beginning of the next world super-cycle. That seems somewhere between premature and stupid at least for oil.
Commodity super-cycles are caused by transformational periods of economic development and massive capital investment. They are characterized by demand growth and high commodity prices that may last for years.
Figure 5 shows world crude oil and condensate supply and price from 2000 to the present.
An oil super-cycle began in about 2003 and ended in 2014. It was caused by a plateau in oil supply in the face of rapid economic growth in developing countries like China, Russia, Brazil and India.
High oil prices resulted in development of tight oil, and renewed exploitation of oil sands and deep-water objectives. An additional 10 mmb/d of supply were added after 2010. Prices collapsed from over-supply in 2014 ending the super-cycle.
The present oil supply situation could not be more different than in the early 2000s. World output today is low because there is too much supply for existing demand. It is low because OPEC+ is withholding 8 to 10 mmb/d. It is artificial. Global debt and unemployment have never been higher. This is not the stuff of super-cycles.
After the 2014-2016 price collapse, the U.S. oil-directed rigs count almost tripled at an average WTI price of $54 per barrel (Figure 6).
Once prices reached that level in early 2018, rig counts flattened despite higher prices than anticipated removal of Iranian exports with U.S. sanctions announced in April of that year. Rig count didn’t increase because investors withheld capital from oil companies. That was the beginning of the end of the shale boom. Investors demanded financial reasons to bring more capital to oil companies.
Last week, 152 U.S. oil companies told the Dallas Federal Reserve Bank that they were profitable at $52 per barrel WTI price. Why should markets pay more? The executives of those same companies said that they expect WTI to be $61 per barrel by the end of 2021.
$61 has been a strong resistance level for WTI since mid-March. It would neither surprise me if that level were exceeded nor if price consolidated in the $50 range in coming weeks and months. The data does not suggest that prices will move much higher for long and certainly does not support the beginning of a new super-cycle.
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