Comparative Inventory Tells Recent Oil Price Story

Analysts propose all kinds of explanations for why oil prices have fallen since late September. They are all somewhat true but the real reason is that comparative inventory (C.I.) has increased.

Crude plus refined products C.I. rose almost 2.5 million barrels (mmb) for the week ending January 5 (Figure 1). C.I. has increased +34 mmb since September 1 and WTI price has fallen -$18.75 since September 29.

C.I. goes up and WTI goes down. That’s a pattern that you can take to the bank. Until C.I. starts to decrease, oil price is going to wander aimlessly a few dollars above or below its marginal price.

Estimating marginal price is another useful aspect of C.I. Figure 2 shows the long-term trend line that correlates C.I. and WTI price. That trend line or yield curve suggests that the WTI average spot price of $72.49 last week was about $1.50 more than the marginal price of $71.

Excursions from the yield curve are common. They ordinarily occur when markets are testing the possibility of a structural change in supply urgency.

For example, C.I. for the first quarter of 2023 (Figure 2) was similar to the value for last week but price was about $5 higher. That was probably because in Q1 markets were testing the meme that the end of China Covid lockdowns would boost oil demand.

When that didn’t happen as expected, the second quarter average price dropped below the yield curve. In the third quarter, C.I. had fallen considerably since Q1, and markets were testing the meme of an impeding supply deficit. That didn’t happen either so now, price-C.I. data points are following the yield curve.

This morning (January 11), WTI price is more than $2.00 higher than it was yesterday because Iran seized an oil tanker in the Persian Gulf. Frankly, I am surprised that markets have discounted the geopolitical risk as much as they have since the Hamas-Israel conflict began in last year. I wrote a post in mid-October suggesting that prices could easily reach $100 to $120 if the conflict widened.

Markets have become progressively quicker to discount oil supply risk over the last five years or so. When the core of the Saudi refining complex was attacked in September 2019, WTI increased about $7 but the average price for the last week of September was lower than for the first week.

Traders make a living on the short-term movements of price. Most investors, however, are more interested in making a profit on price changes over a somewhat longer period of weeks to months. For them, I recommend adding comparative inventory to the tools they use.