Hurricane/tropical storm? No big deal. Some explosions rattling ships in the Persian Gulf region? Yawn.
Oil markets, probably more than any commodity markets, have long been criticized as responding excessively to short-term developments and ignoring long-term trends. If that’s the stereotype, the past few days pretty much put that to rest. Yes, oil is higher than it was at the start of the month. But given all that’s gone on, why it isn’t soaring at even greater altitudes is a topic of significant discussion.
By Friday morning, about 1 million b/d of U.S. offshore Gulf of Mexico production had been shut in as a result of the impending arrival of Tropical Storm Barry. The explosive incidents – were they bombs, were they mines, we’re still not really sure–weren’t all that long ago, but they’ve faded from memory.
Instead, the just-concluded week ended with three reports – from the Energy Information Administration of the U.S. Department of Energy, the International Energy Agency and OPEC itself – that all said pretty much the same thing: the world needs a lot less oil from OPEC next year than it is producing now. Rejecting the short-term concerns for the longer-term numbers is the sign of a more mature rational market, not the crazy one of caricature.
In a recent story here on FreightWaves, we made the point that in the last roughly 8-10 years, global oil demand has gone up about 10-12 million barrels per day. OPEC has let the rest of the world’s producers, particularly the U.S., claim more than 95% of that growth. Next year, in order to keep markets balanced, those three reports are saying that OPEC can’t have any of the anticipated growth in demand and will have to give up even more of what they have now.
“Clearly, this presents a major challenge to those who have taken on the task of market management,” the IEA said in summing up its forecast.
Prices have moved up considerably this month, so dismissing the impact of both geopolitical and weather factors shouldn’t be done lightly. WTI on CME sunk below $52/barrel on June 17; it surpassed $60/barrel this past week. On that same date, the price of ultra low sulfur diesel (ULSD) on CME was less than $1.80/gallon; it took a run at $2 this past week.
But the combination of Middle East tension and a storm ripping through the heart of the production in the Gulf of Mexico – to say nothing of the closure of the Philadelphia Energy Solutions refinery, the biggest in the Northeast – a few years ago would likely have sent markets higher.
Then why didn’t they? Because of the same reasons that the various reports cited here are proclaiming that world supply and demand balances are vulnerable to being thrown out of whack next year: the rest of the world is producing lots more oil.
It isn’t just a U.S. shale story anymore. For example, the OPEC monthly foresees non-OPEC supply of petroleum (which includes natural gas liquids) rising to an average of 66.87 million b/d from 64.43 million b/d in 2019. That’s a more than 2.5 million b/d increase. But the EIA, for example, sees U.S. output rising only about 1 million b/d from the end of this year to the close of 2020.
Meanwhile, the EIA sees world oil demand rising to an average of 101 million b/d from just under 99.87 million b/d in 2019, an increase of about 1.2 million b/d. That’s a 1.3 million b/d gap between new supply and new demand.
There’s an old line about good times: every day is like Christmas. For OPEC., those numbers evoke a Christmas metaphor in another less pleasant way: there’s no room at the inn.
The result is that what OPEC simply refers to as the difference – demand less non-OPEC supply less OPEC NGL output – is the oil needed by OPEC. According to OPEC itself, it was 30.6 million b/d in 2019, and it will be down to 28.74 million b/d in the first quarter 2020 and 29.27 million b/d for all of 2020. Current OPEC production estimates vary but for the sake of simplicity, assume 30 million b/d as a good number. Ultimately, that difference is why oil is not higher given weather and geopolitical factors.
The IEA numbers are even more bearish, projecting a first quarter call on OPEC crude – the call is their version of the OPEC difference – of 28 million b/d. In the IEA report that came out Friday, the agency noted that OPEC hasn’t produced that little oil since 2003. It took the U.S. invasion of Iraq to help push that number down in 2003.
If OPEC were to get down to 28 million b/d in the first quarter, it would mark a decline of 5 million b/d from the all-time high levels of autumn 2018. That would be an unprecedented decline and highly unlikely to happen. OPEC’s agreement among itself and with the Russian-led group of other nations in the OPEC+ group, reached earlier this month, called only for a continuation of the cuts that already had been exceeded to get down to the 30 million b/d level.
So if supply and demand get out of whack in 2020, what happens to the excess? It goes into inventories. The IEA went so far in its report to say that the “main message” of its July summary was that supply exceeded demand by 900,000 b/d in the first half of the year even with OPEC slashing output. The IEA’s expectation had been that the OPEC cuts plus healthy demand growth – which never emerged – would lead to a decline in inventories of 500,000 b/d.
In the dry understatement of the week in the oil industry, the agency noted: “Clearly, market tightness is not an issue for the time being and any re-balancing seems to have moved further into the future.”
The setup for 2020 is likely to mean that the growth in inventories will continue. That’s great news for oil consumers, maybe not as good news for transport services with the U.S. fracking industry as their customers.
That is ultimately why the market isn’t reacting more vigorously to the various bullish stimuli around it, like storms and bombs. There’s so much oil out there, and likely to be even more of it, that there’s just no need to worry about its supply.