Tight Oil Inventories Support Record Prices

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Bloomberg radio featured an energy expert late this week who claimed the ‘world was awash in oil’ and prices were being manipulated upward by ‘Wall Street speculators’. We are not sure what data he is looking at, but global inventories and demand/supply metrics point to a tight crude oil market in our opinion. This environment is supporting higher crude oil prices – and has pushed the WTI futures market into ‘backwardization’, a bullish condition where current prices are higher than futures prices.

The IEA in a report issued this week estimates that world oil demand will increase by 0.9 million barrels per day to an average 89.2 mln bpd in 2011. Demand will increase by a further 1.3 million bpd or 1.5% to 90.5 mln bpd in 2012.

Meanwhile the IEA estimates that global oil supply rose by 1.0 mb/d to 89.3 mb/d in October from September. The IEA has demand at 90.2 million a day for the fourth quarter, so the supply short fall is now estimated to be around 0.9 million b/d. The IEA said a series of production outages in the North Sea and in countries such as China, Syria and Yemen meant that supplies of crude oil have not grown as fast as projected.

With regard to the IEA report the Financial Times reported Friday that the market remained tight (emphasis mine):

The International Energy Agency has warned that the oil market supply and demand balance remains tight, supporting prices above $100 a barrel despite weakening economic growth in Europe and elsewhere.

The western countries’ oil watchdog said in its monthly report, released on Thursday, that oil inventories in rich countries stood in September below the five-year average for a third consecutive month for the first time since 2004.

The IEA said that there was clear fundamental support for “stubbornly high prices”. Oil inventories in Europe fell in September to their lowest level in nine years and the IEA warned that preliminary data suggested a further drop in October despite weakening regional economic growth.

oecd europe oil stocks

The following chart from the Financial Times article illustrates how tight the European inventories are – the lowest in nine years - which explains the robust pricing available for Brent crude:

Meanwhile the US EIA’s report was also issued this week, and it forecast crude oil demand gains in 2011 and 2012. World crude oil and liquid fuels consumption will grow from its record-high level of 87.1 million barrels per day in 2010 to 88.2 million BPD in 2011, and will reach 89.6 million BPD in 2012.

None of these reports, or inventory data, indicate a world that is ‘awash’ in crude oil. Only if you assume Libyan production returns to pre-war levels very soon can you make an argument that the market is balanced – otherwise supply is very tight and will remain so. We expect crude oil WTI prices to breach the triple digit level before Christmas – which would be very positive for our LSGI holdings.

U.S. Gasoline Spending Hits Record

Americans are on pace to spend a record $489.7 billion on gasoline in 2011, which is $100 billion more than they did in 2010. The only year that came close was 2008, when U.S. motorists spent about $448 billion on gasoline. In 2008 the U.S. average price peaked at $4.114 a gallon, but prices quickly declined from those summer highs

at the pump

The Los Angeles Times reports that growing global demand and rising U.S. fuel exports are leading to ‘increasing pain at the pump’. One analyst expects a gallon of regular to climb as high as $4.50 a gallon in California by Easter. And they note ‘If you think gasoline is expensive now, just wait until next year: A combination of growing global demand and rising U.S. fuel exports could send gasoline prices to record highs in 2012.’
The following chart in the LA Times article illustrates the trend toward higher gasoline prices:

Record US Refinery Exports

It was also reported last week that U.S. refiners exports of refined fuels surged to an all-time high as an average of 895,000 barrels a day of refined fuels in August were shipped compared with 730,000 barrels a day during the first half of the year.

Diesel was a major export, and a majority of the shipments went to Central and South America. Exports of U.S. refined fuels are expected to increase, with global demand projected to rise sharply in the coming years, analysts say – which should keep fuel prices higher than they otherwise would be in the U.S. During 2010 refined product exports averaged a then record 656,000 barrels a day, the seventh straight year in which refiners set a new high for fuel exports. In 2003, U.S. refiners exported a little more than 100,000 barrels of fuel a day.

In a slow growth economy these higher domestic prices are not helping consumers – but firms in the energy sector for the most part are doing well.

Crude Averages Over $100 Barrel in 2011

real oil price 1970-2011According to BP’s Statistical Review this year will be the first year when crude oil prices will average over $100 a barrel (Brent pricing). In real terms the average price is the highest in 147 years (since 1864 – keep in mind the ‘first’ well drilled for oil was in Pennsylvania in 1859).

Strong global demand coupled with supply issues in Libya, Yemen, Syria, and elsewhere have supported upward trending prices. In a recent report the IEA estimated that 90% of future growth in oil production will need to come from North Africa and the Middle East – but recent violence and instability will slow capital expenditures needed for such exploration and development activity. Net crude oil imports over the next decade or so will soar in China and India according to the report – and will actually decline in the U.S. as domestic production increases. The Eurozone will overtake the U.S. as the largest oil importer in 2015 according to the report.

The Financial Times indicated with the higher prices the Eurozone’s import bill has soared – raising additional headwinds in their combined economy. The long term trends in pricing and imports (projected in the IEA study) are illustrated in two excellent charts from the Financial Times:

IEA Outlook Report November 2011

The IEA issued a global energy outlook earlier this month and made a presentation to the press on long term trends. Some of their more interesting slides speak for themselves:

vehicles per 1000

Meanwhile U.S. crude stockpiles fell 6.22 million barrels in the week ended Nov. 18 to 330.8 million barrels, according to Wednesday’s Energy Department report, the biggest drop in nine weeks. Supplies were expected to climb 500,000 barrels. European crude oil inventories remain at 8 year lows as concerns over supplies disruptions rise with North Africa and Middle East unrest.

Bloomberg reported on how tight the energy markets remain:

Inventories of crude and refined products in industrialized nations fell below the five-year average for a third consecutive month in October, the first time that’s happened since 2004, according to the Paris-based IEA. Stockpiles declined by 11.8 million barrels to 2.68 billion. . . . “Inventory levels and spare capacity in commodities, certainly in the oil sector, are a lot lower than they were in 2008,” said Colin O’Shea, the London-based head of commodities at Hermes Investment Management Ltd., which has about $2 billion in raw-material holdings. “I don’t feel that the demand loss that we could potentially have now is the same as it was in 2008.”

Goldman Sachs Group Inc. raised its forecast for West Texas crude to $102 a barrel for the first quarter based on supply/demand metrics. JP Morgan Chase cut the West Texas Intermediate price forecast for next year to $107 per barrel from $110 and lowered its Brent outlook to $112 per barrel from $115.

Oil Supply Disruption Threats

With the nuclear development issue heating up with Iran the Financial Times ran an article on how many of the countries in Europe and North America could deal with any supply shortfall using their strategic petroleum reserves, even if the amount was relatively large. What the world is missing according to the article is the fact that India and China have very slim petroleum reserves – and likely would drive the price of crude oil on the market to new highs in a bidding frenzy should supplies be threatened. The article explains:

…With limited strategic reserves to fill any gap in the event of an Iranian-triggered supply disruption, China and India could – and most likely, will – panic, moving to hoard oil.

Philip Verleger, an independent oil economist, has documented the problem in a report entitled Is the World Prepared for a Disruption of Iranian Production?, the best account so far of the oil price and economic implications of rising tension in the Middle East.

Mr Verleger warns that China and India are both big buyers of Iranian oil and not members of the IEA, and that “the elimination of Iranian exports” to China and India “could ignite a bidding war” for oil similar to that witnessed in the late 1970s after the Shah’s collapse.

This low probability, high impact event is one that is difficult to model – but is another argument for buying companies with reserves in politically stable and physically secure parts of the world. But current events are much more frequent, and have the potential to be much more disruptive then we have seen in decades.

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About Joseph Dancy