Oil Is At An Important Crossroads
I just want to wish everyone a Happy Thanksgiving! I am back from my trip and the publication schedule will be returning back to normal. I hope you find the article today helpful as I brainstorm through how I am currently seeing the oil market.
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We are approaching an important crossroads for the oil market. At $78/bbl WTI, we are approaching both a technically important level and a psychologically important level. We started the year around this price and if oil prices continue to fall and break $76/bbl, we are at risk of testing $66 to $70.
The weakness in the oil market comes on the heels of substantially lower total oil inventories. According to the IEA, OECD total oil inventories (including SPR) fell below ~4 billion bbls for the first time since 2004. But despite lower overall global oil inventories, commercial total oil inventories are flat for the year thanks to the SPR release.
And on a coverage ratio basis, you can see we have been flatlining since the start of the year. Since the SPR release was the main reason why inventories stayed flat, one has to wonder why the end of the SPR release isn't a catalyst for oil prices going up.
Think about it for a second here, if the whole world knows that the US SPR releases are going to unwind by the end of December, why are:
Brent timespreads selling off and near contango.
Why are oil prices back to where they started for the year?
And why are traders not scrambling for barrels for the start of next year?
In my view, there are just far more questions than answers at this point. In addition, oil bulls could add even more ammunition to the discussion by addressing the fact that:
The oil supply side appears to be disappointing to the downside with the recent OPEC+ production cut.
US shale oil production showing slower growth ending the year near ~12.4 million b/d.
And years of low upstream capex investment resulted in even more supply disappointments down the road.
I think the only way to address some of those earlier concerns is by revisiting how we got to $125/bbl and why we are back to this price level. For starters, we must rewind back to the Russia/Ukraine invasion. At the time, oil prices rose on the geopolitical instability, which then manifested itself into worries about supply disruptions in Russia.
In April 2022, IEA published a report warning that over the coming months, Russia could lose up to ~3 million b/d of production. This turned out to be dramatically false as Russian oil production has stayed flat since then. But the IEA report prompted the global coordinated SPR release effort (~1.5 million b/d). Despite the incoming SPR release, the oil market rallied and prices reached a level that started demand destruction.
And for those of you that are unsure about the demand destruction thesis, you just have to look at the monthly oil demand chart provided by the EIA on US gasoline.
It was very evident that the summer of 2022 saw lower gasoline demand than in 2021 despite COVID restrictions being completely lifted. This, unfortunately, is the result of lower demand from elevated prices.
Coupling the lower-than-expected demand with China surprising to the downside with its insistence on zero COVID, and the end result is that the demand side disappointed by ~1.5 million b/d to the downside.
The end result was an oil market that was supposed to be in a ~3 million b/d deficit turning into zero (1.5 million b/d demand disappoint + 1.5 million b/d of SPR release).
And to OPEC+'s credit, they have announced an effective production cut of ~1 million b/d, which should help push commercial inventories lower post the SPR releases.