Oil Inventories: Time for a Price Pop

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 |  About: The United States Oil ETF, LP (USO)
by: Gregor Macdonald

Total OECD inventories of Oil continue to build and are nearly back to the highs of the decade, last seen in 2006. Global oil demand in 2009 is projected to be 3.00% below 2008 levels, according to the IEA in Paris. The world’s auto industry is in collapse. Weak industrial demand for natural gas in North America has sent that fossil fuel below the cost of production. And there is rumored to be more oil floating in storage than ever before. So how, under these conditions, could there be an oil price spike?

Here’s how: global oil production is down 4.2% through the first 6 months following the July 2008 production high. With more supply falls on the way. The global economy only needs to wheeze and stutter a little to get oil to 60.00, under these conditions. If the global economy were to actually get off the floor, there could be a price spike sometime in the next 9 months. Not a huge one above 100.00. But enough to give us a warning. Should this happen, I would regard it as a preview of the much larger price spike that I see coming between Q4 2011 and Q3 2012.

While changes in demand are usually magnified against supply, I do believe it’s fair to say an annualized drop of 8.4% in oil production dwarfs a 3.00% projected drop in global demand. My hunch is that we may see neither extreme. I would not be surprised to see 2009 finish out with only a 2.00% drop yoy in global demand, and for the oil production decline to halt around 6.00%. That is still a pretty good spread, between the two.

One surprise has been how well non-OPEC supply has held steady, through the latest reported month of January. Sure, non-OPEC peaked years ago, in 2006. Still, it’s recovered some of the late Summer losses from Gulf of Mexico hurricanes, in the aggregate. That has surprised me, and some of my fav analysts in London.

The price of oil currently remains trapped between the spot market which has as its only concern clearing prompt supply, and the growing recognition that very high global inventories are looking down on falling production. Even a stabilization of demand now would finally cause the world to start chewing its way through those inventories. First signs of such appear to be coming through now in global gasoline, and diesel. For those of you looking for the proverbial W in the global economy, you may just get some petrol angst along with rising rates, risk appetites, and a short recovery that fails.