Poor Oil Demand Meets Excess Supply; Prices Should Drop

Below is a nice set of charts from RBC Capital Markets depicting the basics of the crude oil and petroleum products markets. If demand/supply dictates price trends, crude oil prices are unlikely to go much higher in coming quarters and, in fact, should decline.

On the supply side of the equation, the world is awash in oil and petroleum products and signs are all pointing to a worsening of the situation.

• US crude inventories are at a 19 year high and OECD inventories are at a 10 year high.
• Refined products inventories have been flat in recent months, a period during which they normally decline significantly.

OPEC’s production has declined along with demand resulting in estimated OPEC’s excess capacity of nearly 6MM Bopd or 7% of global demand, the same level as during the 1990’s when oil prices were around $20.

US demand for refined products has plummeted and remains very weak as is OECD’s demand.

Total oil demand was 83.3MM B/d in Q109, a whopping 3.7MM b/d (4.2%) below last year, twice as large a decline as in Q408. Most analysts are assuming demand will recover during the rest of the year. But why would that be since we are still at the second derivative stage in the economic “recovery” process, i.e. the world economy is still declining!

China is doing better but it cannot, alone, make up for the huge demand shortfall. China consumes 7.6-8.0M b/d and its consumption rate has declined in Q1.

Also, oil tanker rates have fallen to 6 year lows and have not shown the typical seasonal bounce in April, indicating continued poor current demand.

While one can build a bullish scenario for oil over the next 3-5 years (see Tony Boeckh: Another Oil Supply Shock Ahead and China Buys Gold), the shorter term outlook seems to point downward.

Disclosure: No positions.

Comments

[Mark Alley:]

Don't bet on it. Freya's comment is correct--demand from major economies will pick up, and faster than a 3-5 year horizon. And the article fails to note that oil is priced in dollars, which should speak volumes about price.

May 21 10:10 AM

[31October:]

The author is correct about western economies (look at USA fudged employment numbers, German industrial collapse, etc.), and there could be a sustained decline in oil due to demand destruction. The author will probably be correct for a year...

...But eventually,maybe a couple years, oil will *explode* from restricted supply meeting increased demand. 1/3 of global oil comes from Saudi fields that are in decline, (provable because they did not increase drilling & production when oil was high.) The USA gets get more oil from Mexico than from Saudi Arabia, but Mexico will be an oil importer within a couple years. Pemex's biggest well is declining at 15% per year and in three years, it will only produce 500,000 barrels per day. By 2012, the two biggest producers start running low.

Also by 2012, China will grow, the US will eventually get employment back, Indians will be driving, and eastern Europe will have absorbed Euro-zone factory work, all AT THE SAME TIME that the US dollar plunges and reduced oil supply meets increased demand.

Anti-matter, I'd like to introduce you to matter.

May 21 11:10 AM

[E Thomas St.:]

Don't forget that the value of the Dollar makes a huge impact on the price of Oil. Supply, Demand, and Conversion Value.

May 21 01:21 PM

[The Aft Deck:]

Forget an Oil Drop, $70 is my target on it by end 2009, falling dollar and demand shift could see that as high as $80

May 21 02:22 PM

[Jasper M:]

HERESY!!
Freya,
Needn't be "forever". Six years seems a certainty to me, and that means 6 years of demand destruction.
And if credit deflation props Up the dollar (despite the best efforts of all involved), that will provide further pressure on oil.

May 21 03:32 PM

[OilFinder:]

Be wary of the hype about Indians driving tons of new cars. There is much evidence they're on their way to switching to a natural-gas based economy, thanks in large part to large new discoveries off their coast which have recently gone into production:
www.business-standard..../

And another:
www.marketwatch.com/st...
^
"In February alone and at the low oil prices prevalent then, India's oil import bill of over $4 billion comprised nearly a quarter of the country's total imports. As the new supplies of natural gas replace other feed-stocks for consuming industries in coming months, the trade deficit on account of oil and oil products will narrow.

Government officials reportedly estimate that at current prices, the D6's peak production capacity will effectively shave off India's oil import bill by $9 billion -- more than twice February's oil imports."

I don't think that's as true in China, but I wouldn't be surprised if they make some switch from oil to NG in some industries. There is a lot of LNG capacity coming online in the world right now and you can be sure China will take advantage of it, especially if oil prices start going too high again.

May 21 03:48 PM

[AssetReset:]

Oil equities are my ultimate hedge:

Excellent dividends across the board in case of further market drops (better than my best MM/bond)
Play on increase in oil
Hedge against drop in dollar
Hedge international recovery before US

May 21 04:09 PM

[Alex Filonov:]

Unfortunately, physical supply and demand is less important than supply and demand of futures. The same funds which lost many billions last year on oil futures are buying them again now.

May 21 10:51 PM

[igggy:]

Natural gas seems to be a great alternative to oil especially in the US. I can't wait to switch from an oil furnace to a gas one once we have a gas line put in. People seem to forget that there are alternatives to oil in most applications. Plus, the new EPA standards will start making an impact on gas consumption.

I am bearish on oil for the next 5-10 years. I think it's all 'thesis' trading right now. Green shoots, weak dollar, China, blah, blah, blah. I think the picture will change dramatically by the end of the year and we'll be looking for a 'safe haven' again.

May 22 07:52 PM

[KIT:]

On May 21 01:21 PM E Thomas St. wrote:

> Don't forget that the value of the Dollar makes a huge impact on
> the price of Oil. Supply, Demand, and Conversion Value.

Normally it does like USD and gold normally move opposite but they moved together for most of last year. You simply can not raise the price of oil ( for any reason ) if in fact no one is buying it. This fact will be shown true when the day comes that OPEC pumps one barrel of oil and ALL the worlds storage is full. The price of all barrels after that one is ZERO. We may see this effect in NATGAS first as its storage is running out too.

Would you pay for gas if you fill your tank and the pump keeps running? The fuel on the ground has no value.

May 23 08:01 AM

[dcb:]

Most western european counties and Japan have never used as much oil as they did in the 70's. This can actually happen with a consistent governmental policy. You are correct that growth will occur in emerging countries, but not having as developed a system of infrastructure they can diversify (think brazil). If the US actually decided to have a rational energy policy, and emerging economies adopt policies that move them along a smart path you can't make this prediction for the future. Don't forget the carbon issue. I'm not saying what you say isn't true, but it is based on the premise that the future will look like the past. I don't think you can do that.

I think you are better of with the global water fund with supply and demand issues than oil, but perhaps a mixture?

I would like to point out that China adopted higher fuel efficiency standards than the us (don't know where Obama's new ones stand)


On May 21 11:10 AM 31October wrote:

> The author is correct about western economies (look at USA fudged
> employment numbers, German industrial collapse, etc.), and there
> could be a sustained decline in oil due to demand destruction. The
> author will probably be correct for a year...
>
> ...But eventually,maybe a couple years, oil will *explode* from restricted
> supply meeting increased demand. 1/3 of global oil comes from Saudi
> fields that are in decline, (provable because they did not increase
> drilling & production when oil was high.) The USA gets get more
> oil from Mexico than from Saudi Arabia, but Mexico will be an oil
> importer within a couple years. Pemex's biggest well is declining
> at 15% per year and in three years, it will only produce 500,000
> barrels per day. By 2012, the two biggest producers start running
> low.
>
> Also by 2012, China will grow, the US will eventually get employment
> back, Indians will be driving, and eastern Europe will have absorbed
> Euro-zone factory work, all AT THE SAME TIME that the US dollar plunges
> and reduced oil supply meets increased demand.
>
> Anti-matter, I'd like to introduce you to matter.

May 23 08:52 AM

[MattZN:]

I think oil prices are well within the realm of chaos theory now. I look at inventory levels and normally those would bode ill for future prices, but at the same time the unprecedented contango we had earlier in the year has significantly skewed the meaning of those inventory levels. If a large enough percentage of the inventory is caught up in contango arbitrage the actual capacity available for spot sale is far lower then current levels would suggest.

People very easily forget that storage has a time component to it too. For example, consider a 80% storage level where 100% of the stored oil is designated for spot sale -- 30 days storage tops. Now consider the same 80% storage level but where 50% of the stored oil is being held for arbitrage 8 months ahead. There is a massive difference between the two even though the storage level is the same.

The only thing we know for sure is that the mess will probably play out before the end of the year since most of the arbitrage done early in the year was for 9-12 months ahead.

So, go figure... who knows what the hell will happen.

-Matt

May 23 02:31 PM