Looking Under The Hood Of The U.S. Oil Market

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Includes: BNO, CHK, DBO, DNO, DTO, DWTI, KMI, OIL, OLEM, OLO, SCO, SZO, UCO, USL, USO, UWTI
by: Scott Anderson

Summary

US total petroleum stocks hit another record high last week at 2,063.9 million barrels.

US domestic crude production is now declining at an annualized rate of about 800 thousand barrels a day.

Led by gasoline, petroleum consumption is up 4% vs last year.

For the past few months I have been researching oil and gas companies like Chesapeake Energy (NYSE:CHK), Kinder Morgan (NYSE:KMI) and others primarily trying to get a handle on the underlying bankruptcy risk in the sector caused by low oil and gas prices. The answer, not surprisingly, depends almost exclusively on where the price of oil is headed. For some perspective just two months ago oil was around $30, and CHK had just bounced off of $1.50 lows back up the $2.50 ballpark. Since then, oil is up nearly 50% getting close to $45, and CHK is knocking on $7.00, just a little shy of a clean triple. Maybe not a linear relationship, but you probably get the point.

US Weekly Petroleum Status Report:

To get an idea of what is going on with prices, let's take a look under the hood of the oil market by delving into the details of the EIA's " Weekly Petroleum Status Report". Released each Wednesday, the Weekly Petroleum Status Report contains weekly data for hundreds of series, including what I am primarily interested in, which is the weekly flows. Using this data set, we can walk each week from beginning petroleum stocks, adding all of our weekly inflows, subtracting the weekly outflows, and ending up with ending stocks. Any single week may not particularly useful, but by analyzing the flows over time, we can tease out some useful information. If you want to follow along, the excel file and EIA data I used in this analysis is available for download at Excel-Data-Junkies.com.

Petroleum Stocks:

The chart below shows us weekly petroleum price versus the ending total petroleum stocks. Looking back to early 2014, oil was around $100, and total petroleum stocks were a little over 1,700 million barrels. Starting that spring, petroleum stocks started creeping up, and by late summer, oil prices started to fall. For two years now, this has been the pattern, inventories continue to build, and prices continue to fall.

Clearly we can see that at least over time, inventory levels and crude oil prices are correlated, and this makes a lot of sense. If petroleum stocks are increasing, it is pretty solid evidence that oil producers are pumping more oil out of the ground than consumers are willing to purchase at the current market price. The chart below illustrates the problem.

Trailing 52 Week Average Inflows/Outflows:

Here we have trailing 52 week inflows and outflows charted against one another. From 2013 until the end of 2014, inflows and outflows remain fairly close. Then at the end of 2014, inflows take off, primarily thanks to increased domestic production of crude and NGL's. Outflows do pick up as prices fall, but by early 2015, the imbalance is 3-4 million barrels a week. A year later in the spring of 2016, if you focus on the last few months, it looks like the gap between inflows and outflows has finally started to narrow. Daily domestic crude production is now dropping at a rate of about 15,000 barrels/d each week. It may not sound like much, but annualized it's about 800 thousand barrels a day. On the other hand, consumption, especially of gasoline has noticeably increased thanks in part to the dip in prices. If you pencil it out, a scenario where we start seeing respectable weekly petroleum stock draws by the summer driving season doesn't seem that far-fetched, though it doesn't exactly seem inevitable yet either.

Domestic Production:

This chart shows us weekly domestic production, the largest of the inflows. After peaking last summer, production fell about 500 thousand barrels/day before stabilizing. By the early February 2016 we can see that decline has resumed, followed a few weeks later by a price bottom of $26 and subsequent recovery to the mid $40's.

The 2015 exit rate for production was 9.202 million barrels a day, and through 17 weeks of 2016 the average decline is about 15.5 thousand barrels a day per week. If this rate continues, we could exit 2016 at about 8.400 million barrels per day for an 800 thousand barrel a day year over year loss in daily production.

Outflows/Consumption:

Weekly petroleum outflows represent the petroleum stocks that move each week from commercial storage to retail locations for sale to the end user, and is our best proxy for consumption. The categories the EIA tracks are: Gasoline, Distillates, Jet Fuel, Propane, Residual Fuel Oil, and Other Oils.

Gasoline is the largest category making up a little less than half of weekly petroleum consumption. While gasoline consumption has been trending up for most of the last 2 years, there was a slight dip between December 2015 and January 2016. As gasoline prices fell, in February along with crude, consumption quickly picked back up and now look to be headed to levels not seen since before the "Great Recession."

Distillates, primarily diesel fuel are the second largest category of petroleum consumption currently running at about 3.75 million barrels a day over the last 52 weeks. Surprisingly, distillate usage has been declining over the last few months partly offsetting the increases in gasoline consumption. In the last few weeks this has turned back up, but two weeks doesn't make a trend.

2016 Year To Date:

Source: Excel Data Junkies

Through 17 weeks of 2016, inflows are down 19 million barrels and outflows are up 21 million barrels, leaving the total petroleum stock gains nearly 41 million barrels under where they were a year ago. Unfortunately for US oil producers, that just means the oil glut is growing at a slower rate of 3.7 million barrels a week instead of 6.1 million barrels a week.

Summary:

Oil prices continued to rise last week and into this week despite a strong build in total petroleum stocks. In the weekly data, we do continue to see consumption increase, and domestic production decrease, leading the market bulls to hope we can reverse the ongoing glut and start to see some material petroleum stock draws in a few months when the summer driving season gets into full gear. In my opinion, it is this hope that has driven the recent rally in crude oil prices and the stocks of oil and gas companies. At first glance, it seems like a fairly reasonable hope given the data we have in front of us. However, I will point out that this is far from certain. While the decreases in domestic production do seem pretty solid, and may even be accelerating, the primary risks I see to this scenario are imports and consumption.

Imports have been running pretty strong lately at a little over 40 million barrels a week and if they remain high could easily make up for the decline in production. At a weekly decline of 15 thousand barrels a day, that's just 105 thousand barrels a week, or 1/10 th of one supertanker load. Sure, it's cumulative, but for reference, 2007 net imports averaged over 86 million barrels a week, so the capacity to import is there as long as we have space to store it. Consumption, while up recently could be driven mostly by the price decreases that still have gasoline under $2.00 a gallon here in Houston where I live. Whether or not consumption will remain elevated and support higher prices is still an open question. For now, oil in the $40-$50 range seems reasonable, with large 2%-3% daily swings up and down following the news cycle. If consumption continues to head up, domestic production continues to decline, and imports stay relatively constant over the next few months, I see no reason why oil can't break into the $50's. However, If any of those conditions fails, and inventory builds continue well into summer, look out for oil to head back to the $30's.

For troubled companies like CHK, heading into 2017 with oil at $60+ with a solid upward trend line supported by declining US petroleum stocks should be enough of a life line to have a fighting chance at survival. On the other hand, hitting 2017 with sub $45 oil, $2.00 natural gas, and record petroleum stocks would likely be enough to sink CHK and others in a similar situation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.