Crude Oil: The Market Is Rebalancing

| About: The United (USO)

Summary

Crude oil inventories posted a large 3.2 million barrel decline last week.

The decrease was largely due to growing demand from refiners as gasoline consumption soars.

With US production falling and supply interruptions in Canada, the global oil glut has largely rebalanced.

I expect crude oil prices to trend higher heading into the summer driving season.

Crude oil prices (NYSEARCA:USO) (NYSEARCA:OIL) have remained firm near $50 per bbl over the past few weeks, though prices are still up 80% from earlier this year. I believe the trend is for higher oil prices as the recent EIA Petroleum Inventory data suggests that the market is rebalancing. The report showed that crude oil inventories posted a 3.2 million barrel decline last week, versus estimates of a 2.7 million barrel decline. This was largely inline with the API report that showed an inventory decline of 3.56 million barrels.

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A look inside the numbers

As has been the case all year, the headline inventory number is being driven by the volatility in crude oil imports. These fell to 7.7 million bpd for the week, down 134,000 bpd from last week and up 9.5% from last year's weekly average of 7.0 million bpd. If imports had stayed flat week over week, the crude oil inventories would have fallen by 2.3 million barrels rather than the 3.2 million barrels drawdown.

Surprisingly, crude oil imports from Canada actually rose 18% to 3.1 million barrels last week. As a result this report does not likely take into account the full impact of Alberta wildfires which took offline ~1 million bpd of production. Expect imports to fall significantly over the next few weeks.

As for some slightly bearish data, US oil production actually rose 10,000 bpd to 8.75 million bpd. Though, this is largely from increases from Alaska due to pipeline deliveries. The more stable lower 48 production was down 8,000 bpd, good for an annual run rate decline of ~420,000 bpd.

Over the past 4 weeks, production has averaged 8.76 million bpd, down 7.9% from the 2015 average of 9.50 million bpd and down 10% from the 2015 weekly production high of over 9.7 million bpd set in April 2015.

With US production down 1 million bpd from its peak and another 1 million bpd offline from Canada, it is likely that the global oil markets are near balanced. Indeed, the IEA recently adjusted its estimate for the first half of 2016 oversupply from 1.5 million bpd down to 800,000 bpd. They also noted that this surplus would more or less evaporate in the second half due to growing consumption.

On the demand side, both gasoline and distillate consumption are rising. Refiners processed 16.4 million bpd, up 1% from last week's 16.2 million bpd, though still slightly under the 2015 weekly average.

Stockpiles of gasoline rose 1.0 million barrels. When adjusted for increased consumption, averaging ~9.6 million bpd, stockpiles are below 2015 levels at around 25 days of supply. Given that we are entering the summer driving season, stockpiles should trend lower.

As for distillates, stockpiles rose by 1.8 million barrels. While the stockpiles are still high at 149.6 million barrels, when adjusted for increased consumption, ~4.6 million bpd, they are at just under 33 days of supply, inline with the 2015 average, though still at historically high levels.

Conclusion

Overall, this was an moderately positive report for those that are bullish oil prices. On the supply side, US production is declining, with the uptick from Alaska likely short-term in nature. The trend is for even larger supply cuts as rig counts are still way below replacement levels. Given the recent trend, US production could fall to as low as 8.2 million bpd by the end of the year. Coupled with supply interruptions overseas, the oil glut is on the way out.

On the demand front, refined products consumption is surging for gasoline, up ~5% from 2015 levels and set to hit ~7% in the summer, and has recovered for distillates. Though, elevated stockpiles may pinch refining margins. Crack spreads have tightened in recent weeks and are running far below 2015 levels.

As for how to play an oil price recovery, most of the oil majors such as Exxon Mobil (NYSE:XOM) Chevron (NYSE:CVX) BP (NYSE:BP) Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) ConocoPhillips (NYSE:COP) are the way to go due to their size and dividends.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Disclosure: I am/we are long COP.

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.