Have you ever read something and it sounded so nonsensical that it caused your brain to hurt? Maybe make you want to curl into a ball and acknowledge that numbers don't make any sense anymore? That's me as of the time of this writing. After news broke from Venezuela regarding the oil production and consumption picture and how bad they see it, it's hard to wrap my brain around the situation but in this piece I will examine what this news is and what it means not only for the oil market but what it means for investors in companies like Memorial Production Partners (NASDAQ:MEMP), Approach Resources (NASDAQ:AREX) and Legacy Reserves (NASDAQ:LGCY), as well as for the United States Oil ETF (NYSEARCA:USO) and other oil-related ETFs moving forward.
A bold statement from Venezuela
On multiple news outlets, including CNBC, it can be seen that oil prices have retreated a little bit after Eulogio Del Pino, Venezuela's Oil Minister and the President of PDVSA, the country's state-run oil company, came out and claimed that the oil market is nearly 10% oversupplied. When I first saw the headline, I thought that's not really news because if you look at the size of the oil glut today, using OPEC's estimate of OECD stocks (for commercial use) and factoring in my own estimate for the size of the excess oil at sea, the overall oversupply for all petroleum products across these categories seems to be about 15.8% so, if anything, I figured his statement was bullish rather than bearish.
After reading it some more, however, I found that something was amiss. According to the article, which cited the PDVSA's internal TV station, Del Pino wasn't referring to the amount of extra oil in storage right now compared to where it probably should be in order to hit the recent historic average. No, he was referring to how much oil is being produced today above and beyond what is needed on a day-to-day basis. For clarity, check out the image below, which shows his statement on the matter.
For those of you who have just read the statement, Del Pino is saying that, in order for supply and demand to match, global oil production would need to fall by 9 million barrels per day. To put that in perspective, the total amount of oil produced by the U.S. alone comes out to 8.493 million barrels per day, so this plus nearly the amount of oil currently being produced by OPEC member Ecuador would need to come offline in order for no build to be taking place.
How large is the glut?
From time to time I've tried to figure out how large the global oil glut is on an absolute basis. Using an article I wrote here where I looked at the OECD onland commercial storage glut, I concluded that (using updated numbers) the amount of oil today above the historical average of what should be expected comes out to 448 million barrels. If you add to this the 122.7 million barrels I estimated from excess oil out at sea, this implies a glut of 570.7 million. Of course, non-OECD nations also likely have oil on hand but I can't find reasonable data to support how large any excess amounts there might be.
What are the facts?
The fact of the matter regarding the oil picture is that no reputable source that I've come across will support a claim anywhere near this large. OPEC's own numbers, for instance, suggest that, with global oil demand at 94.27 million barrels per day this year while production (assuming the rest of the third quarter and all of the fourth quarter this year look the same in terms of OPEC output as the first two months of the quarter did) should be about 95.54 million barrels per day. This implies a glut of 1.27 million barrels per day so any decrease greater than that will, keeping all else the same, lead to a shrinking glut.
In order to put this in perspective, if we make the assumption that oil production could fall by the 9 million barrel per day number provided by Del Pino without seeing prices increase high enough to cause output to rise and without seeing a drop in demand, then the glut number I provided above would vanish in about 74 days. However, we need to keep in mind that just because oil inventories are above an average does not mean that they are at a glut. We could probably see total inventories (OECD plus at sea) come in at a healthy 150 million barrels beyond these averages and still enjoy very attractive oil prices. With this adjustment in mind, the glut would disappear in just 54 days.
An alternative to using OPEC's own numbers would be to use those provided by the EIA (Energy Information Administration). Their estimates indicate that with supplies at 96.20 million barrels per day this year and demand at 95.36 million barrels per day, the glut would be just 840 thousand barrels per day throughout 2016. If we keep everything else in my estimates the same and see 9 million barrels per day come offline, we would reach average inventories in 70 days. Adding an extra 150 million barrels that would probably be acceptable, we would hit that limit in only 52 days.
Based on the data provided, there's something seriously wrong with the numbers circulating major news sites right now. Either there is faulty reporting (most likely accidental) on the issue or Del Pino's understanding of the global oil market is severely lacking or he knows something that OPEC, the EIA, and other sources do not know. An alternative to this is that Del Pino wants nothing more than a deal to be reached with OPEC and non-OPEC members to stabilize prices and is doing everything in his power to push prices lower before a meeting between some producers later this month in order to incentivize that, which may make the most sense here, especially when you consider that Venezuela has been perhaps the hardest hit of all OPEC nations and desperately needs higher prices before it can even hope to survive economically.
Disclosure: I am/we are long AREX, MEMP, LGCY.
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.
Additional disclosure: I own LGCYO, not LGCY