A Chunk Of The Oil Glut Just Vanished

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Summary

In this article I decided to write about new data from the EIA regarding oil supply and demand data and what it means for investors.

While supply and demand data is somewhat mixed (with a tilt in some areas toward the negative), updated data suggests that something positive just happened.

If the EIA is correct, a sizable amount of oil just came off the global glut and, as a result, the inventory picture looks far more bullish than before.

The other day, the EIA (Energy Information Administration) released a report called the Short-Term Energy Outlook. In that report, the organization announced some interesting findings regarding the global oil market and what they expect moving forward. In what follows, I will dig into this data and give my thoughts on what their findings will mean (if they are, indeed, correct) 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.

Supply and demand is mixed

First and foremost, I believe it would be a wise idea to look at the supply and demand picture according to the EIA and how they believe it has changed. To some degree these changes have been for the better, while to some degree the changes have been for the worse. Take, for instance, the case of global supplies, shown in the table below.

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

Based on the data provided, global supplies this year should be about 96.04 million barrels per day. While this represents an increase of 230 thousand barrels per day this year compared to last year, it's actually positive for long-oriented oil investors because when you look at the data compared to what was forecasted a month earlier, supplies this year should be about 160 thousand barrels per day below what was estimated then. While this news is great, the data also shows that supplies last year were likely 90 thousand barrels per day above prior estimates, while supplies next year should be 220 thousand barrels per day above forecasts and a whopping 970 thousand barrels per day above 2016's levels (compared to a build under the prior data of 590 thousand barrels per day).

Overall, despite seeing bullish data for 2016 in and of itself, the supply picture as a whole will be more bearish than before. In part, this should be due to higher than previously forecasted OPEC production. As can be seen in the table below, OPEC output this year should be about 32.45 million barrels per day, about 40 thousand barrels per day above last month's estimate. What's worse is that next year's should be about 33.03 million barrels per day, an increase of 80 thousand barrels per day over last month's forecast. What this seems to indicate is that the EIA does not believe an OPEC deal will be material or that, more likely, production will increase next year despite the group's recent decision to cut production to between 32.5 million barrels per day and 33 million barrels per day. If OPEC does honor this decision, this could prove a nice upside surprise for long-term oil bulls relying on the EIA's data.

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*Source: Created by author with data from the EIA's Short-Term Energy Outlook

Another contributor to this is higher than expected production from the U.S. As you can see in the table below, domestic output should be about 8.73 million barrels per day this year, down 690 thousand barrels per day compared to last year's output and an improvement of 40 thousand barrels per day compared to last month's numbers. However, output next year should average about 8.59 million barrels per day, an increase of 80 thousand barrels per day compared to prior forecasts of 8.51 million barrels per day.

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

The picture for demand is also mixed but isn't, in my opinion, as bad as the supply data provided. As you can see in the table below, global oil demand next year should be about 95.33 million barrels per day, about 30 thousand barrels per day lower than estimated a month ago. This represents a year-over-year increase of 1.29 million barrels per day (compared to a prior estimate of 1.48 million barrels per day before). In 2017, the data looks worse, with a drop in forecasts of 110 thousand barrels per day and suggesting an annual increase of just 1.34 million barrels per day (compared to 1.42 million barrels per day before).

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

Though this looks negative, we should keep in mind the change made to 2015's data, where the EIA thinks output was 160 thousand barrels per day higher than previously forecasted. If we keep the same 2015 base estimate of 93.88 million barrels per day, the two-year increase in oil would come out to 2.79 million barrels per day, a modest decrease compared to the 2.90 million barrels per day estimated using last month's data. That's still negative but not so negative that investors should lament.

Keeping these supply and demand imbalances in mind, we arrive at the table below. What this data shows is the amount of excess crude (supply minus demand) this year compared to my prior forecast. Due to the changes made by the organization, the excess last year should have been 1.77 million barrels per day, 70 thousand barrels per day lower than last month's estimate, and the excess this year should be 710 thousand barrels per day, 130 thousand barrels lower than estimated before. However, due to the higher supplies next year and the lower demand forecast, the excess next year should be about 340 thousand barrels per day, which is far worse than the 10 thousand barrels per day the organization forecasted last month.

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

What about inventories?

Overall, what we see from all of this is that there are good and bad things reported by the EIA but the bad seems to overcome the good when you look through 2017. This is important to keep in mind but the most important thing relates to how large the global oil glut actually is. Keeping all else the same, if the glut vanished tomorrow and we still had 2017's data remaining unchanged, much, much higher oil prices would be realistic, so it's the amount of oil in storage that we need to keep an eye on.

In the table below, you can see what the picture should look like for oil storage in the U.S. This includes all commercial crude plus other commercial petroleum products. Based on the data provided, due to the positive changes discussed above, as well as a downward revision made by the EIA regarding oil inventories, stocks at the end of last year totaled 1.289 billion barrels, a decrease of 31 million barrels compared to what was forecasted a month ago. By the end of this year, inventories should have increased to 1.301 billion barrels, but this will still be a whopping 50 million barrels below last month's forecast for 2016. Even given the dour 2017 data, inventories here at the end of next year should be at around 1.272 billion barrels, a drop of 32 million barrels compared to last month's forecast and 29 million barrels below 2016's levels.

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

We can see a similar, though less pronounced, trend for OECD inventories, as can be seen in the table below. If the EIA is right, inventories last year were at about 2.967 billion barrels, 30 million below last month's forecast, and inventories at the end of this year should be 3.049 billion barrels, a decrease of 41 million barrels compared to the 3.090 billion barrels estimated last month. The only area where matters seemed to have worsened is with the OECD inventory levels for next year, which should see an increase (compared to last month's data) of 11 million barrels, rising to 3.073 billion barrels. This is rather negative and suggests that a glut may (if the EIA is correct) last a bit longer than anticipated, but this also assumes their pessimistic demand and supply data is correct.

Click to enlarge

*Source: Created by author with data from the EIA's Short-Term Energy Outlook

Takeaway

Based on the data provided, investors have a right to have mixed feelings regarding this data; I certainly do. However, when you look at the data as a whole and what it means for inventories, the picture is fairly straight forward. At this time the picture for inventories on the global front just took a sizable haircut but if pessimistic data persists then things will be a tad worse off at the end of next year than we are otherwise forecasting. This also assumes, however, OPEC does continue to increase output year-over-year and that the economy remains sluggish, things that investors are right to wonder about but should not put a great deal of confidence into.

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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.