2009 Oil Estimates

Includes: DBO, OIH, OIL, USO, XLE
by: Nick Abe, CFA

On Friday we wrote a morning commentary about the expiring WTI January contract (for oil) and the huge price discrepancy between it and the January Brent contract and the February WTI contract. The reason for this discrepancy, we assume, is that someone got caught long oil and was unable to take physical delivery of it due to lack of storage.

So the January contract traded under $33/bbl while the February contract stayed above $42. Quite an arbitrage spread if you had the storage capacity and it certainly doesn’t speak to the health of the current oil market. Yet we remain bullish.

There are a couple of facts about oil. In 2008 demand was about 85 million barrels per day and supply was around 85 million barrels per day. Obviously when oil prices were extremely high, we saw all kinds of new supply coming on. I read a story about some dentists and doctors in Saskatchewan that set up their own oil rig in the summer. Even still, the supply of oil from 2004 ($37.66/bbl average price) to 2008 ($97.98/bbl average price) only increased from an estimated 83.1 million barrels per day to a peak of 85.69 million barrels per day (those are EIA estimates).

During the same time period, demand increased from 82.41 million barrels per day to a peak of 86.94 million barrels per day (currently they estimate we are at 85.27 million barrels per day). OPEC made up about 30-32 million barrels per day of supply during that time period. They have some of the cheapest production in the world, but are planning to cut to 25 million barrels per day. Assuming they can only get to 27.5mm (due to cartel cheating) then world supply goes from 85.69 barrels per day (Q3 estimate) to something in the neighborhood of 81.19mm bbls/day to 83.19mm bbls/day.

That of course assumes that all the increased supply of the past 4 years does not disappear due to lower prices.

World estimates for 2009 oil demand usage are falling, but most estimates are still in the 85mm bbls/day range. That means, once OPEC cuts are in place (even though we know they are going to cheat), there will be a daily shortfall of approximately 2 to 3mm bbls/day in supply. I have seen estimates put the amount of crude at sea (as floating storage) at between 50mm and 100mm barrels. Meaning, within 50 days of the supply cut (and once again, bear in mind that these numbers completely overlook any shuttered non-OPEC production) all of the floating storage will be used up.

I honestly don’t know how the market will react to that news, since, as I’ve said before, I don’t have a degree in psychology, but I would have to imagine that what is currently holding the crude market down is the excess inventory. If that is removed I have to imagine the crude price goes higher, albeit not back to $100/bbl as there would be plenty of shuttered production to come back online to demand.

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