Does Oil Price Divergence Reflect Demand?

Includes: OIL, USO, XOM
by: Carlos X. Alexandre

The “Arab Spring” is not playing a big role into the oil price and is being viewed as old news, especially as far as West Texas Intermediate is concerned. However, Brent crude has taken on a life of its own, mostly due to Iran’s influence and predisposition to play politics with its core revenue stream. Disagreement among OPEC members is politically justifiable, because many are facing discontentment by their respective populations, and the added cash is crucial to providing the resources to quell the uprisings.

Brent has diverged from West Texas Intermediate, and is now carrying a risk premium of close to $20 per barrel over WTI. That premium differential is a reflection of geographic proximity and more accentuated dependency on the Middle East/North Africa sources by European markets, not demand

As far as European consumption is concerned, Reuters had an article on May 25 titled “Europe oil demand at 1995 lows as prices bite.” In addition,

Efficiency gains have reduced European oil demand over the past five years. Crude price changes do not normally have as much impact on retail demand as in the United States because tax in Europe makes up a much larger share of total fuel costs.”

OPEC knows the numbers and is caught trying to maximize revenue while facing declining demand.

The build up in U.S. inventories despite last week’s drop continues to provide mixed messages to the market. According to last week's inventory report published by the EIA,

Over the last four weeks, crude oil imports have averaged nearly 9.0 million barrels per day, 707 thousand barrels per day below the same four-week period last year.

Furthermore, the drop of 4.8 million barrels still leaves inventories above the “upper limit of the average,” as highlighted in the same EIA report. Gasoline inventories increased – also in the upper limit -- and we’re well into the driving season.

At 369.0 million barrels, U.S. crude oil inventories are above the upper limit of the average range for this time of year. Total motor gasoline inventories increased by 2.2 million barrels last week and are in the upper limit of the average range.

Is China consuming it? The Chinese government doesn’t talk much and keeps the numbers close to the vest, although it will become rather obvious in due time that volume will fall well short of projections, as statistics are assembled by all means available.

I understand that “peak oil” is of concern to a segment of the population, and is viewed as a driving factor. But as we progress, disruptive technologies will solve the issue, and eventually render oil as a less relevant fuel than it is today.

Exxon Mobil (NYSE:XOM) announced a big find in the deep waters of the Gulf of Mexico on June 8, with the “potential for more than 700 million barrels of recoverable oil equivalent” -- or more than 8 years of world supply. Granted that finding the fossil fuel is only part of the equation, and bringing oil to market adds other challenges, especially in deepwater.

Exxon’s report on energy outlook to 2030, available as a pdf at its website, has an interesting statement.

ExxonMobil expects global energy demand in 2030 to be about 35 percent higher than in 2005. Demand growth would be far higher – with 2030 energy consumption nearly double 2005 levels – were it not for expected improvements in energy efficiency.

And outside of alternative fuels and new discoveries, efficiency is the main reason why consumption will not grow to satisfy “peak oil” theories. To illustrate the idea, I shall point to Michigan State University's College of Engineering, only one of many institutions in the constant pursuit of energy solutions. If the topic “peaks” your interest – no pun intended – click on this link and view a video featuring Dr. Norbert Mueller describing the “wave disk generator,” a revolutionary new engine.

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