Production For Oil Will Pull Price Downward Despite Any Economic Demands

by: D. H. Taylor


The U.S. economy is expanding and crude usage is heading higher.

Production levels still outpace demand.

Despite any increases in economic activity, oil prices may be going sideways.

The U.S. and the world economies are expanding. Typically, this would mean more demand for oil, pushing up prices. However, the world virtually awash in oil supplies despite any increases in economic activity would draw down oil supplies. Now, it appears that even more supply is hitting the market and this will likely continue to depress the price of oil.

I had been long oil from about $51.00 via a risk reversal; I bought calls and sold puts. Recent supply activity has pushed oil prices down more. I wanted to take a much closer look at production levels in the United States and Canada. Comparatively, they are on the very same track, as the chart shows.

One of the things about this chart that sort of pops out at me is that despite the biggest recession in world-wide history, The Great Depression notwithstanding, there was hardly any down move in production. Typically, when there is a major contraction in economic activity, you see that in nearly all of the charts you look at. Economic contraction and charts heading lower mostly go hand in hand. And, here, oil production largely did not stop nor even abate.

However, there was major economic contraction. Usage for oil dissipated significantly over that period of time.

Clearly, two things have taken place in the chart above. First, when the recession showed up people buckled down and decreased expenditures. Driving saw a big decrease. This came from both personal miles driven as well as businesses cutting back on shipments and corporate travel. This trend stayed that way for several years. The decline started in 2008-2009, and driving really did not pick up until about the end of 2014.

That in itself is interesting because if you look at the chart for price during that period of time, you see a lack of cohesion with price and demand:

In 2008 through to 2009, there was a massive selloff in oil. Then, even though the economy did not pick up, the price of oil did. During that time, again with the graph above, driving faltered significantly and production remained flat.

This does not suggest that oil is only used for driving. It is to suggest that driving, a big consumer of oil via gasoline, does have an effect on the price from simple supply and demand. However, the price of oil became irrational with respect to what was being produced and consumed. Again, there was another selloff.

Now that consumption is clearly picking up and has edged higher than its previous levels, one would think that price would be moving higher. Despite that simple rationale, production has been increasing in the United States and Canada significantly. I expect this to continue.

As it turns out, hydraulic fracturing, a.k.a., fracking, is getting less and less expensive as a means to getting oil. If the cost of this process continues to drop, then you will likely see more and more supply coming to market.

Ultimately, there is far too much supply coming to market to counteract the uptrend in demand. This is good news if your economy is beginning to expand and you would rather there not be a tax on consumption from rising oil prices. This is, however, bad news if you are an economy that is dependent upon oil for revenue. Without naming names, some economies hope to command the world with their oil reserves. This will be difficult if there is too much supply coming from various other areas of the world.

I was long oil. I took a moderate loss with a hedge. I think we will likely get above the $50.00 handle at some point again. However, I do not see that happening any time soon. Largely, with the price of oil I can see a lot of really choppy trading ahead and no clear direction. This is where specs get killed. My advice, until the supply levels find a new equilibrium level compared to demand, sit back and watch a lot of sideways happening.

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

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.