Why The Oil Market's Scared

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Includes: BNO, DBO, DNO, DTO, OIL, OILK, OILX, OLEM, OLO, SCO, SZO, UCO, USL, USO
by: Daniel Jones

Summary

In this article, I wanted to go over some mixed oil data that shows why the market has been scared recently.

While some data was positive during the week, the picture was certainly more bearish than bullish.

Thankfully, with the worst of the SPR oil sales likely taken care of for this year, some pressure should be alleviated closer to the end of the year.

Oil prices tanked on June 14th and remained under pressure the rest of the week after news broke that inventory data came in worse than many had anticipated. In addition to mixed, but generally bearish, inventory metrics, we also saw, during the week, growing production, weak demand in one key area, and a continued rise in the rig count. In what follows, I will go through this data and give my thoughts on what it all should mean for investors in oil-related companies and in the United States Oil ETF (NYSEARCA:USO) and other oil-related ETFs.

Mixed inventory numbers

*Created by Author

According to the EIA (Energy Information Administration), crude inventories for the week managed to fall by 1.7 million barrels, dropping from 513.2 million barrels down to 511.5 million barrels. Though this is a nice reversal compared to the surge in inventories seen a week earlier, and it was better, by far, than the nearly 2.8 million barrel build estimated by the API (American Petroleum Institute), it was below the 2.5 million barrel decline forecasted by analysts. In the graph above, you can see the trend that stocks have taken over the past 52 weeks and, in the graph below, you can see the same graph but zoomed-in on so that you can more easily see weekly fluctuations.

*Created by Author

Sadly, crude stocks were more the exception than the rule, however. Take, for instance, motor gasoline inventories, which grew by 2.1 million barrels to 242.4 million barrels during the week. Fuel ethanol stocks also climbed, growing by 0.5 million barrels to 22.5 million, and residual fuel stocks increased 1.4 million barrels to 41.3 million. Meanwhile, propane/propylene stocks and distillate fuel stocks rose 2.4 million barrels and 0.3 million barrels, growing to 52.8 million barrels and 151.4 million barrels, respectively. The biggest addition, however, came from the "Other" category of petroleum products, which grew by 2.7 million barrels during the week to 287.6 million barrels.

So one-sided were the increases during the week that only one product category managed to report a decrease. If the EIA's numbers are accurate, then kerosene-type jet fuel stocks dipped by 1 million barrels, falling from 44.6 million barrels down to 43.6 million barrels. Despite this, total crude plus petroleum product stocks for the week grew by 6.8 million barrels, jumping from 1.3465 billion barrels to 1.3533 billion barrels.

Rising production and mixed demand

*Created by Author

In addition to seeing some bad inventory numbers on the whole, we also saw, after a brief respite in last week's report, domestic oil production resume its growth. During the week, according to the EIA, domestic output grew to 9.330 million barrels per day, up 12 thousand barrels per day (or 84 thousand barrels for the week) compared to the 9.318 million barrels per day seen a week earlier. It should be noted that growth was hindered by a 13 thousand barrel-per-day drop seen from Alaska during the week, without which production would have jumped 25 thousand barrels per day. In the graph above, you can see the trend that production has taken over the past 52 weeks and, in the graph below, you can see the same graph but zoomed-in on so that you can more easily see weekly fluctuations.

*Created by Author

On the demand side, things were mixed. If the EIA's estimates are accurate, motor gasoline for the week averaged 9.269 million barrels per day, down from 9.318 million barrels per day a week earlier and down a lot from the 9.762 million barrels per day seen a year ago. Using the four-week average, demand shrunk by 1.2% from 9.641 million barrels per day last year to 9.528 million barrels per day in this report. Meanwhile, the four-week average picture for distillate fuel demand remained strong, growing from 3.827 million barrels per day last year to 3.984 million barrels per day this year.

Another uptick in the rig count

In addition to seeing inventories rise, on the whole, we also saw the rig count increase during the week, as reported on Friday. According to Baker Hughes (BHI), the US oil rig count for the week came in at 747 units, up 6 from a week earlier. This represents a huge increase over the 337 units seen in operation a year earlier. Meanwhile, in Canada, the oil rig count soared higher by 17 units to 91. This is meaningfully larger than the 28 units in operation the same week last year. Keeping all else the same, both of these imply that higher production should come about in the future.

A look at government oil

Earlier this year, I covered a bit of what investors should expect from the US government in regards to sales from the SPR (Strategic Petroleum Reserve). Under the 21st Century Cures Act, the government is expected to sell around 10 million barrels from the SPR this year. Over a three-year period, total sales under this legislation should total 25 million barrels. In addition to this, the Bipartisan Budget Act, under Section 404, is calling for total sales worth $2 billion between 2017 and the end of 2020, with around 7.5 million barrels expected for this year. Of course, this assumes $50 per barrel oil, a number we are below right now, so the total sold this year could very well be more. If oil averages, say, $47 per barrel this year, we could be looking at closer to 8 million barrels sold instead. In the image below, you can see expected sales under various forms of legislation moving forward.

*Taken from the EIA

In my prior article on the topic, I pointed out that, so far, we hadn't seen any negative consequence from the sales, but recent rises in inventories suggest that this picture is changing. That said, just how much do we need to sell before SPR inventories no longer flood the market this year? If the EIA's estimates are correct, the government has, so far, sold about 10.5 million barrels since the start of 2017. This means we are more than halfway through the sales for this year, with around 7 million barrels left to be unloaded (maybe 7.5 million barrels if we average $47 for WTI). This is positive because it shows that some of the pain this year has already been put on and should ease as we near the end of 2017.

Takeaway

Based on the data provided, it's clear that this past week's oil report was anything but great. Oil investors right now are scared because they see this as a sign of a growing glut, not a shrinking one, but we also need to be aware of the longer term picture. In the past, I have pointed out positive developments shaping the market that seem to be ignored. Add to this that the worst of SPR sales are behind us right now (for this year) and I'm not terribly concerned moving forward.

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.