One Barrel at a Time
"The man who moves a mountain begins by carrying away small stones." - Confucius
The five-year OECD average is a proxy for where we're "supposed to be" for the market to consider itself balanced. Whether adjustments for certain products or infrastructure line-fills should be factored in matters little, it's the yardstick the market is using so we'll take it at face value. Here's the big picture:
OECD petroleum stocks (both products and crude) are approximately 250M barrels higher than the 5-year average. Total stocks as of June are below 2016 levels and heading lower after starting the year higher. What's surprising isn't the trend line, but what's happened since February. Historically stocks on a 5-year average have risen 60M barrels from February to May, but this year, they have declined by 10M barrels, a 70M barrel counter-seasonal draw.
Much of this is attributable to the US. Total stocks in the US are 175M higher than the 5-year average, but from February to May stocks fell over 10M barrels, a 55M barrel difference when compared to the 45M barrel increase in the 5-year average. Concurrently, the US began selling oil from the US strategic petroleum reserves (SPR) (over 16M barrels in 2017), and if we included those barrels, the counter-seasonal difference surpasses 70M barrels. Overall OECD and US inventories are drawing down at a time when it shouldn't.
Getting more granular, crude oil inventories typically build in the first part of the year (when demand is lighter), and then draw throughout the summer. What we're seeing this year is that despite the significant headwinds, crude inventories have drawn earlier and counter-seasonally.
The left graph shows OECD crude inventories increasing in the first three months, but then decreasing very much in contrast to the 5-year average thereafter. On the right side, the US chart shows the same thing; building, peaking and drawing earlier than historical norms.
What about products? Crude oil gets refined into products (i.e., distillates, gasoline, diesel, etc.), so you typically want to see both crude and product inventories drawing down as it means customer demand is robust (as opposed to refineries turning a crude stockpile into a products glut). Here are the products:
Oil products in OECD inventories have stopped building year over year, and US products have drawn deeper thus far than the 5-year average. We're still waiting on OECD products to trend lower, but we believe US products will continue declining throughout the summer.
Regardless of the fundamentals, this isn't what the market wants to see. Year to date, overall inventory appears to be flat, and the market wonders where's the large promised draws? Counter-seasonal draws aren't captivating because they aren't obvious, and weak inventory data in early June, higher production by Libya and Nigeria and the looming increase in US production added to the negative sentiment. The question became if inventories failed to draw in the summer, then how low will oil prices go? This question soon cascaded to others. What's to become of oil 2018? Are we lower for forever now? What's to become of us, and of course the obligatory question in all panicky movie situations, what about the children??
On the face of it, you'd think that the market is right, but ignoring a counter-seasonal draw means you're ignoring underlying demand. Just ask my daughter. Last month someone taught her all about counter-seasonal demand when they "accidentally" ate the chocolate cake she'd been saving for later. Fairly certain her howling meant that she knows counter-seasonal demand can be quite real. It's evidence that the undersupply of oil from 2016 has carried over to 2017. Moreover, we think the recent channel stuffing, floating storage destocking, and SPR sales may have masked an even stronger underlying demand than the market sees, which we'll discuss in the next article.
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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.