Following the OPEC+ decision to extend the output cuts as agreed to last December for nine months through March 2020, WTI crude futures prices dropped 4.81 % ($2.84/b). The reason was that the 1.2 million b/d cut from the October 2018 level has proven to be inadequate. OPEC’s May production averaged about 2.5 million barrels per day lower than it was last October, and still, global stocks have built.
“Inventories have gotten out of our hands in the past months. It’s unfortunate. It’s fair to say that inventories did build in a manner we would like to avoid,” Saudi Energy Minister Khalid Al-Falih said in the press conference following the OPEC meeting on Monday.
In a bid to try to support oil prices, he said,
We are going to attempt to bring inventories down to the 2010-2014 range rather than the bloated 5-year average. That’s another calibration of where we’re going.”
However, that seemed to be contradicted by his assurances that the Saudis would not constrain production enough to bring down stocks. “We are very close to our customers,” he said and that KSA would supply what they wanted.
I calculated the average of OECD inventories over the 2010-2014 period, and it comes to 2.669 billion barrels. That compares to the rolling 5-year average in May of 2.9 billion. EIA’s latest estimate of inventories was 2.902 billion.
Oil Price Implications
I have a regression model that fits prices based on OECD oil inventories and WTI crude oil prices for the period 2010 through 2018. The model provides a reasonably high r-squared result of 80 percent. However, there are periods where the price deviates greatly from the model.
When I put 2.669 billion barrels (the 2010 to 2014 average) into the model, it returns a WTI price of $91.47/b.
The only way they could get inventories down to the 2010-14 average would be a massive production cut by Saudi Arabia. But that would violate Mr. Al-Falih’s promise to keep customers well-supplied.
Furthermore, if it did severely restrict production to lift prices, it would be creating a huge incentive for shale producers to increase production, which in turn, would require deeper and deeper cuts by the Saudis.
I don’t see the new inventory goal as realistic. Instead, I expect Saudis to increase or decrease production to meet customer demands. Inventory levels are likely to drop in the third quarter but then are likely to rise once again in the fourth quarter and first quarter of 2020. And, that assumes a cut of 2.5 million barrels per day from last October, which is why the announced rollover was underwhelming to the market.
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