The Oil Picture Is More Bullish Than The EIA Realizes

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Includes: BNO, DBO, DTO, DWT, NRGD, NRGO, NRGU, NRGZ, OIL, OILD, OILK, OILU, OILX, OLEM, OLO, SCO, SZO, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, WTID, WTIU, YGRN
by: Daniel Jones
Summary

In its latest report, the EIA revised oil data in a way that the market perceives to be quite bearish.

Though we are looking at a glut, the data leaves out important considerations that turn the picture more bullish.

If Russia upholds even half of its bargain and/or if OPEC sees production fall further, the situation is fine for the bulls moving forward.

The first few days of August have been bloody and ugly for oil investors. Due to fears centered around a slowing global economy caused by the Trump Administration's trade war against China, oil prices have tanked and with that drop we have seen many of the oil and gas companies come crashing down as well. Even recent data provided by the EIA (Energy Information Administration) through its monthly STEO (Short-Term Energy Outlook) report shows that slower demand growth and (for next year at least) more robust supply growth might prove to create challenging conditions. That said, when evaluating this data, it's important to take all relevant pieces into consideration because, although it should be taken into consideration, there are valuable assumptions being disregarded that change the picture for the better.

Some revisions in supply and demand

There are only two factors that determine whether oil prices should be higher or lower: the supply/demand balance moving forward, and the degree to which there's a glut or shortfall of oil today. The first informs what the second will look like, and it's only how much oil is in storage that, at the end of the day, will determine whether pricing should move higher or lower. Today, for instance, if the EIA's report is accurate, total OECD inventories imply that there exists a glut among those developed nations of about 20.6 million barrels (using third quarter ending estimates).

In the table below, I provided a breakdown of supply and demand data on a global scale and also gave a look at the implied difference between the figures for 2018, 2019, and 2020. What the data shows, for instance, is that, last year, supply stood at 100.72 million barrels per day, about 0.05 million barrels per day higher than previously anticipated. This year, supply is actually weaker, but this should be made up for between last year and what is projected for 2020. On the demand front, we can see that 2018 was a bit weaker than previously estimated. The same can be said, unfortunately, for 2019 and 2020, with demand coming in 0.09 million barrels per day lower this year than expected in the EIA's July report, and for next year, the difference is 0.06 million barrels per day.

*Created by Author

Taking all of these figures together, you can see in the table that excess inventories last year were greater than previously thought. This year, the data actually happens to balance out, but in 2020, we should see supply exceed demand by 0.28 million barrels per day, or about 0.13 million barrels per day higher than July's report indicated. On the whole, spread across the three-year period, this all translates to an extra 73.13 million barrels more than anticipated that's spread across the globe.

Two different groups that deserve a deeper look are the US and OPEC. In the table below, you can see production data covering the same time frame for each of these. What the data illustrates is that, in the US and among OPEC nations, production this year will actually be weaker than previously anticipated, while in 2020, OPEC will see output come in about 0.06 million barrels per day stronger than what July's report suggested.

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Inventories poised to rise… or are they?

Based on the data provided here, it's clear that the EIA currently expects excess production this year of about 0.11 million barrels per day, followed next year by 0.28 million barrels per day. As a result of these figures, it's expected for both OECD and US inventories to continue rising for the foreseeable future. In the table below, for instance, you can see both sets of inventories forecasted for 2018 through the 2020 period.

*Created by Author

If the EIA is accurate, US commercial inventories should end 2019 at about 1.292 billion barrels, an increase of 30 million barrels compared to what we saw in 2018, but actually 1 million barrels lower than previously anticipated. In 2020, we should see a further increase of 30 million barrels to 1.322 billion, with this number coming in 6 million barrels greater than July's forecast suggested. OECD stocks, meanwhile, should grow from 2.861 billion barrels last year to 2.901 billion barrels in 2019 before rising an additional 58 million barrels to 2.959 billion barrels next year. This 2020 ending figure is about 25 million barrels greater than the 2.934 billion barrels the EIA anticipated previously.

If what the EIA is projecting turns out to be accurate, this could mean a lot of pain for long-term oil investors. This is because, assuming a 60-day upper range to commercial supplies, the inventory level at the end of next year implies a glut among OECD nations of about 58.6 million barrels. Though this is not horrible, it's large enough to probably cause some disruption to pricing, but it's important to keep in mind that there are two assumptions where I believe the EIA is being overly aggressive on.

The first and biggest of these is Russia. Right now, Russia is a party to the OPEC cut agreement, and in the first few days of July, the nation produced only 10.79 million barrels of oil per day. Under the agreement, this number will likely rebound to the amount they agreed to, which is about 11.19 million barrels per day, before long. This year, the EIA believes that Russia will produce 11.45 million barrels per day, while in 2020, they expect them to produce 11.43 million barrels per day. Assuming the nation holds true on its agreement and if cooperation among OPEC and certain non-OPEC nations continues, matching their pledge in both years would remove 182.74 million barrels of oil from the world. That alone could change the outlook for oil bulls.

A smaller issue that needs to be addressed is OPEC output, which continues to decline due to sanctions on Iran and economic and sanctions-related issues when it comes to Venezuela. This year, the EIA expects OPEC's output to average 30.13 million barrels per day, and while the first half of 2019 saw output average 30.21 million barrels per day from the group, output in the past couple of months has dipped south of 30 million barrels per day and will likely continue falling some. Next year's forecast for 29.79 million barrels per day is on the right track to where we seem to be headed, but if Venezuela collapses entirely and/or if we see any outages from Libya or Nigeria, we could easily see output fall to eventually 29.50 million barrels per day.

Takeaway

Right now, there's a great deal of pessimism centered around the oil space, but in my view, those sentiments are misplaced. Yes, there are legitimate concerns regarding demand thanks to recent political issues, but on the whole, the oil market looks to me to remain bullish. Even though the EIA's own data points to a bearish outlook seeing Russia stick to its side of the deal for another year and a half and/or seeing continued declines from OPEC alone can easily leave the market balanced for the foreseeable future and, in turn, justify higher prices than what we are seeing today.

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.