New oil price fall is matter of “when”, not “if”, as inventory builds

Oil markets

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Oil storage Jun15bFinancial players have become convinced in recent months that the oil price will rise.  And so far, this has been a self-fulfilling prophecy.  Their buying has led to oil being stored all over the world – in tankers floating at sea and in shale oil wells, as well as in storage tanks.

Unsurprisingly, prices have rallied as all this product was being taken off the market.  But whilst it easy to buy oil in an over-supplied market, the buyers now face the more difficult task of trying to resell it at a profit as we move into the seasonally weaker months of Q3.

The chart above from the Wall Street Journal shows how the volume of oil in floating storage more than trebled between January – May, and is still more than twice the earlier level.  The volume comes from traders taking advantage of the difference between current and future prices (the contango) to buy today and sell to hedge funds and other financial buyers at a guaranteed profit in the future.

But Iran has also been storing oil on ships, to release on world markets if sanctions are lifted following a deal on the nuclear issue, perhaps in the next few weeks

In addition, of course, there is the record volume of oil inventory in the US, as I discussed last week.  Plus US shale producers have drilled 3000 wells in preparation to pump up to 1.3mbbls/day of oil once prices have moved higher.

Oil storage Jun15cAnd in Europe, as the second WSJ chart shows, oil storage has hit a record level of 61mbbls.

And finally, recent months have seen strong buying by China to fill its strategic petroleum reserve.  It had decided to raise the reserve to 100 days of normal demand.  But as a Sinopec executive told Reuters back in March this programme will soon be complete.

It clearly makes no sense for prices to rise on such artificial/temporary types of demand, when the International Energy Agency suggests surplus production is currently running at 2mb/day.

The problem is the record amounts of money that have gone into commodity hedge funds.  This has fallen slightly from the $80bn peak seen in 2013, but still stands at $69bn today.  And, of course, $69bn buys a lot more oil today than it did when prices were at $100/bbl in 2013.

These mounting surpluses are making life more and more difficult for producers in Europe and W Africa.  As I noted last year, Nigeria has lost its entire export market to the US, worth 1.3mb/day, and is instead having to send its oil all the way to Asia.  Now N Sea producers are facing the same problem, with tankers carrying the equivalent of a week’s consumption by the UK now heading to Asia instead.

Of course, as the saying goes, “money talks”.  So as long as financial players keep buying in financial markets, oil supplies will keep increasing.  But unused oil can’t keep being held in storage forever.  Eventually the fundamentals of supply/demand balances will cause prices to fall back to historical levels of $30/bbl or lower.

We cannot know what might be the catalyst for this development.  Perhaps it will be a panic over Greece, or an Iranian agreement, or something else entirely.  But barring geopolitical upset, it is not a question of “if”, but of “when”.

 

 

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