US futures market rally boosts US and OPEC oil output

Oil markets

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US oil stocks Jun15Whisper it quietly to your friends in the futures markets, who are convinced oil prices will soon surge higher.  We don’t want to upset them as they work at their spreadsheets, and send their electronic trades down specially constructed lines at near the speed of light.

But global oil demand growth has already more than halved at just 0.6%/year.   And as the latest International Energy Agency monthly report notes (their emphasis):

“OECD industry oil stocks built by a steep 38.0 mb in April, to stand 147 mb above average levels, as refined-product stocks moved to their widest surplus in over four years.”

That really is quite a lot of surplus oil.  And the US is doing particularly well at building surplus inventory, as the chart shows.  Its levels remain at record highs, with the latest weekly figure 13% higher than a year ago.

US oil, gas Jun15Last week also saw the publication of BP’s annual Energy Statistics review.  It showed that US oil and gas production remains on a steep upward curve:

  • Oil production has been rising at an annual rate of 9%/year since 2009 (green line)
  • Oil consumption has actually been falling slightly over the same period
  • Vehicle miles travelled per driver is back at 1995 levels, whilst autos have also become more fuel-efficient
  • Meanwhile gas production has been rising 4.5% over the same period (blue line)
  • And it, of course, is still much cheaper than oil on an energy equivalent basis
  • So the trend of fuel conversion from oil to gas remains very attractive, with lower prices and abundant supply

There is also the great irony that the flow of funds betting on higher oil prices is actually allowing more oil to be produced, not less.  As the Wall Street Journal has reported:

“Wall Street’s generous supply of funds to U.S. oil drillers helped create the American energy boom. Now that same access to easy money is keeping them going, despite oil prices that are languishing around $60 a barrel.

“The flow of money into oil has allowed U.S. companies to avoid liquidity problems and kept American crude production from falling sharply. Even though more than half of the rigs that were drilling new wells in September have been banished to storage yards, in mid-May nearly 9.6 million barrels of oil a day were pumped across the country, the highest level since 1970, according to the most recent federal data.”

The oil cartel OPEC have similarly been taking advantage of their generosity, producing 1mb/d above its quota in May, and 1.8mb/d about its forecast for demand.

The problem is that a whole generation of oil traders have never known a period when prices were set by markets, not central banks.  They therefore assume these vast surpluses can therefore somehow be wished away.  But instead, their money is leading to a bigger bust for oil prices down the road, not the boom that they expect.

The amount of cash being poured down holes in the ground to produce more oil is vast – $16.7bn of secondary equity offerings took place in Q1, the highest since the boom began in Q3 2010.  And at the same time, the drilling companies are becoming much more efficient in their operations.

In the Eagle Ford field, for example, Statoil has cut its drilling rigs from 3 to 2, but still lifted production by a third.  As it notes, “necessity teaches the naked woman to knit”, and in this case the necessity is clear:

We can’t control the commodity prices, but we can control the efficiency of our wells. The industry has taken this as a wake-up call to get more efficient or get out.”

Investors who continue to ignore these developments will get a wake-up call of their own one day, as the oil price resumes its decline to historical price levels around $30/bbl.

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