As I see it we have an oversupply of two things right now; oil production and opinions offered by pundits for the oversupply of oil! Tune into any financial media outlet and without fail you’ll hear someone talking about how much oil the global economy is producing. The abundance of this narrative alone is enough to cause the price to drop. Most recently, the markets have been harping on OPEC’s decision to not cut production last week, sending the price of WTI down another 15% to the lowest they’ve been in nearly a decade.
When the mid-2015 inventory figures from the International Energy Agency (IEA) were reported in July they showed global production of 96.4mm bbl/d versus demand of 93.1mm bbl/d, an oversupply of approximately 3.3mm bbl/d.
Paint me a skeptic but I don’t buy it and neither does David Pursell, an analyst from Tudor, Pickering, Holt and Co.(TPH) – one of the industry’s most savvy macro forecasters. In a recent call, Purcell contrasts the IEA figures with the OECD inventory figures over that same three month period and comes up with much different numbers. Inventory levels only showed a 90 million barrel add to inventory levels, which during a 90 day period would indicate an oversupply of only about 1 million barrels per day. The IEA is an agency comprised of 28 cooperating governments worldwide that is almost laughably inaccurate when it comes to their reporting and notorious for revising past data long after it has relevance.
In fact, the IEA’s October reconciliation for those same mid-2015 figures increased demand by 800k bbl/d and lowered supply by 100k bbl/d- nearly a 1 million barrel per day swing! This confirms our suspicions that their original data published in July was materially overstating reality. But as the saying goes, there are three sides to every story; your side, their side and the truth. My best guess is that the truth is somewhere between 1-2 million barrels per day which is a far cry from the 3.3mm bbl/d that the current price and narrative has been arm waving about.
Working off a new assumption of, say, 1.5mm bbl/day supply overhang, let’s start to extrapolate out two trends currently underway which I think are reasonably safe to expect will continue.
Firstly, production from the North American markets has finally started declining due to fewer oil wells being drilled and the natural decline curve of existing wells already in production tapering off. As we know full well, the boom in drilling was fueled by high oil prices and the industry’s binge on cheap debt offered to them by a yield-starved financial sector. That cheap capital has dried up as the oil price has fallen and we will simply not see a return to the drilling activity we witnessed at the peak in early 2014.
Estimates range from 500k to 1 million barrels per day drop in North American production for 2016. Let’s err on the side of caution and call it a 500k bbl/d drop in production.
Secondly, with oil prices this low we’re seeing an uptick in demand that is expected to be about 1 million bbl/d in 2016. North American SUV sales are up 10% year-over-year and GM’s largest growth market is China where SUV sales are up a staggering 230% y-o-y. I had heard reports that the wealthy Chinese have developed a taste for larger autos in what appears to be a case of imitation being the highest form of flattery and these SUV sales figures would appear to confirm that.
The above assumes “all else equal” and that we don’t see a wildcard situation such as Iranian production coming to market or a major disruption of supply from an act of terrorism. Black swans are impossible to predict with any accuracy but my inclination is that if there are any it lends itself to supply disruptions more than anything else.
There is a saying on Wall Street that “the price of oil is set at the margins.” My conclusion is that this market is only marginally oversupplied and represents approximately 1.5% of the global oil market. If the above assumptions prove accurate then we could very well see an oil market that is in equilibrium if not undersupplied by the end of 2016. My guess is the price of oil begins to move higher long before that moment actually occurs. Perhaps OPEC has a better handle of actual supply/demand fundamentals than we’re giving them credit for and feel that if they can hold out just a little longer these low prices will fix themselves.
Then again, we all tend to find data to support our own biases one way or another. Perhaps Mr. Pursell and I are guilty of that too. Only time will tell who was right.
We should be seeing the added downward pressure of tax-loss selling throughout the end of the year so December could prove to be a great buying opportunity for the investor who has a medium-longer term time horizon.
This Holiday Season I’m buying my clients, family and friends a basket of oil stocks.
Courtesy: Eric Angeli
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