Crude Oil’s Collapse Is Coming
James Bibbings, July 21st, 2009
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On May 14th I wrote an article called "Oil at $25 a Barrel? Pump Gas $1.50? The Time Is Coming Soon" in it I made several projections as to where I thought the oil market would go. One of those projections was for the period "Early to Mid Summer" seeing as it's just past the middle of July that puts us squarely at mid-summer; time for an update.
To refresh everyone; as of May 14th this is what I had to say for prices through this time of year. Recall when reading my prior call that oil was trading just under $60 per barrel and was charging upward at a torrid pace. The run up at that time also had a gigantic tidal wave of bullish "green shoot" sentiment behind it; I said this:
"In the short term, the crude oil rally which is currently taking place may continue up slightly higher. Over the next several weeks I expect crude prices to rise between $5 and $10 dollars to settle within the mid to upper sixty dollar/bbl level. This price increase will continue to be driven by the irrational exuberance currently plaguing both the equities and commodities markets. The hope that the economy has bottomed, although fundamentally unfounded, will likely give momentum traders more room to run with this rally. This will occur solely because the markets are willing to stay irrational for longer than most can stay solvent. As a result, although I do not buy into the view that "green shoots" are sprouting within the economy, it would be unwise to fight market sentiment in the near term.
Current Supply and Demand Forecasts
Before continuing, here is a brief overview of what the most recent OPEC, IEA, and EIA announcements are suggesting and factually reporting.
OPEC
On Tuesday of last week, OPEC announced that it thought global oil demand would increase during 2010, an estimate which helped to lift the market. It is this same sentiment, along with increased prices, that gave OPEC countries an incentive to cheat quotas and (more on this in a minute) lead them to raise production in June for the third straight month. June production came in at 28.441 million barrels per day, a slight increase from the 28.402 million barrels just a month ago. Although this increase seems small, every drop of oil that hits the market matters when global demand is down as far as it is. Further, this shows that OPEC countries still cannot play by the rules, especially in a recession while prices are rising. In fact they have an incentive to lead the market with improved demand forecasts. I wrote on this briefly in "Crude Oil, Opec, and Super Contango":
"Due to higher than normal oil and equity market correlation, in conjunction with falling demand and increased storage utilization, OPEC can do very little about global supply in the near term. Over the long term there is also little OPEC can do as their true market influence died decades ago. Time and time again the cartel has shown an inability to collude on prices...
The reason the cartel cannot effectively control supply is simple; even if all of the member countries but one stuck firmly to production guidelines, the defecting country would get rich at the expense of the other countries. Since each member country of the cartel wants what's best for itself, they ultimately desire to be the "defecting country." As a result there currently is, and always has been, simply too much financial incentive for OPEC members to cheat production guidelines."
At present production compliance within OPEC is at about 68% which further begs the question; "How reliable are OPEC's forecasts?"
IEA
Broadly, on July 10th the EIA said that demand would decline by 2.9% percent in 2009; worse than previous estimates. However, in contrast to that estimate, they expect demand to increase by 1.4 million barrels per day or a 1.7% jump in 2010. As for supply the agency suggested that a supply crunch would come by 2014. The terms of this supply crunch would require global GDP growth of 5% from 2010 until then; this seems overly optimistic to me. The IEA also suggested that non-opec production would rise more than expected due to strong growth out of Brazil, Azerbaijan, Canada, and Russia. According to the report non-OPEC countries should account for 60% of global production, up from 33%, and will produce an additional 410,000 barrels per day in 2010. Lastly and I think most importantly, the IEA's David Fyfe said:
"There seems to be a thawing in the attitude towards international oil companies gaining access to Russia...Much of the increase in demand may be gobbled up by rising non-OPEC output and OPEC natural gas-to-liquid, so there may not be much more room next year for a huge rise in OPEC output."
This is problematic for demand forecasts suggesting that 2010 demand will be much improved.
EIA
On July 15th, according to the EIA, US inventories were down more than expected and dropped by 2.8 million barrels. They also reported that distillate supplies rose 600,000 barrels and that gasoline supplies rose 1.5 million barrels. This is good news for crude oil producers and refiners, but bad news for shipping companies and the overall market. A lot of what has occurred here is a shift of where oil is stored and the form that it is stored in. The EIA, on July 7th spoke on demand and rose estimates that it would increase slightly in 2009 and climb 170,000 barrels per day to 83.68 million. Although they pointed out that this was still well below 2008's 85.41 million BPD consumption. They also touched on 2010, and suggested oil demand would increase by around 1 million barrels per day globally to 84.79 million.
After reviewing supply and demand estimates and reviewing my thoughts from May this is where I think oil is headed during the next 3-6 months.
