inventory check in

There are two main sources for inventory data available free on the internet.  The first is from IEA, the International Energy Agency.  Members of this organization include most of the so called developed countries of the world.  Most of the countries of Central and Western Europe, as well as USA, Canada, Japan, Australia, New Zealand, and Turkey are member states.  The organization was created in the wake of the first oil crisis in the early 1970s to make policy recommendations to promote energy security for the developed world.

Their latest month reports are available only to subscribers, but the prior months are available free.  The reports are much less detailed than the data available for the USA from the US Energy Information Agency (EIA), another good online source of inventory data, but the great advantage of the IEA is that they are global, and oil is a global market.   The data quality also may be somewhat worse because of limited reporting from many countries, but it is presented well, and their reports convey what is going on in the world market very effectively.    There are a couple charts from the December report I would highlight.

Supply has been exceeding demand for 6 consecutive quarters, and the excess supply is now close to 2 million barrels per day.

Over the past two years OPEC supply has been in decline, and non-OPEC supply has been rapidly increasing.   Supply changes in Iran, Iraq, and Libya have been responsible for most of the volatility in OPEC production.  For non-OPEC, the vast majority of the supply growth has been from USA tight oil.

The Saudis have not increased production, they have simply refused to drop their production and balance the market, as they have historically done in recent decades.

OECD total stocks are at record levels and continue to trend upward.  We are currently in a true excess supply situation.  This is totally different from the 2009 price crash, which was associated with a general financial panic, and not a fundamental supply-demand imbalance.  

There are a couple of different ways that this glut could end:  

1) Shut ins- The first and most jarring way for the market to balance would be for prices to get so low that they are below the cash-cost of the most expensive producers.  There was a recent article in Rigzone.com that described a report form Wood McKenzie estimating cash-costs for various producers.  Note that this is different from the so called break-even point, which also includes depreciation expenses for the capital invested in the project.  If the oil price goes below cash-cost for a producer that means he is actually losing more money for every additional barrel produced.  The logical thing to do would be to shut in your production when the price goes below the cash cost.  The article suggests that only .2% of world production is cash flow negative at $50 oil, and 1.6% is cash flow negative at $40.  Those producers tend to be US "stripper wells" (old and very low production wells), Canadian oil-sands, and North Sea deepwater.  Short dips below $50 might not cause this oil to be shut in because restart costs may be high, and a shut in can impair the productivity of a well.  In the case of offshore, several fields might use the same infrastructure, so it would be the economics of the entire area that might dictate when to shut in.  So if oil were to get below $40, that might be the magic number for production to shut in, and the imbalance to be resolved in the short term.  I would imagine that oil sands mining operations would be among the most likely to be shut in first, but I don't know enough to say for sure.

2) Natural declines and capex reductions-  Oil production from an existing well declines gradually.  From some new tight-oil wells it may decline as much as 60% or more in the first year.  The oil producing regions of the world that are un-economic at $50 oil is a long one: large portions of US unconventional, some Canadian oil sands, Gulf of Mexico deepwater, North Sea, Brazil pre-salt fields, various West African off-shore projects, some of the central-Asian conventional projects, some of the Arctic projects in Russia, etc.  If we see capex cuts, we should see natural production declines in the more expensive areas that will not be offset by new production.  This will eventually balance the market.  This is more relevant to the longer-term supply-demand balance, and is unlikely to arrest the decline in the very short term.

3) Demand increases spurred by low prices or economic growth- Americans are buying pick-up trucks at an incredible rate, and demand increases may help close the imbalance.  Unfortunately, demand tends to be quite inelastic in the short term because oil is generally not substitutable for any other type of energy.  Oil at one time was used in power plants (it still is in a few places), and electricity production is generally substitutable with gas or coal.  This ability to substitute provides a check on the volatility of the prices of gas and coal, but there is no similar check on oil price volatility.

4) Voluntary cutbacks in supply-  If OPEC, perhaps in concert with other significant non-OPEC producers were suddenly announce that they would balance the market with supply cuts this could resolve the imbalance overnight.  The Saudi's would presumably have to participate in this though, and so far they are showing no intention of doing this.  They are even talking down the price further every chance they get by saying they wouldn't cut supply even if it hit $20.  In a recent interview the Saudi Oil minister Ali Naimi said they wouldn't cut output no mater what.

The solution won't necessarily be just one of these things, but will likely be a combination of factors.  These are interesting times in the world of energy, and it is hard to say what the future will bring.  I hesitate to make any specific predictions, except to say that I don't expect sharp rebound in the oil price in the short term, and another leg down in the spot price is certainly not out of the question or even unlikely.