Checking in. A look at the supply-demand balance over the past year.

I have not bought any energy stocks since last writing here.  The world has remained grossly oversupplied, to the tune of about 1 million barrels per day.  World inventories are at their highest level in history.  Demand grew at 1.9% (1.8 million barrels per day) for 2015 vs 2014 of which 1.1 million barrels per day of growth was in the Asia/Pacific region.  The remainder of .6 million per day demand growth was spread out fairly evenly across the world.

The biggest driver of Asian growth was China.  Motor gasoline demand grew at .2 million barrels per day as auto sales reached an annual rate of 16.5 million vehicles, or similar to the US rate of sales.  The key difference is that in the US new vehicles are largely replacing scrapped vehicles.  In China only about 1 million vehicles were scrapped in 2015, and the rate of growth for the in-use fleet of passenger vehicles was an incredible 20% annually.    India products demand also grew at about .3 million barrels per day, another strong driver of the Asian demand growth.

 Supply demand balance from IEA December report.

On the supply side, after years of non-opec supply growth driven mainly by the US, non-opec supply growth slowed dramatically over the course of 2015.  US supply growth has finally reversed.   The oil rig count stands at 545 according to the december Baker Hughes report, down by about two thirds since peaking in late 2014. Russian growth, which has been a surprise, is also projected to stop next year by IEA.  Overall, former Soviet Union exports were roughly flat at about 9 million barrels per day.   By the end of the year non-opec supply was probably contracting.    

But this slack was taken up by strong opec supply growth.  Saudi Arabia has often been given the credit for OPECs all-out production, and they certainly are the most influential OPEC member, since they are the only ones who maintain significant spare capacity. But in fact the Saudis have not added much to the glut, since their own increases in supply have largely been soaked up by increasing domestic demand.  Total exports have hovered around 8 million barrels per day of crude and products since 2012.  Iraq, on the other hand has gone from exporting around 2 to 2.5 mbd in early 2014, to exporting about 4 mbd in late 2015.  Iraq remains a potential source of increased supply in the long term, but a stretched budget, political instability, and lack of investment suggest that further production growth may be some years off.  Libya and Iran are the two most likely growers in 2016.  Libya is producing at less than .5 mbd, compared to their levels of 1.7 mbd before Gadhafi’s ouster.  There are some indications that the fighting there may stop. Iran has lots of spare capacity ready to come online if sanctions end.  Both areas are also affected by chronic underinvestment, and good grow supply over the longer term under the right conditions.

IEA projects continued oversupply until late 2016.  Overall, I think there are a lot of reasons to continue to be pessimistic. In the near term, we can expect a contraction of supply in the US, but this may well be offset by continued OPEC growth driven by Libya and Iran in the short term.  In the longer term (3-5 year), these low oil prices will reduce production in expensive deepwater areas like Gulf of Mexico, Canadian Oil Sands, North Sea, Offshore West Africa etc.  It will also reduce exploration budgets, which will reduce very long term supply.  Demand will continue to grow in the short term, driven by Asia.  But in the longer term, unlimited demand growth is not a given.  It is still very hard to say what the equilibrium price would be.  Given that US tight oil can work fairly well at $50-60/bbl, I would view this as the upper end of the likely price range over the next few years. 

Key points:

1. The world is still oversupplied, although the 1 million barrels per day of oversupply is easing.  There is a good chance supply and demand will be in balance at the end of the year (but with unprecedented high inventory levels).
2. Large capex budget cuts will lead to significant declines in US on-shore volumes next year, and will result in longer term declines (or at least will prevent growth) in other high-cost areas like Canadian oil sands and deepwater gulf of mexico, north sea, Brazil, West Africa, etc.
3. There is still a risk for another big leg down in oil price.  One obvious scenario would be Iran exports coming back online with a vengeance.  Another, perhaps less likely, would be running up against physical limitations for storage, a scenario put forward by the Venezuelan oil minister.