Factors Impacting the Oil Market

[dan_s]

The IEA's Oil Market Report (which you all should have read by now) shows the global oil markets back in balance within 6 to 9 months. Here are some factors to consider.

Most of the comments below are from Ellen Wald, Ph.D who writes for Investing.com. I've added a few thoughts.

1) Summer Demand (the BIG ONE)

Oil demand ALWAYS rises over the summer months. In the United States, American gasoline consumption reaches its peak between June and August—typically requiring 100,000 extra barrels per day. Saudi Arabia is a small country, but it too relies heavily on its own oil to generate power for basic services. In Saudi Arabia alone, demand for energy to run air conditioners in the summer months can use an extra 900,000 barrels of oil a day. This seasonal demand growth happens to have coincided with several supply disruptions this year.

In the U.S. "summer blend" gasoline requires more black oil, increasing demand for crude. This legal requirement increases demand for crude oil by about 500,000 barrels per day.

2) Asian Crude Oil Consumption

Chinese crude oil demand remains strong, but not because Chinese consumption is continuing to grow. Most of the growth seems connected to the fact that China is exporting significantly more refined products—especially diesel. In other words, China is buying cheap crude oil, refining it, and selling the resulting products to its regional trade partners. Whether this new export business can continue to support Chinese crude oil demand is largely dependent on the needs of its trade partners and may not be sustainable.

India, on the other hand, could be poised to become the next big manufacturing center. If the government’s “Make in India” campaign is successful, India could experience huge growth in demand for crude oil and refined products. The IEA expects Indian demand to grow from 4 million barrels a day in 2015 to 10 million barrels a day in 2040. OPEC seems to agree, and cited India as a source of demand growth in the future. However, these projections are largely based on growth experienced by China over the past decade and may not prove transferable to India’s economy since a variety of political and societal conditions differ.

IMO this is where IEA's 2016 demand forecast has been way off. IEA started the year predicting demand for refined products would grow my 1.2 million barrels per day. IMO when the final numbers are in, demand will have grown by more than 1.8 million barrels per day YOY.

3) Shale Oil Supply

This is a huge question mark in the equation. Many shale fields in North Dakota have been neglected due to the high extraction costs there, whereas shale oil production in Oklahoma and Texas has held up better (but it is falling). The active rig count in the U.S. has inched up the last three weeks. However, the active rig count will need to double before U.S. oil production stops falling.

See the IEA Drilling Activity report which shows oil and natural gas production declines in the seven major producing regions of the U.S. The SCOOP/STACK area is not listed, but my bet is that production is increasing in Central Oklahoma.

At the same time, the number of bankruptcies in the shale oil industry continues to grow. This is compounded by asset sales to private equity companies that are not equipped to operate the oil rigs and instead pay the bare minimum to maintain the properties until they can resell them at a profit. The prevailing belief is that as the price of oil climbs, more shale areas will come back online. However, the reality is more complicated. The cost of production varies greatly by company, by geography, and even within a given shale area. This is a case of too many variables to accurately predict what will happen, particularly as the price of oil hovers on the edge of profitability.

4) Nigerian Supply Outages

The Niger Delta Avengers are still causing havoc in Nigeria. They recently rejected talks with Nigeria’s government and attacked another Chevron oil well. Shell even stopped trying to repair a pipeline the group attacked months ago. It is unclear at this point if the saboteurs would be pacified by the old amount of subsidies the Nigerian government once paid them to keep quiet. Since the government seems unable or unwilling to crush them militarily, this conflict—and resulting production outages—will likely persist, at least over the next few months.

IMO rebel forces in Nigeria want to overthrow the government, so this situation will get worse before it gets better.

5) Venezuela is on the verge of collapse

Venezuela's government is almost entirely dependent on cash flow from oil sales to survive. Living conditions are terrible for the average citizen and getting worse. Government forces are having a tough time controlling people that are starving.

6) Iranian Supply Growth

Iranian production growth appears to be filling in for the decline in Nigerian production. Iranian oil production is close to 4 million barrels a day, and Iran claims it will continue to grow over the next several months. However, Iran has yet to attract real foreign investment in its oil and gas assets. The country has signed memoranda of understanding with Italy, South Korea, and Japan, but has not yet entered into firm agreements. This is largely because the Iranian government has not conclusively determined the terms for foreign investors—a controversial political issue in Iran. Iran claims it will announce the terms in June or July, but at this point, who knows?

Plus, Trump threatens to rip up the Iranian Nuke Deal and re-instate the sanctions. This could get interesting in November.

OPEC production declined by 110,000 barrels per day from April to May and spare capacity is almost nil.

7) Remember that Speculators set the Oil Price

Actions by speculators amplify trends in the oil market. A high percentage of the NYMEX oil futures contracts are owned by funds that have no intention of taking physical delivery of the oil.
They tend to over-react to:
> Weekly storage reports
> Economic news
> Increases or decrease in the active rig count
> Anything a Goldman Sachs analyst says

The good news is that global oil supply & demand are coming back into balance. Fundamentals do rule in the long-run.