In recent months, much has been written about the massive supply overhang depressing oil prices.
Hardly a week ago, the International Energy Agency reported that the oil supply exceeded demand by 3.3 million barrels per day in the second quarter of the year. But where is that overhang? Those of us who follow markets daily have been hard-pressed to find it.
As is well known, global oversupply originated in the United States because of spectacular shale production growth there.
This growth tended to displace light sweet crude imports into the US, particularly from Nigeria. As a result, the Nigerians struggled to find replacement buyers, and the North Atlantic Basin, broadly encompassing a triangle from West Africa to the Netherlands and over to the east coast of the US, had been weak for months.
The trade press regularly reported stories of Nigerian cargoes going unclaimed and crude backing up in Aframax tankers waiting to offload in Dutch ports.
All of this was taken as evidence of a global overhang, and indeed, the Atlantic Basin appeared to be the epicentre of downwards oil price pressure.
All this has changed in the past two weeks. Vessels have offloaded, tanker day rates have collapsed, and bidding for Atlantic Basin cargoes is brisk. The overhang in the Atlantic appears to have cleared.
Of course, US shale producers were not the only ones ramping up production. Opec, having decided last autumn not to cut production, instead opted to push up supply in the first quarter of this year. Iraqi production is up more than 600,000 bpd year on year, and Saudi production, by some counts, is up as much as 900,000 bpd compared with last Autumn’s levels. Iraqi production growth, while higher than generally expected, was nevertheless comprehensible within the broader context of the redevelopment of that country’s oil sector.
On the other hand, Saudi Arabia caught everyone off-guard. No one expected the kingdom to lift production by as much a 900,000 bpd, and we still don’t really know why they did it.
To some extent, these gains have been offset by smaller production declines in Nigeria and Kuwait, but Opec production overall is up by 1 million to 1.2 million bpd since the collapse of oil prices last autumn.
Rather than holding production at existing levels last year, Opec has poured oil on to the fire, as it were, jacking up the global overhang.
So where did the incremental Opec production go? Some of it stayed right in the neighbourhood, with some of the Saudi increase destined for domestic use. The remainder headed to Asia, primarily to China. But look for excess inventories in China, and they are hard to find.
True, inventories levels are up, but they have been up every year with increasing Chinese consumption. Try to count the barrels, and China’s inventory of the three major liquids – crude, petrol and distillates – actually appears 40 million barrels below expected consumption-adjusted levels.
Some inventory may be hiding unreported in China’s smaller, “teapot” refineries, but the simple narrative says that the Chinese, like the Americans, have taken low oil prices as a reason to hop into their cars and drive.
And if that were true, we would expect Dubai oil prices to be backwardated.
In backwardation, prices encourage inventories to be brought forward for consumption now, rather than held back for consumption later. This strongly suggests there is no overhang in Asia.
Asian buyers import principally from the Middle East, and therefore Arabian Gulf prices are the appropriate measure for Asian demand. And these prices are, and indeed have been, in backwardation.
And that leaves us essentially with the US market itself. After peaking in May, US crude and product inventories declined –until early this month. Since that time inventories have crept back up, leading investors to wonder whether shale production might not restart at oil prices lower than recently believed.
Recent production data has also tended to support a more bullish view of US supply. Having trended down from its March peak, US crude and condensate output rebounded in the first two weeks of this month.
US shales were showing more resilience than traders had expected, and this weighed – and has continued to weigh – on oil prices. Nevertheless, production fell again in the week of July 10. And we have reason to believe it will continue to fall. Pipeline and railcar data, which is available on a weekly basis, suggests that shale output is declining. If so, the energy information administration should report US production falling like a stone over the next two months.
Steven Kopits is the president of Princeton Energy Advisors in Princeton, New Jersey