Oil prices have increased 60% since late January. Is this an oil-price recovery?

Two previous price rallies ended badly because they had little basis in market-balance fundamentals. The current rally will probably fail for the same reason.

The Oil Glut Worsens But Prices Reach 2016 Highs

Although oil prices reached the highest levels so far in 2016 during the past few days, the global over-supply of oil worsened in March.

EIA data released this week shows that the net surplus (supply minus consumption) increased to 1.45 million barrels per day (Figure 1). Compared to February, the surplus increased 270,000 barrels per day. That’s a bad sign for the durable price recovery that some believe is already underway.

The production freeze that OPEC plus Russia will discuss this weekend has already arrived. Supply increased only 20,000 barrels per day in March. Consumption, however, decreased by 250,000 barrels per day. That’s not good news for the world economy although first quarter consumption is commonly lower than levels during the second half of the year.

Meanwhile on Wednesday, April 12, Brent futures closed at almost $45 and WTI futures at more than $42 per barrel, the highest oil prices since early December 2015.

The April IEA Oil Market Report was also released this week and it largely corroborates EIA data. First quarter 2016 liquids supply surplus was 1.53 million barrels per day compared to EIA’s 1.71 million barrels per day for the quarter (Figure 2).

The first quarter 2016 surplus fell 220,000 barrels per day from the fourth quarter 2015. Overall supply declined 660,000 barrels per day but demand fell by 880,000 barrels per day.

IEA’s demand growth forecast for 2016 remains 1.2 million barrels per day. 2015 demand growth was a very high 1.8 million barrels per day because of low oil prices. 1.2 million barrels per day is, however, consistent with average growth from 2011 through 2014.

Price Cycles

Oil prices have increased from $26 to $45 per barrel during the current January – April price rally (Figure 3). This is based partly on hope for an OPEC-plus-Russia production freeze that almost everyone agrees will do nothing to balance global oil markets.

There were two major price cycles in 2015. During the first cycle, WTI prices increased from about $44 in mid-March to more than $60 by early May over a period of about 50 days. This was based on plunging U.S. rig counts and withdrawals from storage. Prices remained around $60 per barrel for 25 days and then fell to about $38 by mid- to late August over a period of 72 days. The total trough-to-trough period of the cycle was 157 days.

During the second cycle, prices increased from $38 to more than $49 per barrel in only 7 days in late August 2015 based on good economic news about China and U.S. storage withdrawals. Prices fluctuated between $39 and $49 with an average price of almost $45 per barrel for 93 days. After falling below $40 per barrel in early December, prices dropped to $26.55 on January 20, 2016, a period of 46 days.The total trough-to-trough period of the cycle was 146 days.

At the beginning of the present cycle, prices increased from $26.55 to $33.62 in late January and then dropped to $26.21 on February 11. This “double-bottom” pattern probably tested the low-price threshold for the greater oil-price collapse that began in June 2014.

That does not mean that a price recovery is in progress. It suggests that because $26 per barrel is so far below the marginal cost of production that prices are more likely to increase going forward than to discover a lower bottom.

Following the double-bottom, prices increased to $41.45 on March 22 over a period of 40 days. Prices fell to $35.70 over the next 12 days before increasing to $42.17 on April 13. Yesterday, prices fell to $41.52. The total duration of this cycle is 63 days so far.

Inventories

Aside from the global production surplus, the huge amount of oil in storage is the other key factor working against a price recovery right now.

Last week, a larger-than-anticipated 4.94 million barrel withdrawal from U.S. storage re-ignited the price rally that had stalled during the previous week. A 6.6 million barrel addition this week was largely ignored by the market as futures prices fell only $0.44 yesterday.

U.S. stocks are near record high levels of 78 million barrels more than at this time in 2015 and 138 million barrels more than the 5-year average (Figure 4).

OECD stocks are also at record levels of 3.13 billion barrels of liquids (Figure 5). That is 359 million barrels more than the 5-year average but 54% of those volumes are U.S. stocks.

Comparative inventory patterns have been mixed and unclear for the past few weeks. Cushing stocks have been decreasing but Cushing-plus-Gulf Coast and overal U.S. crude oil inventories have been alternating between decrease and increase. It is, therefore, too early to tell whether comparative inventory data supports a price increase or not.

U.S. Crude Oil Production

U.S. crude oil production continues to fall although not enough to significantly reduce the world supply surplus. March production fell to 9.04 million barrels per day, 90,000 barrels per day less than in February and 660,000 barrels per day less than peak production in April 2015 (Figure 6).

EIA forecasts that production will drop another 920,000 barrels per day by September 2016 for a total decline of 1.58 million barrels per day compared to April 2015.

That’s all good news except that U.S. liquids production increased 130,000 bpd in March and the world market balance is measured in liquids (Figure 7). Moreover, production is 1.85 mmbpd more than in January 2014 when the global supply surplus began, just a bit more than the present supply imbalance.

A Path To Oil-Price Recovery?

A year-and-a-half into the oil-price collapse, this market looks for any excuse to raise prices. A meaningless OPEC-plus-Russia production freeze has entranced market observers since the beginning of 2016.

EIA and IEA data indicate that world supply is flat-to-declining already without any help from those major exporters. The problem is that consumption has also been declining and that the net production surplus remains around 1.5 million barrels per day.

No lasting price recovery is possible until the market moves convincingly toward balance.

Inventories exceed all historical levels. Comparative inventories may be declining and that is hopeful. Still, inventories fell at the beginnings of the two price cycles in 2015 only to increase again with oil prices falling to lower levels than at the beginnings of those price rallies.

No lasting price recovery is possible until inventory levels move convincingly toward 5-year average levels.

I hesitate to say that this time may be different. Yet, growing concern about long-term supply because of deferred investment may differentiate this cycle from the previous two. The late January – mid-February 2016 “double-bottom” event also suggests that this cycle may be somewhat different from those in 2015 insofar as it may not end with prices lower than at its start.

I suspect that the present price rally is the first in a series of upward-increasing cycles. It will probably end with lower prices in a few months but I doubt those will be below $30 per barrel and may settle in the low-to-middle $30 range. Bad news about the world economy has the potential to move the lows lower. Political instability particularly in the Middle East has the potential to move prices higher despite fundamentals.

Results of the upcoming Doha meeting are already included in current pricing. Unless the outcome is unexpectedly negative, there may be a brief price bump but only a production cut will move prices higher over the longer term.

We are on a path toward price recovery but it will be a slow and a long one with many bumps along the way. I doubt that means a return to the $90-plus price levels of 2011-2014 nor do I think that the global economy is strong enough to support anything approaching those levels.

Markets don’t always move according to the fundamental elements of supply, demand and inventories. A meaningful, longer-term price recovery, however, must be based on those fundamentals. We’re moving in that direction but we’re not there yet.