February 11, 2015

The front page of The Wall Street Journal on Tuesday, February 10 proclaimed “Oil-Price Rebound Predicted” according to the IEA (International Energy Agency).

Not true.

The February 10 IEA Oil Market Report states that some “market participants are seeing light at the end of the tunnel” based on oil company spending cuts. It goes on to mention that over-supply could become as bad as in 1998 when oil prices plunged to almost $11 per barrel.

That’s some kind of light at the end of that the tunnel!

I believe that oil prices will increase strongly before the end of 2015 but there has to be a reason. Budget cuts and falling rig counts may create a feeling that production will fall but markets don’t move far or for long based on feelings.

The first reason for a rebound in oil prices will be a production cut after the June OPEC meeting. That didn’t happen in November because Russia said no. I think Russia will be ready by June.

The second reason will be when North American oil production starts to fall, hopefully around the same time as an OPEC plus Russia production cut. Another reason may be a political event that introduces a fear premium into the price of oil like ISIS in Iraq, Ukraine or something not on the radar yet. That’s how the world is.

With that out of the way, let’s look at the facts. Two charts are all we need.

Both IEA and EIA (U.S. Energy Information Administration) released new data on February 10, 2015. I used IEA quarterly oil supply and demand data to make the following chart.



World quarterly liquids supply and demand. Source: IEA.

(Click image to enlarge)

The chart shows that demand exceeded supply through the 4th quarter of 2013. That’s why oil prices were high in much of 2013 and in the first half of 2014. Supply has exceeded demand for all of 2014. That’s why oil prices fell (a lag before the market reacts to a change in supply-demand balance is common).

The difference between supply and demand was greatest in the 2nd quarter of 2014 (1.27 mmbpd supply surplus) and then it dropped to 0.84 and 0.81 mmbpd in the 3rd and 4th quarters, respectively. Better but still too much of a supply surplus.

EIA publishes monthly supply and demand data, and a forecast. The second chart incorporates that data.



World monthly liquids supply, demand and 2015 forecast. Data to the right of the vertical dashed line is an estimate. Source: EIA

(Click image to enlarge)

This chart shows that production fell from its high in October 2014 but so has demand. The difference between supply and demand in October was a 1.19 mmbpd supply surplus. It fell to 0.68 mmbpd in December but has increased to 0.97 mmbpd in January 2015 (world demand usually falls in the first part of the year).

That is better but still too much of a supply surplus. EIA data says the U.S. production continues to increase as expected but not part of a reason for an oil price bottom or rebound.

I don’t have a lot of confidence in forecasts but let’s understand what EIA’s forecast means. It suggests that supply and demand will be almost in balance in February 2015 but that the supply surplus will return in force in March. After that, the gap will narrow and by September 2015, balance will return and remain through the end of the year.

That is when oil prices may start to rebound.

EIA apparently believes that U.S. and Canadian tight oil production will have fallen enough by late in the 3rd quarter of 2015 to bring world supply and demand close to equilibrium again. If OPEC cuts production, so much the better for re-balancing the oil market.

In this week’s Musings From the Oil Patch, Allen Brooks suggests that the small oil price spike in late January may have been short covering by traders at the end of the month. He cautions that refineries are preparing for the summer driving season and will not be buying as much oil during the turnaround time which is now. That will build inventories and lower oil prices.

Mike Bodell (personal communication) is even stronger. He feels that storage inventories may reach 70-75% of capacity soon and that will crush WTI prices possibly through the end of 2015. He thinks that events in Iraq with ISIS and in Ukraine with Russia may have created a fear premium that pushed oil prices up a week ago. This fear premium isn’t over yet.

The message is reasonably clear: oil prices will rebound when something tangible happens.

It will be late summer before any drop in North American tight oil production shows up in the data. An OPEC cut may happen slightly sooner–we’re talking about only a million or so barrels per day surplus after all. A political event could happen any time…or not. Any or all of this will coincide nicely with increased demand during the northern hemisphere summer.

That’s what two charts and a bit of interpretation can offer and it’s not bad. Prices will rebound this year but not until there is a reason.