Although I disagree with the vast majority of the bear calls that have existed all year (all of which were documented as being false, by the way) one thing stands out as a red flag: demand.

The reliance on strong demand to justify increased supply, as is the case with OPEC, is one example. The other is US producers using stronger demand to draw down inventory while keeping production flat. I still expect production to decline in the second half of this year in the US, by the way. However, the sudden surge of US production in fall last year was, in part, due to prices remaining elevated but also the industry’s reliance on massaged economic data that showed a stronger US economy on the surface, but weaker underlying activity. The weaker activity finally surfaced in quarter one this year and in the current quarter, even though GDP is about to get massaged again through seasonally adjusting the data. Related: This U.S. Shale Play Has Flattened Out Substantially

The point is that the oil industry believed the economic data and media hype about a strong economy and thus kept pumping. The broad weakness in commodities is a reflection of that false reality, with the stronger dollar helping to weaken things further. What should be cautioned against is continued reliance on demand pull as a means to balance the market in an economy built on bubbles and debt. It simply won’t last as, once again, the false reality will be exposed.

I do think demand for gasoline in the US and Asia (remember that in winter, weak Asian demand was all the rage as the reason why oil must fall) is up strongly, but will it last is the question. Related:Oil Markets Could Be In For A Shock From China Soon

The most likely scenario is that it will wane at some point in 2015 and as the economic false realities get “popped” as the equity bubble bursts, demand will eventually fall. In the US, by that time, supply will likely be falling tied to depletion. Many E&P companies can’t support capital spending through cash flow, that is why major consolidation will likely take place over the coming months as it seems to be the only recourse for smaller producers to survive. They simply won’t be able to grow production to support higher cash flow nor will they have access to capital markets as they have in past. They will soon realize that production isn’t going up anytime soon and prices are not likely to rise much above $70 either.

OPEC’s loose quota of 30 million barrels a day (MBD) (their production remains consistently over this to retake market share) seems equally flawed as they too are relying on a false sense of demand to justify these levels. Related: Busting The “Canadian Bakken” Myth

The claims of global markets being 2 MBD barrels a day oversupplied are completely false too, no doubt as the IEA recently revised demand figures pre 2014 and will do so post 2014, further demonstrating the data massaging going on. Markets are much tighter than perceived, and probably should be, given what I believe is a waning demand picture coming in 2016. Both OPEC and U.S. producers alike should heed the warning by anticipating this and better managing supply as opposed to relying on massaged economic numbers from governments who seem content doing it. If they don’t, they may find themselves sand bagged again.

By Leonard Brecken of Oilprice.com

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