With Brent oil prices hovering right around $55 per barrel—the highest level in months—the oil market has picked up momentum. There are plenty of pitfalls ahead, but the underlying fundamentals offer some reasons to be slightly bullish on crude.
As the IEA mentioned last week, global oil supply fell in August by 720,000 bpd, a sizable decline that has chipped away at the global surplus. At the same time, demand continues to rise; the agency had to revise up its forecast for the year for demand growth to 1.6 million barrels per day (mb/d), from 1.5 mb/d a month earlier.
But the more intriguing trend is the global decline of refined product stocks, a drawdown that has picked up pace over the past three months. The IEA estimates that OECD refined product stocks stood just 35 million barrels above the five-year average in August, down by two thirds from the 103-million-barrel surplus at the start of the year.
As mentioned before, demand appears to be strong, which the IEA says is the result of “robust economic growth in Europe, the US and Asia.” U.S. gasoline consumption in June, for example, was 665,000 bpd higher than a year earlier. The IEA said it’s possible that refined product stocks would fall back within the five-year average before the year is out.
However, there are a few caveats to consider, which might help explain falling OECD refined product stocks and don’t necessarily point to bullishness in the market for crude. For instance, there were significant refinery outages in Germany, Greece, Mexico and the Netherlands—which, as the IEA points out, are all part of the OECD. With refining runs abnormally down, refiners drew down on storage. Some of those outages could be restored, easing the pressure on inventories.
Also, Hurricane Harvey will result in a one-off draw on stocks, albeit a potentially large one. The massive disruption of refining operations along the Gulf Coast left refined product production severely down. Most refineries have resumed operation, but some are still running at reduced rates.
One other small caveat: The “five-year average” itself continues to rise, a reflection of the fact that the past five years increasingly encompasses surplus years. What is “normal” for storage is a moving target, a definition that is continuously revised up. In that sense, as time passes, it will be easier and easier for storage to look more “average.”
But with those caveats out of the way, the market looks to be on sounder footing than at any point in recent memory. That has corresponded with a rise in crude prices to their highest level in months: $50 per barrel for WTI and $55 for Brent.
Crude inventories are still elevated, but they started from a higher baseline than refined products. And while the drawdown in gasoline and diesel has occurred at a faster rate than for crude, it can also be considered as a precursor to steeper declines in crude inventories. As refineries deplete their storage, they’ll step up processing in order to avoid a shortage. As the IEA put it: “The fact that product stocks are approaching the five-year average shows that market rebalancing is under way and sends a signal for refiners to increase crude runs, which could in turn reduce commercial crude stockpiles.”
This checks out with data regarding short-term floating storage levels, which the IEA says is now below five-year average levels and has actually declined to its lowest point since December 2014. Floating storage is a more expensive way to store crude, and as such, will be first to draw down. The fact that the Brent crude futures market has flipped into a state of backwardation—a situation in which near-term contracts trade at a premium to futures further out—has likely accelerated the depletion of storage. If oil prices a year out are lower than they are today, it makes no sense to store oil.
Nevertheless, some analysts see the latest market tightening as seasonal and perhaps transitory. In a research note, Harry Tchilinguirian, head of commodities strategy at BNP Paribas, wrote that the “oil market will continue to struggle with excess supply,” and WTI will average less than $50 per barrel through 2018. "While demand seasonality in the summer worked to reinforce the impact of supply restraint by producers, the autumn will work against OPEC's efforts as oil product demand and refinery crude throughputs decline."
By Nick Cunningham of Oilprice.com
