Crude Oil Market: A Perfect Bear Storm Despite the Euro Pop

EconMatters's picture

By EconMatters

Crude oil prices, along with world stocks, surged on Friday after euro zone leaders reached an accord on directly recapitalizing regional banks as well as measures to cut soaring borrowing costs in Italy and Spain.  Brent crude jumped more than 7% in one day to close at $97.80 a barrel, while WTI also settled up 9.36% to $84.96 a barrel on NYMEX.  However, for the quarter, spot Brent and U.S. oil futures still fell 20.4% and 17.5% respectively--their steepest quarterly percentage drops since the fourth quarter of 2008 post financial crisis.  Looking ahead, we believe this little 'Euro pop' will soon fizz out weighted down by the reality of basic market fundamental factor.     

First of all, the Euro accord bandaid does not fundamentally change what's causing the current crisis to begin with--high sovereign debt, out-of-control government spending, and insolvent regional banks.  Add to this scenario is a slowing of European demand, parts of Europe are in a recession, and this not only affects less oil being consumed in Europe, but backs all the way up the supply chain from Ford automobiles being sold and needing to be manufactured, to Chinese factories needing to ratchet manufacturing cycles down to account for less demand out of Europe.

Macroeconomics aside, the oil inventory picture in the U.S. is also quite interesting these days, to say the least. For example, On 1/27/2012 there was 338,942 Million Barrels in US storage facilities, then on 2/24/2012 it started slowly rising to 344,868 Million, then Inventory builds started accelerating as on 3/23/2012 there were 353,390 Million on hand, then we jumped dramatically to 375,864 Million Barrels on 4/27/2012, with another sizable increase to 384,740 on 5/25/2012, and on 6/22/2012 the number stands at 387,166 Million Barrels in US Storage facilities, way above the five-year range. (See Chart Below)  

Chart Source: EIA, June 27, 2012


This is taking place despite the domestic refinery run rate has increased from 85% in January to 92% in the week ending June 22 (See Chart Below).  As of June 1, 2012, crude oil inventories held at Cushing, OK were 47.8 million barrels, the highest level on record, according to the U.S. Energy Dept.  These are historically high numbers, but the magnitude of the rise over what is generally the stronger part of the US business cycle each year is the more compelling story.  


Chart Data Source: EIA, as of June 22, 2012


With record refinery runs, we still cannot make a dent in the oil Inventories, which implies that there is a lot of oil in the market.  In fact, if this trend continues, even just for the next three months, we are going to shatter previous storage records here in the US.  At current rate, the inventory number could smash through the 400 Million Barrel level over the next quarter.

This does not bode well for the oil market when the slow part of the year comes around in August and September, where Gasoline demand drops off rather sharply, and is usually the slowest part of the year in terms of fuel usage, demand, and prices typically drop significantly each year.  Technically, WTI could easily blow below $70/b with no major support till $60/b comes this August/September, and prices would remain challenged in the short to medium term.  

What are the reasons for this glut of oil in the US? There are several, China has slowed manufacturing and exports, i.e., their economy has pulled back considerably. India is having all sorts of credit worthiness concerns, and is also growing at a slower rate. So in short, the emerging market economies are using less oil.  


The demand picture in the U.S. is also quite dismal.  EIA data show in the first quarter, total U.S. liquid fuels consumption fell 3.7% YoY due to high prices and record warm weather.  For the second half of 2012, and 2013, EIA expects a YoY increase of only 1.2% and 0.6% respectively in liquid fuels consumption.   

Furthermore, there are more domestic oil production mostly from unconventional shale plays, as there are more Capex drilling projects started during the beginning half of the year on high oil price.  This has also pulled a lot more independents into drilling, and we are producing more oil each day than we actually consume or need.  This has been one major contributing factor in these continuous inventory builds during the strong part of the usage cycle, as refineries are operating at record utilization levels since the recovery with the seasonal spring/summer driving season going from March with Spring Break through basically labor day, (some say July 4th is the peak of the Summer driving season).   


Internationally, the Libyan oil is back on line, and other oil producing countries pumping more oil out of the ground compared to the last 5 years during this era of elevated oil prices. The Saudis are producing at the high end of their range as well.  In a recent report, U.S. EIA noted that global company held oil inventories in the major industrialized nations will be sufficient to cover 57.7 days of demand at the end of 2012, the highest level in 15 years.


Basic economics plays a role in this story as well.  Just ask this one question--Where are the high margin business opportunities over the last 5 years? It sure isn`t in the Banking Industry with deal-making and large scale private equity deals falling off a cliff. It hasn`t been in the real estate market either.


Market dynamics 101 stipulates that high oil prices leads to higher margins, which leads to more investment resources being directed to this sector which ultimately rebalances the market, and oil prices come back down. This is why there is often a boom and bust cycle that plays out in many investment sectors, and historically the energy and oil sectors have been the poster kids to this rule.


So essentially, five years of really high prices--higher than the actual fundamentals of the economy should dictate--have caused an artificial market scenario where longer-term demand was being stifled by currency concerns, inflation concerns, while commodity investment in general has served as a case of over investment in this area in relation to true, actual Global demand.


Throw in the fact that it seems everybody (governments as well as consumers) is in debt,nobody has any money, credit issues are becoming increasingly burdensome to deficit financing to artificially stimulate growth via the government intervention route, all these factors are forming a perfect storm for the oil market to face some major headwinds for the next 5 years. 

Further Reading - Brazil and Petrobras: Oil Dream or Oil Potential?

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Lucius Cornelius Sulla's picture

If the yield on XOM goes above 5%, I'll be backing up the truck.

ricks cabaret's picture

The net oil import dependence of the US shows no signs of stabilizing. It keeps sinking.

The Energy Information Administration's April figures, released June 28, recorded the fact that US net import dependence measured in barrels per day reached another recent low. We'll define "recent" as the time period that began with the August 2006 net imports of just over 13.4 million b/d, the highest ever.

In April, that figure was down to 7.37 million b/d. That's a decline of about 45%.

With US production increasing at 1 million b/d avg over 6 years (and accelerating) and China only growing at several hundred thousand b/d (and decelerating) - and world reserves at record levels... remind me again what country's demand will prevent oil prices from sinking?

The only countries with increasing demand are Saudia Arabia, Iran, and China - 2 of the 3 will be in a price feedback loop and the other's increases are less than production increases.

Dreams versus math - glad there are plenty to trade against... go play your Beatles records and ride on into the sunset.







FieldingMellish's picture

Last week we had an article positing the exact opposite and explain why inventories at Cushing were so high and prices were out of whack. meh.

Bloodstock's picture

Since when does making sense have any bearing on the District of Criminals? Hope the writer is correct though.

Hohum's picture

Hey everybody,

Look, the oil price will plummet, oil production will follow and voila! Peak oil.

I am Jobe's picture

Yawn. I think I will watch some porn now.

impermanence's picture

The price of gas will trend lower until the election.  Then, our masters will decide how much to raise the price depending on the average distance it takes the average person to get to Mal-wart.

LawsofPhysics's picture

"five years of really high prices--higher than the actual fundamentals"


FAIL, how much fiat has been printed in that five years?  Last time I checked the average joe around the world is still using fiat.  Unless you are bypassing the dollar and making direct deals or trading  gold  for oil...

oh wait...


Hello BRICs,

Slim's picture

Consider the total destruction of the shadowbank market (monster velocity engine for said currency base) as well as all the old debt (call it phantom fiat) still being incinerated daily as write-offs/downs and mark to unicorn continues 5 years with no end in sight.

Base X Velocity = Total Money

1 X 10 = 10

10 X 1 = 10

It's when you have 10 in the base and velocity suddenly screams up that you have the real inflation issues that everyone has been preaching for years.  Might happen but not soon (banks are still hemoraging globally with soveriegns picking up the slack) how much is already implied in current prices?  How much of current prices were unrealistic with expectations of inflation built in which allowed said pricing to actually impact real inflation out there for a time (i.e. oil goes to 100, people see inflation but drops back to $80)?  This isn't unimportant and while Soros' reflexivity theory is at play here a bit, escape velocity has eluded the central banks to this point and likely will for the foreseeable future.

Not saying that expansion of monetary base isn't important or concerning but this wasn't done randomly - it was done to try to plug the "Titanic meets Iceberg" hole in the global banking and shadowbank lending systems (which were driving real inflation via multiplier for a long time under a very constant currency base).  Do not underestimate the damage done here as its magnitude is every bit to scale with the base expansion and likely significantly bigger to this point.  A unit of fiat is not a unit of fiat without examining the change in the multiplier or the systems generating it (and said multiplier is basically brain dead on life support).  It's the multiplier that most people have completely failed to notice/see and certainly the banking system wants one to believe it is still intact both for faith as well as so they can jam around the equity, commodity, and currency markets to make some trading profits and get people out of cash which is further damaging to said velocity in a levered system.

ricks cabaret's picture


Some supporting facts (in no particular order)...

U.S. year-on-year oil demand changes:
April 2012 -1.77 pct
March 2012 -5.58 pct
Feb 2012 -0.72 pct
Jan 2012 -4.46 pct
Dec 2011 -4.99 pct
Nov 2011 -1.28 pct
Oct 2011 -2.2 pct
Sept 2011 -3.31 pct
Aug 2011 -2.59 pct
July 2011 -4.0 pct
June 2011 -1.3 pct

US oil demand will fall to a 15-year low of 18.77 million bpd this year, led by a drop in gasoline demand to an 11-year low, government forecasters said

European oil demand has dropped by 2.5% per year for the last 10 years

Of the 91 million barrels per day produced globally, China consumes approx 12% of the demand - their growth rate in oil demand is dropping to approx 5% this year and their domestic production is rising by approx 5% this year.

Net-net China should place an additional need for, at the most, a few hundred thousand bpd onto the world market.

Saudi Arabia has just proven to the world that they do have lots of spare capacity (over 1.5 mil bpd) - which they have stated publicly for years, but many analysts had their doubts.
Saudi Arabia *will* cut production to shore up prices - but they have proven to have very little control during recessions.

US production is the big surprise here... ramping much faster than expected.


In 2012, tight oil output will reach 720,000 bpd, or 12.5 percent of domestic production, it said.


The estimates -- based on a "reference" case, which assumes current technological and demographic trends will continue -- show that total U.S. oil output will reach a peak of 6.7 million bpd in 2020


Just like with everything else on this fine site, folks... you have to pick your entry points, stay small and/or nimble... the spectre of war can wipe out a leveraged position overnight.

Also on the other side of the coin, dont forget that Obama is not afraid to release the SPR reserves - even at oil price lows (as he did last year)... he attacked speculators once before and may do it again.

Thanks for the article, OP... I was starting to feel lonely :-)








LawsofPhysics's picture

If only U.S. demand was not totally irrelevant.  International oil companies will sell their oil to many international players.


Buy into the dip.

orangegeek's picture

The near term is a wave 2 retracement.


The longer term view is very bearish.

sushi's picture

 EIA noted that global company held oil inventories in the major industrialized nations will be sufficient to cover 57.7 days of demand at the end of 2012, the highest level in 15 years.

-- End Quote

And the reason for these high inventory levels is to ensure there are no shortages for the 57.7 days of bombing that will be required to subdue Iran and reopen the straits.


vast-dom's picture

yes i agree sushi. and this article is nonsense.