This week’s marked sell-off in crude oil prices came as no surprise to petroleum geologist Art Berman, who has been predicting the price decline for weeks now. More to the point, Berman says it’s not over yet and lower oil prices are still to come. Berman gave an excellent long-form interview for this week’s MacroVoices podcast. The program begins with a market summary and the interview begins at 7:09, and is summarized below. After the interview, a second short interview follows with the founders of #OOTT, the Organization of Oil-Trading Tweeters, an online community of oil traders who share research and trading ideas on Twitter.
Berman begins by observing that it’s Labor Day weekend – the end of summer driving season and historically speaking, what should be the end of a period of seasonal de-stocking of crude oil inventories, which is critically important to make room for the storage demands that predictably come during fall refinery maintenance. But Berman shows that nation-wide crude oil inventories have actually INCREASED to the tune of 6.46mm barrels over the last 6 weeks, a period when inventory levels historically move in the opposite direction!
Berman then introduces his Comparative Inventory charts, which measure inventory growth relative to historical norms, effectively factoring out seasonality effects from the data. Seen in this view, the build in inventory over the last 6 weeks is actually 16mm barrels above and beyond seasonally adjusted historical norms, completely anomalous given this time of year:
“This has really been a surprising development and this translates into really huge changes in comparative inventory. So, we’re adding millions of barrels a week in terms of comparative inventory, it amplifies that effect, and I think in a lot of ways that helps to put to put the downward price into some context. It also helps to understand how totally artificial this latest price rally has been about sentiment and hope that maybe OPEC is going to do something.”
Later in the interview, Berman is emphatic: “Buckle up for what’s coming”, as he predicts that the imminent shift from a seasonal de-stocking period to a seasonal re-stocking period will bring a series of markedly larger crude oil inventory builds.
Next, Berman shows that a 6-month price cycle has recurred in WTI prices for the last two years. He predicts that the next significant move down is now upon us:
“What we saw a year ago was a very rapid increase in August (surprise), prices went up to $50, rattled around, and then crashed down to $26 by the end of 2015. It’s hard not to remember we saw something like this a year ago. Is it important that it happened at the same time of the year? Well, again, we’re in fall refinery maintenance season and we’re seeing this anomalous build in absolute and comparative inventories that we didn’t see a year ago. All it would take is some more economic bad news about China, the OPEC meeting in Algiers this month doesn’t produce any meaningful results.”
Berman goes on to explain why he believes that Cushing and PADD 3 (Gulf Coast) inventories, in aggregate, are the most important determinants of future oil prices. By this measure, the picture is once again quite bleak, with Cushing+PADD3 inventories increasing by 5.5mm barrels in the last 6 weeks, and 2mm barrels this week alone!
Berman expresses dismay that the capital providers “haven’t wised up yet”. He observes that despite deteriorating fundamentals, if anything, credit appears to be increasingly available to E&P companies:
Next, Berman likens the oil market price cycle to what he calls Einstein’s Definition of Insanity, observing that each time another round of OPEC propaganda about a “production freeze” induces another short squeeze, eventually gravity sets back in and fundamentals take over again:
Elsewhere in the interview, Berman expounds on that point, saying that any production freeze rhetoric from OPEC is “pure theatre”, and meaningless in terms of actual supply/demand fundamentals.
"First of all, [oil] market balance isn't the problem. By freezing production, forgetting for a minute what that production may be, how in the world does that affect market balance? It really doesn't at all. If we're talking about a 2mm barrels per day of production surplus, maybe that helps, but market balance isn't the problem. I think it's theatre and we're running out of ways to get out of this problem quickly. [The upcoming OPEC meeting] could be setting us up for a huge disappointment."
Berman goes on to observe that where most analysts expected U.S. domestic production to “fall off a cliff”, that never happened. Meanwhile the rig count is on the increase, particularly in the Permian basin where the lowest break-evens [in domestic U.S. shale] are found.
An additional note on "hope factors" for increased prices, Berman states the hope factor for rising oil prices are fading fast:
“Whether you subscribe to the apocalyptic view of the drilled and incompleted wells, or rig count, I think we’ve gotten to the point where our expectation is that U.S. production is not going to drop much more. That has to have a psychological effect, while we were six months out and production was dropping several hundred thousand barrels a day per month, there’s hope...I think the hope factor, even though we have cut out 800k barrels per day, has faded - it’s gone. So what’s the next shoe to drop? Where are we going to find the solution, the silver bullet? I think we’re running out of options.”
Berman debunks the myth that lower prices automatically result in increased consumption with this very telling chart:
Berman emphasizes that below $40 per barrel, lower prices no longer translate to a pickup in demand, contrary to popular belief.
"The economy doesn't have any more [oil consumption] EXCEPT at rock-bottom oil prices. What this is telling me is that there is a [consumption] ceiling and this helps explain the inventory issue as well - if people simply limit their consumption at some price-level that's much lower than what producers need to breakeven, where does it all go? At some point it comes back to haunt us is where it all goes. At some point, because of these Einstein insanity cycles we're going through, we will run into a supply deficit and that's a scary thing."
After reviewing the chart book, several more topics are discussed at length, including decreased price sensitivity to elevated inventory levels since 2012, because of increased pipeline capacity OUT of Cushing to PADD3, the change in trajectory of junk bond pricing possibly being related to a strategy change from OPEC, and much more.
The interview concludes with Berman’s long-term forecast: Continued LOWER oil prices for several months to a year as we work through the inventory glut, followed by what Berman describes as a “moon-shot” (massive increase in oil price) as lost production capacity from offshore eventually catches up with the market. Berman predicts that the “Moonshot” will cripple the global economy resulting in a global recession, eventually forcing energy prices much lower again.
"We're in a cycle of lower prices for some time to come (months or even years) certainly until we work through the inventory overhang of 140 million barrels. There really no justification in history or logic for a return to oil prices of $60 or $70/bbl. We'll get this cycle of bouncing off of ceilings and floors below the price the industry really needs to keep itself whole. And that's because the economy is fundamentally weak. But, we're deferring investments in proven reserves - all we got to do is spend a couple of billion dollars to develop existing proven reserves - and we've deferred somewhere in excess of 20-30 billion barrels just in the last year and half and we continue to go down that road. So, there is going to be a time, no matter how weak the economy is, no matter how much we can't change this, we're going to end up with insufficient to meet our most basic, fundamental transport and manufacturing needs. When that happens, we'll see a moon-shot in oil prices."
The full interview is definitely worth a listen this Labor Day weekend. After the interview with Berman, the founders of #OOTT, the Organization of Oil-Trading Tweeters, are interviewed about the rapid growth of their organization and the free research they offer investors.