Released on October 2, 2002
(Next Release on October 9, 2002)
To Be, Or Not To Be
Despite OPEC’s self-proclaimed role as a reliable supplier of reasonably priced oil, commercial
crude oil inventories continue to plummet towards new startling lows in the world's largest oil
market, and the U.S. marker crude oil, West Texas Intermediate (WTI), remains over $30 per barrel
and is threatening to climb higher, causing concern in some quarters over the global supply of
crude oil. Even as producing and consuming country officials met recently in Osaka, Japan to
communicate policies, an apparent split in perspectives seemed to deepen as OPEC talked about
stabilizing over-supplied markets haunted by war fears, while consuming country officials argued
that seasonally higher demand levels this winter would require much more OPEC supply than likely
forthcoming without a quota increase, especially if global inventories are to avoid falling further
below already alarmingly low levels.
While oil markets are fraught with uncertainty, imbedded on both sides of the global supply/demand
balance, one point seems clear. Oil markets are not over-supplied. For this to be the case,
inventories would have to be high and/or rising at a more rapid than normal pace. Yet, preliminary
data suggest that OECD crude and product stock totals fell below year-ago levels in August, continuing
contra-seasonal movements begun as early as the second quarter of this year. Weak builds then have
been followed by outright drawdowns in the third quarter, based on both available supply and demand
data and reported inventory levels.
In the U.S., the pattern is even more striking, which is to be expected, since the U.S. was the
repository of most of the world's surplus inventory last year, as well as the first half of 2002.
Deep OPEC production cuts relative to last year, ranging from 2 to 3 million barrels per day for
the first 6 months of 2002, and depressed Iraqi oil exports, averaging 1 million barrels per day
to date less than last year, have combined with economic recovery (albeit at a slower pace than
some expected) and firming underlying oil demand to elevate crude oil prices. Consequently, refiner
margins have been depressed, thereby generating more than ample incentive for refiners, especially
in the United States, to reduce oil purchases, imports, and refinery operations, while meeting
firming customer requirements by drawing down crude oil inventories. Even ignoring last week's
sharp added downward pull from Tropical Storm Isidore, U.S. crude oil inventories were already
24 million barrels below last year and well below the normal range as of September 20. But,
more than anything, it is the trend that belies OPEC rhetoric, with U.S. crude oil inventories
plunging from high levels at the end of February 2002, some 44 million barrels over year-ago
levels, to current levels of 275 million barrels, a decline of 52 million barrels in just seven
months, a near record drop. (The only two periods with a sharper drop over a seven month period
were in December 1990/January 1991 following Iraq’s invasion of Kuwait and December 1999, when
similarly deep OPEC production cuts combined with preparations for Y2K to sharply draw down
primary inventories.)
Just as worrisome is the third quarter turn in U.S. distillate fuel inventories. As
discussed here in the September 25 issue (see
TWIP, 9/25/2002),
distillate stocks have dropped from still high levels at the end of June, a 17 million
barrel surplus over June 2001, to 130 million barrels, now only 5 million barrels from
the lower limit of the normal range for the end of September. Low refinery margins and
continuing strong gasoline demand this fall suggest that the relatively low distillate
production levels seen in July and August that were partly behind the distillate turn
downward, may not catch up with seasonally rising deliveries, especially if more normal
weather combines with structural improvement in the fourth quarter.
Speaking of structural improvement, what about supposedly weak demand prospects? EIA is still
forecasting a global rebound this winter, primarily driven by an assumed return to normal
weather, continuing recovery in air travel, and rising U.S. and worldwide economic activity
levels, including improvement in the manufacturing sector. Of the average growth globally
expected this winter of about 1.5 million barrels per day, 0.6 million barrels per day of
this is anticipated in the United States. So, at least according to our forecasts, oil
demand is not expected to be “weak” this winter.
And what is the evidence supporting this? For starters, U.S. gasoline demand growth in
September averaged 150,000 barrels per day, based on the four weeks ending September 27,
continuing the strong pattern seen all year with an average growth rate to date of 2.6 percent.
Even factoring out 0.5 percent or so for air travel substitution, underlying gasoline demand
growth of about 2 percent appears to reflect an economy in recovery mode. While others have
recited the lengthy list of recent indicators of renewed sluggishness, including equity value
declines, drooping consumer confidence, and re-flattening in manufacturing, other factors,
including the lowest interest rates in 40 years, rising personal income, and low inflation
continue to provide consumers with the means to increase spending. Sour mood swings aside,
it is not surprising then that consumer spending remains buoyant, led by strong housing and
auto markets. As such, numerous forecasts (including EIA’s) still call for a sharp pick-up
in third quarter GDP and an average U.S. growth rate of about 2-3 percent for the year as a whole.
Since gasoline demand is very closely correlated with GDP and real income, even air travel
substitution rates of as high as 1 percent are consistent with average GDP growth this year,
both observed through the second quarter, and expected for the balance of the year. Put
differently, if gasoline demand continues to grow at anything close to rates seen so far,
it would be highly unusual for GDP to sink below the 2-3 percent growth rates EIA and others
assume going forward, which bodes well for oil demand growth in general.
What, then, are the signs here? Recall, first, that in previous issues of This Week In
Petroleum, we have documented that much of the U.S. sag in oil demand last winter can be
attributed to one-time factors, e.g. very warm weather, low natural gas prices, and the
September 11 impacts on jet consumption. This suggests that with economic growth resurfacing,
oil demand should be growing as these factors dissipate with the end of winter. And,
indeed naysayers not withstanding, this is exactly what U.S. data show. U.S. total petroleum
demand began its recovery in May by climbing slightly (0.9 percent) over year-ago levels, and
growth has strengthened steadily since, with September data to date showing 1.2 percent growth
over September 2001 demand.
But, since skeptics may argue that growth relative to the weak levels seen last year following
September 11th is a hollow victory, let's look at light product demand, (i.e. gasoline,
distillate, and jet fuel) thereby factoring out distortions stemming from structural decline
in heavy fuel oil consumption and other one-time anomalies, largely associated with volatile
natural gas prices. And, let’s look at the May through July period, well before any September
11-related distortions, and for which the latest final U.S. monthly data exist. Comparing
May - July light product consumption this year with last, we see growth of about 180,000
barrels per day, or 1.3 percent; furthermore, while May - July 2002 demand falls below recent
trend levels, the gap is a mere 30,000 barrels per day, only slightly more than the below-trend
dip seen in 2000 when the U.S. economy was still growing at a robust pace. Hence, we can
dismiss this as white noise.
Herein, then, lies the disconnect. U.S. crude oil inventories are very low and sinking fast,
while distillate fuel inventories, even total commercial petroleum inventories, are dropping
toward the low end of the normal range. Indeed, U.S. total commercial petroleum inventories
have dropped in the third quarter only three times since 1986, one of them in 1999, a troubling
reminder of the apparent retracing of the 1999/2000 cycle evident in U.S. and global markets
movements since the end of last winter. With recent solid U.S. demand growth poised to jump
sharply this winter, U.S. and global market fundamentals are firming rapidly and oil prices at
$30 are merely reflecting this. Indeed, with crude stocks in the Midwest at record lows, and
closely correlated with WTI prices, further upward pressure should not be unexpected.
And yet OPEC fiddles. How can oil markets be characterized as "fundamentally weak"? It
would seem that such bearishness stems from a one-sided perspective or looking glass. If
one focuses only on current global or OECD inventory levels and only on apparent global demand
growth to date this year, one "sees" weak consumption and still adequate stock levels. But,
of course, what is unseen in this is the essence of imbalance, a harbinger of forthcoming
volatility, namely the steep downward trend in inventories at a time when stocks should be
building for winter use. Even ignoring the clear signs of structural demand improvement noted
above, the real blindness is on the supply side. Oil prices depend on both sides of the global
balance, and deep OPEC cuts have more than offset non-OPEC supply additions and any weakness to
date in global demand. Thus, it seems the growing divide between producers and consumers is
less due to market uncertainties and more the direct result of opposite perspectives. And
whether OPEC is seen as a stabilizing force or as an organization in which increasing volatility
is rooted may also be a matter of perspective.
|