What is the oil rally running on? “Gasoline!” cry bulls. “Fumes!” cry bears (and the odd headline writer). To find out who is right, it is worth comparing this rally with the one that happened almost exactly a year earlier.
The similarity doesn’t end there. This chart shows what happened with oil prices at the start of this year and last, but indexed:
The one big difference in that chart is the two sudden dips witnessed this year in January and last month, where oil fell into the mid-$20s a barrel. This is a portrait of a market trying to find a floor from which to bounce back. So maybe the floor has been found: Oil is now about 33 percent off its low point for 2016; last year’s rally from March through June involved a gain of 41 percent. What’s more, this rally copies last year’s in another important aspect: Spot prices are rallying faster than futures, tightening the spread between them and indicating that excess supply is draining out of the market:
There is just one niggling problem with this interpretation: Excess supply isn’t draining. Wednesday’s weekly report from the Energy Information Administration showed a 10.4 million-barrel surge in USA commercial crude oil stocks, and they remain stuck at levels last seen when the Great Depression was getting underway. Take a look at how full the tanks at Cushing, OK — the notional delivery point for Nymex oil futures — are now compared with a year ago:
Tanks aren’t just brimming in the USA, but across the world. A year ago, the International Energy Agency was sounding this warning: Barring any unforeseen disruption, OECD stocks may by mid-2015 come close to revisiting the all-time high of 2.83 billion barrels reached in August 1998, shortly before WTI prices sank to an average monthly low of $11.22/bbl.
As it turned out, commercial stocks of oil held in OECD countries had already risen above 2.9 billion barrels by the middle of 2015 — and then kept going. Looking ahead from here, current supply and demand forecasts imply that, even if the much-vaunted freeze in OPEC production were to take hold, there may be a run on bathtubs to store barrels by the time summer is in full swing:
The bullish element in that chart is the way oil inventories level off in the second half of the year. When you’re trying to get out from under 3.3 billion barrels, though, just leveling off doesn’t really do the job. Moreover, these numbers assume no increase in Iranian production, despite the country’s avowed intention to add to the flood. Progress on that front has been slow, as Bloomberg reported this week, but it is very early days, and any extra supply will add to the glut.
With a wary eye on Iran, oil bulls are keeping the other one trained more hopefully on the USA The EIA’s weekly report also showed that domestic production in the week ending Feb. 26 had slipped by almost 250,000 barrels a day compared with a year earlier. Those initial weekly estimates are notoriously subject to revision. But with rig counts continuing to drop and yields on junk bonds issued by the exploration and production sector much higher than a year ago, a chaotic round of spending cuts and bankruptcies in the oil patch should take more supply off the market:
Don’t forget, though, 2015 also kicked off with expectations of USA supply rolling over that didn’t pan out. The IEA’s projections for this year, which imply that flattening of oil inventories later this year but no
real decline, already factor in a
drop in USA production of almost 500,000 barrels a day. So it would require an even bigger drop to move the needle and justify a sustained rebound in oil prices.