Oil Markets Are Balancing Faster Than IEA Would Have Us Believe

Fundamentals point toward market balance but pessimism is dragging oil prices down. IEA has apparently succumbed to this negativity but their data suggests that things are getting better, not worse.

In a business-as-usual world in which nothing unusual happens, the world will be close to market balance some time in 2016. If anything unusual happens, all bets are off and oil prices could rebound much faster than anyone imagines.

NYMEX WTI futures prices have fallen 34 percent since October 2015, and are below $30.00 per barrel for the first time since 2003. Prices have gone through four cycles of 30-40 percent increases and decreases over the past year (Figure 1).

Figure 1. NYMEX WTI futures prices and price cycles in 2015. Source: EIA, Bloomberg & Labyrinth Consulting Services, Inc.

(Click image to enlarge)

The two price rallies from March-to-June and from August-to-October were based largely on hope and the price decline from June-to-August represented a return to the reality of supply and demand fundamentals.

The most recent price decline that began in October is a bit different. Here, confirmation bias has replaced critical thinking about the oil market. The ruling paradigm is that prices are likely to stay low for years or even for decades and evidence is easily found that favors and confirms this bias. I believe that this paradigm is incorrect.

Despite troubling signals of structural weakness in the global economy, data suggests that the oil market is stumbling toward balance. Although I have said that prices must go lower in order to flush out the zombie producers, IEA’s statement in the January Oil Market Report that the world could drown in over-supply is based more on sentiment and pessimism than on data.

Stumbling Toward Market Balance

The best way to show this is by using both IEA (International Energy Agency) and EIA (U.S. Energy Information Administration) data. Each has its advantages and disadvantages.

IEA data estimates demand—oil use (consumption) plus stock increases—whereas EIA estimates only consumption, a proxy for demand. EIA presents monthly global liquids data while IEA only presents quarterly data. EIA forecasts both supply and consumption a year forward whereas IEA only forecasts demand. Together, the two provide a reasonably full view given the difficulties and uncertainties involved.

IEA data shows that global over-supply (supply minus demand) of liquids was 1.83 mmbpd (million barrels per day) in the 4th quarter of 2015 (Figure 2). Although that is an increase of 250,000 bpd over the 3rd quarter, it represents a 530,000 bpd decrease compared with the second quarter, the highest level of over-supply since the price collapse began in mid-2014. Furthermore, the 6-month moving average (1H MA in Figure 2) of market balance shows that the production surplus is decreasing.

Figure 2. IEA World liquids market balance (supply minus demand) and Brent crude oil price. Source: IEA & Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Total supply actually decreased somewhat in the 4th quarter, and it was the seasonal decline in demand that increased market balance. I am not trying to make a case that things are great but simply that the data indicates that things are moving slowly in the right direction.Related:Oil Stages Rebound From Twelve Year Lows

EIA’s monthly data shows that market balance is clearly improving with a decline of almost 1 mmbpd in supply surplus from August (2.51 mmbpd) to December (1.55 mmbpd) (Figure 3). The 4-month moving average (4 MMA in Figure 3) reinforces the observation that the over-supply is decreasing.

Figure 3. EIA Market balance vs. Brent crude oil price. Source: EIA & Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Much of IEA’s negativity is because of lower forecasted demand growth of 1.2 mmbpd in 2016 (Figure 4). This is based largely on pessimism about China’s unstable economy and declining oil demand, discouraging economic expectations in the developing world, and renewed Iranian production.

Figure 4. IEA annual liquids demand growth and 2016 forecast. Source: IEA & Labyrinth Consulting Services, Inc.

(Click image to enlarge)

Let’s put this in context. 1.2 mmbpd is disappointing only compared with 1.7 mmpbd in 2015 but that was the highest demand growth in 5 years. 2016 demand growth is more than the average for 2011 through 2013 when oil prices were more than $100 per barrel, and is one-third higher than in 2014 when the oil-price collapse began.

Source: http://oilprice.com/

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