Crude Oil Production & Supply: Have We Made Any Actual Progress in A Year?

Crudefunders |

At Crudefunders (www.crudefunders.com), we often quote what we were all taught a long time ago: “The trend is my friend”. Nothing could be more true when it comes to the price of crude oil over the last twelve months! During that time, we watched with anticipation while crude oil prices increased 106% from a low of $26.19 in February to $53.99 this past Friday. Gasoline prices had risen in the US from $1.74 per gallon to $2.30. As the economist on our team, I was curious and decided to dissect the numbers to see if we actually did make progress in the marketplace over the last year. If we looked only at prices, we would have to say, there was an impressive structural change, but my gut was saying “maybe not!”

On the first day of graduate school, I had an economics professor tell me, “As an applied economist, you must develop a set of gut instincts. These instincts won’t fail you when the numbers do.” Don’t tell anybody, but that’s an economist’s little secret. It’s our special set of tools that we use when we get stuck on a problem. My professor, Dr. Jaime Malaga said “Economists worth their salt have developed these tools over a period of years, and they often help us understand what really is, versus what we think we see.” He used to say, “It is a function of practice, practice, practice.”

Now, I’ve been an economist for a number of years and I’m looking at the measures that make up the price of crude oil and they don’t add up. My gut is telling me something is amiss...

This Time Last Year...

At the beginning of last year, we watched the price of WTI crude oil drop 28% from $36.60 to $26.19 in the first 42 days of the year. US production continued to fall dramatically from its peak in 2015 of nearly 9.6 million barrels per day to 9.186 million barrels in February of last year. We also noticed that even though we had reduced nearly one half million barrels of crude oil production from US daily production numbers, that reduction didn’t have much of an effect on prices. US crude oil producers needed to roll back more production... and they did. Over the next 21 weeks, they had cut production over one million barrels per day from the 2015 high, bringing US crude oil production down to 8.428 million barrels per day, according to the United States Department of Energy’s Energy Information Agency (EIA). The price of West Texas intermediate crude oil on the New York Mercantile Exchange (NYMEX) rose 75% in direct response to the US reductions. The newly reduced production numbers were working well in the United States as it appeared we were heading back toward a balance of supply and demand. Decreasing US production would gobble-up excess US crude oil in storage and prices could rise again, uninhibited.

Prices were rising again and prospects looked good for continued success, until we hit the end of the summer drive season. Hopes were soon dashed as economists began to understand that cutting US production would only provide a short term boost to prices. Real price growth could only come from worldwide reduction in the amount of crude oil produced. You see, the US is not the “Big Dog”. We only produce a little over one third of the crude oil that the Cartel does. In other words, OPEC controls the market because they have the biggest share of production. So, for a real structural change in prices to occur, OPEC would need to cut its production and get others to join in on the cuts.

It’s funny how these things work, because at that same time, the Saudi’s had been looking at their books and realized they needed more cash flowing to their treasury to meet the growing business needs of the Kingdom. Other OPEC members needed prices to rise as well, to add back desperately depleted resources to their countries’ coffers. Even the Russians jumped on board because they needed cash! All of a sudden, market share wasn’t as important as price in those countries. Something needed to change.

There is little argument that the Saudi’s are the most influential members of OPEC. As the “de facto leader,” they began a campaign of lobbying members to gain support for cutting OPEC production. Their efforts paid off, and in November of last year, OPEC committed to reducing 1.2 million barrels per day from its production and the Russians agreed to cutting 300,000 barrels of their own. The funny thing is, by the time the agreement was signed, prices stopped going up because OPEC members, the Russians and the US had all been increasing production in anticipation of these cuts! No cuts had taken place, only the anticipation of the cuts and prices were higher. You know the old saying: “buy the rumor, sell the fact”.

Did The Market Fundamentals Change?

As we look at the price structure of crude oil, it is important to look at other measures that influence the price of crude oil; other than volume and open interest, of course. Volume is the number of contracts traded in a day, and Open Interest represents the number of open positions left unsettled at the end of the day. While there are those who believe these two measures define price direction, I disagree. These metrics are important, but they contribute only to the momentum of a price change. (In other words, volatility,) and they don’t lead to fundamental long term change in direction. Measures like total US production, refinery demand, crude oil stocks (exclusive of the Strategic Petroleum Reserves), the amount of crude oil in storage, OPEC production and the number of crude oil drilling rigs in operation here in the continental United States, have the biggest directional effects on prices. These are the measures we read about everyday in articles related to the price movement of crude oil. So let’s spread them out and see if they support a change in prices.



In February of last year, the US was producing 9.186 million barrels of crude oil per day, and today we produce 9.001 million barrels. While the number is lower, it’s only a little bit lower, and still climbing; so I’m going to call this a “no-change”. Refinery runs were at 15.1 million barrels per day in February of last year and today they are 15.2 million barrels; that’s pretty much the same, so that’s a “no-change”.

Last February, we had 502 million barrels of crude oil in storage. Today we have 518.7 million barrels in storage, and that number has been climbing; so that’s negative. Add to that the fact that there are approximately 521 million barrels of crude oil storage in the US according to a September 2013 E.I.A. report, when storage capacity had just increased from 507 million barrels. That number does not include pipelines, privately held storage, ships and the rail system. These four off-line storage methods can add up to 120 million more barrels.

Another measure is the amount of crude oil OPEC produces each day. In February of 2016 OPEC production was a little over 31.5 million barrels per day. Today, OPEC is producing 33.5 million barrels. While that number is expected to decline further, they only have 310 thousand barrels to go before they reach their goal of reducing 1.2 million barrels per day from their production. Assuming OPEC reaches its reduction goal this month of 1.2 million barrels, they will still be producing five percent more crude oil than they did at the beginning of last year and that’s another negative.

The final piece to this puzzle is the number of crude oil rigs drilling for oil in the continental United States. That number is 602 as of February 24, 2017, marking an increase of 202 rigs from this time last year. That’s a huge negative, especially if the trend continues.

Like all good applied economists, I like charts; they help to tell a clearer story. So, here’s a simple chart showing the five measures discussed above, affecting the price of crude oil and what overall effect they should have on the price of crude oil:

Measure

2016

2017

Change

Effect

U.S. Production

9,186,000

9,001,000

-2%

Slightly Positive

Refinery Runs

15,151,000

15,271,000

1%

Mostly Neutral

U.S. Storage

502,000,000

518,700,000

3%

Slightly Negative

OPEC Production

31,500,000

33,200,000

5%

Negative

Active Drilling Rigs

400

602

51%

Very Negative

Looking at these five measures, it appears the price of crude oil in the United States should be going down, not up. But then, why are the hedge funds, money managers and big banks increasing their long positions for the next “Bull” move? It doesn’t make sense. I remember I used to tell my sons, you can’t wish things to be true just because you want them to be. Life doesn’t work that way… or does it? Maybe these bullish positions represent more of a hope for a more vibrant economy in the coming months; remember, “Buy the rumor”.

Looking back at the last year there were dynamic changes in this world. The economy was stalling again, we elected a new president and crude oil prices had bounced off dangerously low levels and were once again rising. So when we ask ourselves if there was any real change in the fundamentals that support higher prices for crude oil and the products, the answer would have to be “no”. There were huge fundamental changes in the marketplace itself, but the underlying fundamentals that support a higher price for crude oil just aren’t there… not yet!

If you want more information on the energy markets and what is making prices move every day, go to our website www.crudefunders.com and scroll down to where it says “Subscribe”. There you will find our link to the daily commentary “Energy Wise”, a comprehensive piece that includes both fundamental and technical analysis of the day’s energy markets and provides you with the detail that you need. For more on Energy Economist Tim Snyder and his company, go to www.matadoreconomics.com .

Tim Snyder

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