I had the opportunity to be a guest on several affiliated radio programs across the US on Monday of this week, along with co-hosting my own show with Jim Stewart, a 40-year veteran broadcaster, in Lubbock Texas, whose show broadcasts all across the Permian Basin. These shows represented markets from Morgantown West Virginia to San Diego California, from Tampa Florida to Eugene Oregon and from Mc Allen Texas to Lansing Michigan. Either the hosts or their callers on every program asked me the same unprompted question, and they prefaced it by saying, “We were told by several different analysts that the price of crude oil would be trading back in the upper $50s to maybe $60 per barrel by now. What happened; didn’t OPEC fix this?” I told them all the same thing; the problem with your assumption is, OPEC can’t fix what’s wrong.
For the last year and a half, West Texas Intermediate (WTI) crude oil has bounced off its low of $26.19 in February of 2016, and doubled back to $54.33 in February of 2017, before settling back to where we are trading today, approximately $46 per barrel. Today, consumers and producers alike are looking for answers as to why the recovery in crude oil prices has stalled. For the last several weeks, we have taken great pains to identify the sticking points on the supply side of the economic ledger that are playing a role in slowing price recovery in crude oil. We have identified the key issues with the Organization of the Petroleum Exporting Countries (OPEC) and a few other players who are voluntarily reducing their crude oil production in an effort to boost prices. It’s now time to cross the ledger and discuss what we believe the real culprit is: demand.
We will dig deeper into the issues that are affecting demand for crude oil and keeping us from discovering the effective price of a barrel of crude oil. We’ll look into what is keeping WTI from rallying to where many analysts forecast they would be. We will first look at the futures price of WTI crude oil over the last 18 months; where it was and where it is. We will then look at demand as it relates to demand from the refineries, as refinery runs is a dominant indicator. We’ll then address the macroeconomic issues of Gross Domestic Product (GDP), Employment and Durable Goods Orders (DGOs). We’ll tie these issues together to help create a most accurate picture of what is driving the futures price of WTI crude oil today.
WTI Futures Price
Most of us believed, in January of 2016, that the crude oil market had reached its bottom in the middle $30 range for the spot (front month, closest to cash) WTI contract. As a matter of fact, on January 4, 2016, WTI crude oil closed at $36.76, up $0.16 per barrel, from the previous close on December 31, 2015. Many thought it was the bottom and plans were being made to prepare for a new rallying point in crude oil. Surprisingly, the rest of the month continued to stun traders and analysts alike, until February 11, 2016, when WTI crude oil closed at $26.19 per barrel. That price pretty much cleared out every speculator on the Bullish side of things and prices began to rally, as hedgers began to unwind their hedges and the US economy began to recover. Meetings were planned from every corporate board room in the “Energy Patch” to OPEC and around the globe. Prices couldn’t settle here or the economies of most countries that depend on crude oil to fuel them would catastrophically stall, or worse yet, fail.
Below is a graph of the WTI crude oil futures price for all of 2016. We see at beginning of the graph the recovery from the middle $20s per barrel and how long it took to recover. The graph shows recovery actually began about the middle of March 2016. This is when prices responded enough for the Bulls to reenter the market. Then we saw prices increase appreciably up until June 8, 2016, when the price had nearly doubled! For the rest of the year, prices varied widely until the beginning of December when the price of a barrel of crude oil became range-bound.
This graph depicts a price that is going nowhere fast. It’s now time to add the next layer and that is the 2017 to today graph and see how prices are responding as compared to last year.
As you can see in the chart above, the price of WTI in 2017 is not at all responding as 2016 did. There is something pulling the price back down, whether it is oversupply, or our theme for this article
“demand”, prices are in a mess.
In today’s trade, demand is the primary metric affecting the price of WTI crude oil. When demand increases, beyond expectations, it reduces oversupply. When demand decreases more than expected, supplies increase. This is what got us into this mess. We over-produced US and world demand. It is important to understand that increasing demand reduces supply and it is equally important to understand increasing or decreasing supply has no effect on demand. So, oversupply naturally becomes a drag on prices, and likewise, undersupply will always be an “adder” to the market, because price discovery must factor in the amount of time and added resources it will take to bring supply back into balance. By identifying what demand is, we can measure if we are oversupplied or undersupplied or at market equilibrium. In our energy markets, balance between supply and demand is the goal. It is the point at which both buyers and sellers are satisfied. It tells us that when we overproduce supply, prices go down, and it tells when demand goes up, so do prices. The natural consequence of a change in both supply and demand is a change in price.
In order to identify whether we are oversupplied, undersupplied or at equilibrium, we must look at a couple indicators for demand. We use, as our primary indicator for demand, the weekly “Refinery Runs” number that is published by the Energy Information Agency, the reporting arm of the US Department of Energy. This number is published in the “Weekly Petroleum Status Report” and it comes out, except for Holiday weeks, on Wednesdays at 10:30 am Eastern Time. Below is a graph showing monthly average Refinery Runs since the beginning of 2015.
You might notice in 2016, refinery demand in the first quarter of the year was higher than both 2015 and 2017, and demand for crude oil in the refineries was lower this year than the previous two; even with the OPEC program to reduce production. Demand is the key here, and only now are we seeing demand for refined products beginning to rebound to the highs of 2015. OPEC’s current production reduction program can have a supportive effect on prices, as long as it stays in place, but to move out the excess supply and find the market equilibrium we’re all looking for, demand has to keep increasing.
The numbers tell us that while demand for refineries grew by 584 thousand barrels per day from April 1 to May 31 of this year, crude oil stocks dropped 25.7 million barrels during that same time frame. This is good for the market, and that is with a slight increase in WTI crude oil production of 66 thousand barrels per day. More to that point, last week’s numbers for refinery demand now stands at 17.277 million barrels, an increase since April 1,, 2017, of 848 thousand barrels per day; which is a nice increase. WTI crude oil stocks stood at 513.2 million barrels, down 22.3 million barrels on April 1, 2017 and daily production as of last week’s report stands at 9.318 million barrels per day. That is only 119 thousand barrels per day more than April 1, 2017.
You might have read about an uptick in inventories last week of 3.3 million barrels in crude oil and there was an increase of 3.3 million barrels in gasoline inventories, and an increase in the distillates (diesel fuel, jet fuel and home heating oil) of 4.41 million barrels. These numbers tell us the US refineries over produced demand in the past couple weeks, and that is what has pushed prices back down into the middle $45 range once again. Adding to the concerns in the market this week is the worry that last week’s build in inventory numbers will repeat themselves, signaling a reversal of that nice increase we noted above in the refinery runs curve for 2017.
All in all, the key to getting inventories back into the balance is increasing demand. There are other macroeconomic factors that have both positive and negative effects on our prices as well. They are GDP, DGOs and Employment numbers. The GDP, as discussed in previous articles, is an indicator of the overall US economy and the value of its goods and services being sold. The GDP during the late 1990s averaged better than 4%, a good number showing growth in the US economy. After the 9/11 attacks, it pulled back but then recovered until the late 2000s, when we went from -0.3% to -0.8%. By 2010, GDP had recovered to only 2.5%, reshuffling the economic deck for a slower and lower US economy. Then it fumbled around for the next six years at a less than 2% clip. Here’s what you need to know about a sustained growth period of less than 2%—it doesn’t help demand for crude oil and the refined products grow!
When we look at the number of jobs being created by the slow-moving US economy, and you see less than 350,000 jobs being offered, this is an indicator that the US economy is not expanding at a productive or normal rate. Last week’s Employment report showed 138,000 new jobs created in May. That number was below expectations by nearly 50,000 jobs for the month and indicated a slower-moving economy than the experts expected. This too does not help demand increase for crude oil or its refined products.
The last macroeconomic indicator we need to address is US Durable Goods Orders. Durable goods are those large ticket items that are slated to last more than two years. Bull dozers, tractors, trucks, automobiles and computers are examples of durable goods. When Durable Goods Orders fall to -0.7%, it is yet another indicator that the US economy is not growing at a productive rate to help increase demand for crude oil and its products.
These numbers, along with slowing refinery runs, are sending us signals that the US economy may not be growing at the pace we need to sustain growth in demand for crude oil and the refined products. When we put all these indicators together, it paints a picture that something better change in the US economy quickly or the price of crude oil may not recover. Demand must recover for prices to recover. We better not be “betting the farm” on some geopolitical event like another dust-up within OPEC that we saw last week, or a natural disaster like a Hurricane Andrew that chewed up so much of the production and refining capacity on the US Gulf of Mexico to make a run in the energy markets.
So, while we all wait for this week’s edition of the Petroleum Status Report from the EIA, many of us will be holding our breaths in hopes that last week’s report was just an anomaly, and not just because it’s now the beginning of Hurricane Season again.
Read More from Crudefunders
- Who Is OPEC and Why Do We Care?
- OPEC Appears To Be Delivering On Production Cuts, So Why Aren’t Prices Rising?
- When Times Get Tough in the Oil Patch, Amazing Things Can Happen…
- Crude Oil Production & Supply: Have We Made Any Actual Progress in A Year?
- Innovators Make a Difference in Oil and Gas!
- Geopolitical Risk and Its Effect on the Price of Crude Oil
- What Can We Learn from Crude Oil’s First Quarter Report Card?
- Crude Oil: What is the Future
- How Crude Oil Prices React to Geopolitics
- Prices at the Pump Are Rising: Is It Seasonal or Something Else?
- Is Ethanol Worth the Fight?
- What Are OPEC and the Saudis Up To?
- Energy Independence: Why US Crude Oil and Natural Gas Matters
- Crude Oil and Market Psychology
- Crude Oil: A Technical Analysis
- Crude Oil: Technical Analysis II
- Crude Oil: What’s Really Dragging Prices Down
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.