U.S. Oil Inventories Rise, But Not Likely to Reach The Peak of Earlier This Year

On Wednesday, the U.S. Energy Information Administration reported that U.S. crude oil stocks rose 1.7 million barrels for the four-week period ended July 31. Typically, crude oil inventories bottom out in mid-September before rising ahead of heating season, though some fluctuations occur along the way.



Reduced oil consumption due to the ongoing recession that has seen real GDP contract 3.9% from its peak through the Second Quarter has led to higher inventories. During the first 31 weeks this year, U.S. oil consumption has averaged 18.9 million barrels per day. That is 5.6% below the figure for the same period last year. In response, U.S. crude oil stocks have averaged 353.7 million barrels for the first 31 weeks this year. That is 15.1% above the average figure for the comparable period last year.

Nonetheless, U.S. oil consumption has continued to follow broad seasonal patterns albeit with a noticeably sharper falloff between winter heating season and the summer driving season.



If one transposes this year’s trends relative to the 10-year base, the recent uptick in oil inventories was not too surprising. However, assuming that this year’s dynamics remain relatively constant, oil inventories are not likely to rise significantly in coming weeks. Instead, the more normal pattern of falling inventories until sometime in mid- to late-September should resume.



The dynamics that have prevailed so far this year would suggest an initial peak near 350 million barrels before a fresh decline in inventories commences. Then, inventories could fall to around 338 million barrels. Afterward, in the run-up to heating season could again lift inventories to near 350 million barrels. If one considers a 1-2-standard deviation move from the patterns that have prevailed this year, one could see oil inventories bottom out in the 324 million to 331 million barrel range. That would be well above last year’s bottom of 290.2 million barrels. On the high-end, a 1-2-standard deviation difference from the patterns that have prevailed this year would suggest a latter-year peak of 357 million to 364 million barrel range. That would be well above last year’s 321.3 million barrel autumnal peak. However, it would be comfortably below the 375.3 million barrel figure reached for the four-week period ended May 1, 2009.

In the end, what is important is not the exact numbers discussed above, as they are merely meant to provide a quick sketch. What is important is that U.S. crude oil inventories are not likely to return to the peaks reached earlier this year unless the ongoing recession suddenly deepens anew. As a result, the kind of buildup in crude oil stocks that would help spark a fresh collapse in oil prices to or below the $33.87 figure reached on December 19, 2008, much less the $20 figure one analyst has forecast, is unlikely.

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Verleger Prediction of $20 Oil Later This Year Is Highly Unlikely To Verify

On Thursday, Bloomberg.com reported that oil market analyst Philip Verleger predicted that the price of crude oil would fall to $20 per barrel later this year. If the price of crude oil were to drop that low, it would mark the lowest price since February 7, 2002 when crude oil ended trading at $19.64 per barrel.

A closer examination of historic data and underlying fundamentals suggests that a scenario of $20 per barrel oil later this year has little chance at verifying. Although the price of crude oil reached $72.68 per barrel on June 11 before falling just over 18% to $59.52 per barrel on July 14, that recent sharp decline does not presage an imminent crash in oil prices.

• Over the past quarter-century, once the price of crude oil had risen 15% or more above the price at which it had first fallen 40% or more on a year-to-year basis, that outcome was a strong signal that the market bottom had already been reached. Since 1983, there were four occasions on which the market provided such a signal. Over the following 8 months from the date at which the price of crude oil met that recovery threshold, the price of oil remained 40% or more above the bottom that had previously been reached.



During the four previous signals, the price of crude oil ranged from as low as 132.7% of the bottom price to as high as 232.00% of the bottom price during the 8 months following the signal. The low price achieved following the signal had less fluctuation than the overall range, varying from 132.2% to 145.5% of the bottom price.

Assuming that the $33.87 per barrel price that was reached on December 19, 2008 winds up being the bottom—as is strongly suggested by the quarter-century historical experience—and the earlier historic data is representative, that would imply that the price of crude oil would range from as low as $44.93 per barrel to as high $78.58 per barrel in the May 28, 2009-January 28, 2010 timeframe. To date, the price of crude oil has closed as low as $59.52 per barrel (July 14) and as high as $72.68 per barrel (June 11) during the opening part of that period.

• Global crude oil stocks had been rising but could avert dangerous levels. Global stocks had risen 10.4 million barrels in April to levels that were 7.5% above the comparable 2008 figure. However, according to data from the U.S. Energy Information Administration’s Weekly Petroleum Status Report, U.S. crude oil stocks had increased by almost 16 million barrels during that timeframe. In other words, U.S. stocks had played a disproportionate role in leading global stocks higher. Since then, U.S. oil inventories have peaked and begun to fall. As of the four-week period ending July 10, 2009, U.S. crude oil stocks had fallen nearly 30 million barrels from their peak during the same period ended May 1.

That trend could continue until early- to mid-September. Typically, as summer driving season concludes, U.S. inventories begin to increase until heating season sets in during the late-November to early-December period.



During the 2006-2008 timeframe, U.S. oil inventories rose about 1.2 million barrels per week until heating oil season commenced. During the extreme financial market turmoil last autumn, U.S. oil consumption fell sharply and U.S. crude oil stocks rose by about 2.8 million barrels per week. That kind of increase in oil inventories that sent the price of crude oil crashing 76.7% from a high of $145.29 to $33.87 in a matter of months is not likely, as the latest macroeconomic data suggests that a number of major economies are stabilizing. A few, including China, have begun to experience more robust growth, with the Chinese economy expanding 7.9% on a year-to-year basis from a large fiscal stimulus and an extraordinary monetary policy stimulus. That latter stimulus, if it is reeled in, could touch off the development of asset bubbles. Already, the Shanghai Composite has risen 75% this year. But that development is not likely to impact China’s growth very near-term.

Stabilization of the U.S. economy and a return of growth for the U.S. economy and some major international economies over the coming months should begin to pare product inventories (gasoline, distillate fuel, etc.), as well as lead to a gradual increase in global crude oil demand. In its July 2009 report, OPEC estimates that global crude oil demand will rise from 82.80 million barrels per day in the Second Quarter to 84.84 million barrels per day in the Fourth Quarter. If that scenario begins to play out, an abnormally sharp rebound in U.S. crude oil stocks and a rise of global inventories to dangerous levels will become less likely. In other words, the kind of crippling oil glut that could cause a crash in oil prices would become unlikely.

On the supply-side, OPEC is likely to remain risk-averse through much or all of the remainder of this year. So long as U.S. consumption, which has recently flat-lined in the 18.0 million to 18.5 million barrels per day range since mid-spring, down 8%-12% from 2007- and 2008-level consumption, OPEC is likely to remain cautious about increasing production.



Moreover, considering that OPEC continues to monitor global crude oil stocks, and had even used such stocks as a yardstick in setting production quotas in the recent past when oil prices were rocketing toward their July 2007 peak, OPEC is likely to err on the side of caution in restraining its member country production. Its restraint to some recent calls for an increase in oil production after oil prices had doubled from their December 2008 low underscores OPEC’s caution.

As a result, OPEC is not likely to increase its oil production through much or all of the rest of this year, even as demand gradually increases. That production posture should help mitigate the risk of the kind of enormous oil glut necessary to bring about a fresh collapse in the price of crude oil.

In the end, if the Verleger scenario is to pan out, the world would need to witness a significant new regional or global shock that would erase the recent trend toward economic stabilization and set off another dramatic economic contraction on a global basis. While scenarios such as a collapse of Eastern Europe’s banking system could trigger such an outcome, such scenarios are not assured.

Conclusion:

Historical experience, underlying macroeconomic dynamics, and OPEC’s restraint indicate that the price of crude oil is unlikely to collapse to $20 per barrel later this year. Instead, a possible mini-bottom in the $40 per barrel to $50 per barrel range during price fluctuations is far more plausible through the remainder of this year.

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