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The US Oversupply of Oil is Ending: $67+ WTI by Early 2018

The US Over-Supply of Oil is Ending, Labyrinth Consulting Services, November 17, 2017

  • Comparative inventory (“CI”) has been dramatically reduced in 2017
  • Levels have fallen 165mmb since February and are now approaching the 5-year average for the first time in nearly 3 years
  • Causes of the US inventory drawdown are clear: increased exports of crude oil and greater domestic consumption

Comparative Inventory Yield Curve Predicts $67+ WTI Prices by January 2018

  • Interpreted yield curve that correlates CI and WTI price is developed by cross plotting the same data without the time dimension
  • Yield curve may provide price solutions to inventory reduction assumptions in the near term
  • If CI continues to fall at the 9-month average of 4mmb/week, oil prices may be approximately $67/bbl by end of December
  • If CI falls at the 8mmb/week average since late September, WTI could approach levels not seen since before the price collapse in late 2014

Crude Oil Exports and the Brent-WTI Spread

  • Crude oil exports for the 1H17 averaged 0.8mmb/d but rose to 1.8mmb/d in Sept and Oct
  • Increased exports now average 7-12mmb/week and contribute substantially to reduced inventory levels
  • Higher export levels correlate with the increased spread between Brent and WTI prices that began in late July
  • Traders can sell US crude overseas at less than international prices but at levels higher than domestic pricing allows; record exports of 2.13mmb/d occurring during the week ending 10/27
  • Exports have averaged ~1mmb/d in 2017 (almost double levels in 2016)

Structural Problems Getting WTI to East Coast Refineries

  • Spread decreased to about $2.25 with the advent of rail shipments of WTI to East Coast refineries and associated reduced light oil imports
  • Transport cost was reasonable when oil prices were $100/bbl but lower oil prices after 2014 resulted in a progressive decline in rail shipments
  • East Coast refiners increasingly relied again on imported light oil mostly from West Africa to blend with heavier grades of oil
  • Surplus of tight oil returned as production recovered as a result of higher oil prices in 16 and 17. Surplus supply caused discounted WTI prices and recent increase in Brent-WTI spread
  • Some of excess oil has been exported in recent weeks but the price spread persists because import levels are so far unaffected

Increased Domestic Consumption is 2nd Cause of Inventory Drawdowns

  • Consumption reached a 10-year record of 21mmb/d during the summer of 2017
  • August 2017 consumption was 300kb/d more than in August 2016 and that difference accounts for more than 2mmb/week of incremental inventory reduction
  • Increase in consumption that began in January coincided with the beginning of CI reduction that started in February

Greatest Portion of Consumption is From Transportation

  • US travel data seems to contradict consumption data
  • VMT growth has slowed since mid-2017
  • Declining VMT mid-2005 through mid-2014
  • High gasoline prices and 07-08 financial collapse most probable causes
  • Strong VMT recovery with lower gasoline prices with oil price collapse
  • Recent decline in VMT probably because of higher gasoline prices
  • Or, are consumption and travel data explained by late summer hurricanes?

The Possible Downside of Consumption

  • Continued high US consumption is the only area of concern for sustained higher oil prices
  • Sept and Oct consumption were considerably lower than in August
  • It is normal for consumption to decline after the summer driving season but the magnitude of the decline is disturbing
  • Oct consumption was 1.5mmb/d (45mmb/month) less than in August
  • That is more than the total August to January seasonal decline during the previous year (1.4mmb/d, 42mmb/month)
  • So far in November, consumption has rebounded

Consumption Will Decrease If Gasoline Prices Increase With Higher Oil Prices

  • Consumption becomes a greater concern if oil prices increase as much as I expect because gasoline prices will increase accordingly – consumption and gasoline price are negatively related
  • Higher oil price means higher gasoline price and lower consumption
  • $70 WTI will result in almost a $1/gallon price increase above the current average retail price of $2.5 and that may depress consumption

Critical Balance Between Supply & Consumption of Crude & Refined Products

  • Although the large decrease in domestic consumption appears to be rebounding, this must be carefully watched since it has been the main driver of inventory reduction
  • Net crude & product imports are also important as refinery intakes increase following hurricane disruption
  • Brent-WTI spread will largely determine crude export levels that have given a major boost to inventory reduction since the spread widened in late June

Cautiously Bullish on Oil Prices Despite Recent Pullback

  • Cautiously bullish on prices because the Brent-WTI spread has increased and favors higher US exports
  • Domestic consumption is the key driver for inventory reduction and despite uncertainty, looks strong
  • OPEC’s cuts have taken substantial oil off the market & Saudi Arabia will keep some level of cuts in force regardless of disunity in OPEC
  • Expectations for US production growth is exaggerated
  • Peak demand is a fad concern for the medium term
  • Biggest concern is whether higher oil prices will dampen economic growth

Image Source: EIA, Labyrinth Consulting Services

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