The Energy Information Administration ("EIA") prints a weekly piece which is entitled, "This Week In Petroleum", which offers a broad view of what has happened in the last 7-days in the petroleum markets, with a particular focus on the United States. In the most recent version, which was publicized last Wednesday at 1pm, as it is every week, it had an interesting note relating to surplus capacity in OPEC, which was as follows:
"The members of the Organization of Petroleum Exporting Countries (OPEC) generally hold almost all of the world's available surplus crude oil production capacity, providing them with the ability to alter production levels to influence global oil prices and manage market conditions. Saudi Arabia and other Persian Gulf countries usually hold the bulk of available surplus production capacity, with Saudi Arabia stating it wants to maintain 1.5 to 2 million barrels per day of surplus capacity. In contrast, non-OPEC countries generally produce at capacity and tend to have surplus capacity only when oil prices are so low that marginal production is unprofitable and is shut-in."
While there is a great deal of speculation as to what was driving the rampant rise in oil prices into the summer of 2008 (Was it the financial speculators? Was it the evil-doer short sellers?), the fact of the matter remains that based on the measurable data, "oil producers were operating at 98 to 99 percent of capacity". As the global oil market began operating closer and closer to capacity, it became even more susceptible to marginal changes in supply, such as those related to geo-political risk. Currently, OPEC is operating at about 4 million barrels per day of surplus capacity versus the 30-year low of 1 million barrels of surplus capacity in Q3 2008. The current level of surplus capacity is comparable to the level that was maintained for much late 1990s and early 2000s, when oil was at a much lower level even on an inflation adjusted basis.
This spike in OPEC capacity correlates with an increase in U.S. Crude Oil Days of Supply, which has been solidly above 25 days of supply since mid-March, which is a level not last seen since 1995 / 1996. This chart is outlined below. Clearly the major spike up in days supply has been a drop off in demand due to the recession and increasing unemployment, though there has been a sizable increase in domestic production on a y-o-y basis as well. In fact, from February to the week ending May 8th, 2008 domestic oil production in the U.S. has been up on average 5.7%. In aggregate for the year-to-date, the U.S. has produced ~4.163MM more barrels than the year before, which while not insignificant is still less than 10% of the 44.8MM build-up in oil stock we have seen y-o-y. Thus even if domestic production dropped back to levels from a year ago, we would still have had a surplus of oil domestically.
Despite these negative fundamentals, Oil is up ~33% in US$ year-to-date and we see a positive quantitative set up going forward. In fact, we see the TREND upside line at $77.09 versus the TREND support line at $47.94. Based on the current price of oil at ~$59 / barrel, we see a compelling risk / reward of $11 downside and $18 upside, with our TRADE support at $53.84.
The price of oil appears to be signaling one of two things: either demand will at some point in the near future accelerate or that there is a geo-political event on the horizon that will reduce supply.
In 2007, many corporate management teams responded the following way when we asked them about their macro view: "We have no crystal ball." In this case, we really do not have a crystal ball, but one thing we have learned in our careers is that price is a leading indicator and historically reported fundamentals are, by their very nature, a lagging indicator. As always, price rules.
Daryl G. Jones
Managing Director
