Making sense of the disconnect in oil prices
By Deborah Yedlin, Calgary Herald
August 13, 2009
Oil prices edged over the $70 US per barrel mark again this week, staying at a level where they have spent most of August's trading days. But the relative strength being shown by oil prices is continuing to confound most observers.
Inventory numbers released by the U. S. Department of Energy showed yet another build in crude stocks, putting them 20 per cent ahead of where they were at this time last year. For the week ended Aug. 7, inventories rose more than three times what had been forecast by analysts: 2.5 million barrels versus 700,000 barrels. And yet, crude closed at $70.30 US per barrel.
Adding to the pricing disconnect, the department report also showed gasoline demand has not rebounded because lower prices at the pump are not enough to offset the effects of the weak economy.
Other evidence suggests oil shouldn't be trading as high as it is.
Compliance by the Organization of Petroleum Exporting Countries--which agreed to a 4.2-million-barrel-a-day production cut, is waning. No surprise there, as countries seek to take advantage of the higher price and sell more than what their quota allows.
Then there are the millions of barrels stored on floating tankers.
While some might point to the high oil price as being a positive sign underpinning recent sentiment the recession is over, others are not ready to make that connection because industrial demand in the developed world remains weak.
On top of all this come the forecasts from organizations such as the International Energy Agency that only seem to add to the confusion.
In the span of three days, the chief economist of the IEA warned that oil prices going over $70 per barrel could threaten the strength of the global recovery. For this reason, Fatih Birol also warned that OPEC--in the face of weak compliance --should not consider any changes to production quotas at its meeting in September that would cause prices to rise.
At the same time, the IEA also released its demand forecast for the remainder of this year, showing a slight increase from its prior estimates to 83.9 million barrels a day. The modest jump is the result of a more positive outlook for growth in the developing countries-- not a recovery of demand in the developed world. This further supports the view that industrial demand remains moribund.
The bright spot--on the demand side--remains China, which, along with filling its strategic petroleum reserve at current prices, will continue bargain hunting for more oil reserves around the globe.
The U. S. Department of Energy, on the other hand, recently revised downward its estimates for global demand, coming in at an average 83.76 million barrels a day through the rest of the year instead of last month's number that was closer to the IEA's latest estimate.
But it's not time to throw in the towel on the outlook for oil prices.
The U. S.--whose demand sits at an estimated 18.7 million barrels per day--is still consuming more than 22 per cent of the world's daily production. And despite all the oil storage that exists today, two events could cause significant upward pressure on oil prices.
These would be a rise in demand accompanied by declines in U. S. production.
There are some estimates out there that show U. S. oil production is declining by an annual rate of nearly four per cent. This means that the U. S.--absent any major finds--will be able to supply less than 25 per cent of its needs by 2012 given current consumption levels. Factor in the likelihood that less oil--if any --will be coming from Mexico by that time because of its chronic lack of reinvestment and it all suggests that the U. S. dependency on outside sources of oil is set to rise in the coming years.
The only permanent way to change this outcome would be for the U. S. to permanently succeed in diversifying its energy mix and cap the amount of oil consumed. While this seems to be where the current administration wants to go, the chances of it happening in a meaningful way within the next three years is unlikely. And even if a big, prolific discovery were to be made, it would only postpone the inevitable.
Of course, from a Machiavellian standpoint, peak production in the U. S. is good news for Canada and the oilsands. Despite the continued lobbying efforts to restrict oil produced in northern Alberta to flow south--the most recent being renewed opposition to Enbridge's proposed Alberta Clipper pipeline that will flow into Superior, Wis.--the oilsands will inexorably be part of the U. S. energy mix.
All this might just explain some of the apparent pricing disconnect currently in evidence in oil markets and causing oil prices to stay close to the $70 threshold.
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