The End of History (again)

So now its agreed. The oil price is “range-bound”. It’s a bit less clear what the range actually is, but variously $40-$50/bbl or $40-$60/bbl.  The “Lower for Longer” scenario playing out exactly as expected. We can all sit back and watch the US shale (“Light Tight Oil” or “LTO”) be turned on when supply is constrained and prices rise and off when supply outpaces demand and prices drop.  And this will continue briefly until oil demand falls off a cliff and we all drive off into the sunset in EVs.  “Lower for Longer” has become “Lower Forever”.

Don’t we all love a nice neat narrative.

The last time we had such a consensus view, oil had been over $100/bbl for four years straight. The talking heads on CNN, CNBC, etc, the Investment Bank analysts with “notes to clients” as well as certain IOC CEOs were all agreed.  “$100 a barrel is the new $20” had become the accepted narrative. And we all know how that played out.

As per my previous posts (here and here) – I am not claiming any special insight here – the 2014 crash, which looks so obvious in hindsight, I missed just as much as everyone else.  But building on that experience, the big take away is that we should be very nervous when everyone is in violent, complacent, agreement.  You’d think from the current narrative that all the geopolitical uncertainty that used to yo-yo the oil price has been side-lined by US shale (“LTO”).  But currently we have; on-going war(s) in the middle-east, a major falling-out in the key Gulf region, Venezuela on the brink of imploding (along with its 2mmbbls/day of production) and North Korea claiming to have ICBM capability to hit all of the USA, not to mention a certain unusual level of unpredictability in Washington.

Yet with all this going on, we get a small shrug, and “the markets” turn back to studying EV sales data, and fretting about imminent Peak Demand. In my view, two factors are building huge complacency into the market view:

  1. The historically high inventory levels – both the known and unknown storage, and
  2. The view that US LTO is all powerful and will save us all…

On the former – this is a real and physical volume of oil in storage that has an understandable impact on oil price sentiment.   However, the market has been net under-supplied for a few weeks/months now, but this has just started to show up in draw-downs in inventory. That said, there is a long way to go. The absolute amount of oil in storage should be increasing year on year just to keep pace with demand growth – to normalize this, it should be calculated as a “cover ratio” would be. That is, the volume in storage as a function of the days of supply it covers.  In these terms, total storage is ahead of long-term historical data, but not by much.  “Days of Supply” numbers are coming back down, now below the record levels at the same time last year. 

Notwithstanding this, the storage ‘overhang’ is real, but

  • (a) it is decreasing on a weekly basis, and consistently out-stripping estimates – in both crude and products (so its not just a shift from one pocket to the other), and,
  • (b) demand which is probably the biggest variable, is showing signs of growth across the board, against forecasts that are more anaemic.

With respect to my second point; whether LTO is all powerful and will save us all, I think that that should be the subject of another post. For the sake of brevity here, lets just think about US “energy (read oil) independence”. It is not known how much oil is actually recoverable from the shale – its early days, technology will improve (but there has to be a law of diminishing returns) and clearly recoverable volume is a function of price; so huge uncertainties. In 2015 the EIA were reporting 10Bn bbls of 1P+2P, but at this time the Permian was barely included with the reserves dominated by the Bakken and Eagleford. The press has subsequently reported 320+Bn bbls (“Bigger than Saudi”…. misquoting the underlying research). Lets say that it is currently 20Bn bbls at 50$ oil.  With US demand running at 17mmbbls/day that is about 3.5 years worth… so energy independence it isn’t.

Is it going to be the driving factor behind prices until Peak Demand arrives (as surely it will) ? I seriously don’t think so. But more on that anon.

So on a weekend where Tesla launches the Model 3 (which by the way, I totally covet) and Venezuela heads for a constitutional “vote” and a real civil and humanitarian crisis, we might see which variables really drive the equation in the short term.