Monday, January 5, 2015

The Delicate Balance of Supply and Demand in the World's Oil Markets

Updated February 19, 2015

The most recent plunge in oil prices caught most of the world by surprise, however, given the short-term market supply and demand fundamentals, a price readjustment is really not all that shocking.  As I will present in this posting, I think that we need to look at the longer-term indicators and ignore the short-term data points including weekly inventory data and quarter-over-quarter changes in supply and demand to get a sense of what lies ahead. 

Let's look at a chart showing the price history for West Texas Intermediate, the North American benchmark crude:

As we can see, other than the price readjustment during the Great Recession, the dollar-value plunge in prices over the past month are the highest on record.

From what has happened to oil prices over the past month, one would expect that demand for oil is falling off the charts at the same time as supply is rising, also at rates that are off the charts.  That is not quite the case.  Here is a graph from the International Energy Agency (IEA) showing the world demand for oil from 2012 to the present and projected to the beginning of 2016:

Here is a table showing the data (in millions of barrels) and the quarter-over-quarter and year-over-year changes in demand (in percent):

When we look at the year-over-year change in demand to remove the impact of seasonal cycles, we see that the increase in demand is anticipated to range between 0.87 and 0.98 million BOPD throughout each quarter of 2015.  If these projections prove to be accurate (i.e. if the world economy doesn't falter over the next year), the year-over-year increase in oil demand of 0.87 million BOPD at the end of 2015 will be higher than the year-over-year increase of 0.8 million BOPD and 0.73 million BOPD at the end of both 2013 and 2014 respectively.

If we look at the IEA's analysis for released in December 2014, they note that their analysis shows that the global oil demand growth for 2015 has fallen by 230,000 BOPD to 870,000 BOPD not that the demand has fallen by 203,000 BOPD.  While this could be termed "weak demand", the fact is that, in general, on a year-over-year basis, oil demand has shown rather steady growth since 2012.

On the demand side, it is critical that we look at China.  Here is a graph showing China's level of oil products consumption since 2011:

China's oil demand increases for both 2014 and 2015 is expected to be in the 2.5 percent range, somewhat modest when compared to past increases but still significant for the world's second-largest national consumer of oil.

Now, let's look at the supply side of the equation.  In the month of November, global oil production actually fell by 340,000 BOPD to 94.1 BOPD.  On a year-over-year basis, total supply was 2.1 million BOPD higher than the previous year with the gain split evenly between OPEC and non-OPEC producers.  OPEC production fell by 315,000 barrels in November due to disruptions in Libya and despite its stance on maintaining its production levels, Saudi Arabia, the world's swing oil producing nation, actually saw its production drop in November due to closure of its Khafji oil field as shown here on the green line:

You will also note that Saudi Arabia's production level in November 2014 was lower than it was in either 2011 or 2013 and on par with the 2012 production level.  What we can take from this is that, despite the "reality" that we read about in the mainstream media, Saudi Arabia is just holding its own when it comes to oil production levels from its aging inventory of giant oil fields that are requiring significant investments in enhanced recovery methods to maintain production levels.  On top of this, if projections are correct, lower oil prices will quickly lead to a significant retrenchment in the number of high-cost tight oil wells drilled in North America and elsewhere; with the very steep production decline rates associated with shale oil, the 1.9 million BOPD increase in non-OPEC production during 2014 could be reduced quite quickly. 

While I have simplified the world oil supply-demand picture to keep this posting to a reasonable length, to me, the fundamentals of the current oil market indicate that the delicate balance between supply and demand is at a point which suggests that we are very close to a new oil price floor.  Unless we see a substantial decline in the strength of the world's economy (i.e. a return to a Great Recession-type scenario), even with the additional oil production from shale oil, we will see a return to a balance between supply and demand which will push the price of oil back up to the price levels seen earlier in 2014 sooner rather than later.


  1. Your last chart is a fail - mean rate will be less then $40

    1. That's very questionable. Thus far, the $45 area for WTI has held several times. Could it break lower - sure. But forces are in play that allows the market to self-correct and rise to a fair level this year. I think that will be in the $70-80/bbl range.