The oil (and financial) markets have seen a bout of recent panic sell-offs tied to fears about rising pandemic cases.
At the heart of this is angst that the global economic recovery will become derailed. It’s not unexpected market behavior, given prices reflect the collective perception of reality, but does key data suggest these fears are justified?
In assessing the state of the global oil balance, one has to account for 160 oil-consuming countries, 80 non-OPEC oil-producing countries and supply from OPEC’s 13 member nations. It is a significant body of data to continually assess, but a critical point is that all these supply and demand considerations intersect at storage. To be more specific, the net effect on the oil global balance from all production and consumption figures is reflected by the changes in OECD oil inventories. Some background information will be helpful.
Non-OECD consumers essentially use oil on a hand-to-mouth basis. Yes, there are a limited number of cases where a developing country creates infrastructure for holding discretionary oil stocks — China is the primary example (it began building emergency storage in 2006). But, with only a few exceptions, non-OECD countries do not portion out surplus hard currency to build tanks and store extra crude. Such funds are, instead, used to build schools, hospitals, water treatment facilities and so on. As such, oil inventories in OECD countries are the proxy for global stocks and they reflect the interaction of all supply and demand variables.
Think of these OECD oil inventories as being like a scale in your home. A person chooses to eat “better” and exercise more frequently, but gauges progress by stepping on the scale to see if weight is being shed. Basically, assessing OECD oil inventory levels determines whether the global oil balance is tightening (or not).
We recently updated our clients with inventory estimates for the OECD North America and OECD Pacific regions. These two groups account for 67 percent of global storage. Previous analyses we have published show the inventory changes in those regions being almost perfectly correlated with global inventory changes. That said, our estimate showed July storage being drawn down by 19 million barrels. Typically, the two regions experience a collective build in July of 17 million barrels (in July 2020, inventories rose 12.5 million barrels).
While our inventory estimate is preliminary, the data suggests that global oil demand ran stronger than our forecast. This is opposite to what one would expect given the flood of recent headlines. What makes our finding more poignant is that the consensus supply and demand model suggests oil inventories for these same two regions should have risen during July by 25 million barrels.
Lastly we note that, in addition to the prospect of global oil demand being stronger than forecast, we feel compelled to highlight the success of OPEC’s “tight market policy.” Few credit the producer group (led by Saudi Arabia) for having prevented a cataclysmic build in storage last year, when demand collapsed in the second quarter.
Fewer recognize its efforts in having been successful at shedding the excess storage that did accumulate.
Based on our work, the global inventory overhang has already been cut by 300 million barrels. OPEC’s focus on managing inventories points to an oil market that will see higher average oil prices over the medium term (and exporters seeing elevated oil incomes).
Source: Arab News