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Page added on May 8, 2017

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What if it IS Different for Oil This Time?

Consumption

It’s time we prepare ourselves. It may actually be different for oil this time…

Yeah, I know. It’s an article of faith for investors. Anytime you hear someone say, “It’s different this time,” you can chuckle to yourself with an air of superiority, because you know, you KNOW, that person is just wrong. And not only that, but when you hear things might actually be different, there’s probably an investment bubble somewhere…

Like when investors hailed the economic miracle of the internet and wondered if productivity had made a permanent move higher. Productivity growth in the nonfarm business sector had averaged about 1.3% between 1973 and 1990. Then it jumped to 2.2% from 1990 to 2000 and to 2.6% from 2000 to 2007. Nope. For the last decade, U.S. productivity has gone back to 1.2%.

Or like when before the housing bubble collapsed, former Fed Chief Greenspan wondered aloud if the use of derivatives had spread risk around to the point that a full-on meltdown was unlikely. Nope. Just the opposite: Derivatives made sure everything melted down.

The conventional wisdom knows full well that it’s never really different. Situations and players may change, but the plot remains the same, right?

Well, yes and no. There is such a thing as reversion to the mean. Spikes in productivity growth or unemployment or interest rates tend to drop back to historical averages. But that’s not really what I want to talk about today. I want to talk about times when things actually are different…

Big shifts do happen. One of the most popular analogies about this is the makers of buggy whips. In 1890, there were 13,000 businesses in the U.S. that made buggy whips and other products for the horse-drawn carriage. Of course, within two decades, automobiles made them all obsolete.

I’m not going to run this tired simile any further lest it fail altogether. But you get the point: If you don’t see the big changes coming, if you just figure things will go on as they have, well, you can get steamrolled.

It’s Different This Time

I’ve made this observation before regarding China. China began to emerge as a true global power around 2000. It built out like crazy. In just the three years between 2011 and 2013, China poured more cement than the U.S. did in the entire 20th century. Those years, however, marked a crescendo.

For over a decade, China was a voracious consumer of copper, steel, iron ore, coal, etc. Resource-based economies expanded production to meet the need. Caterpillar shares soared as the world dug. After the financial crisis, starting about 2010, China dumped $1 trillion in stimulus into its economy. That marked the crescendo. And now it’s over…

Commodity prices have trended lower ever since. China’s economy is awash in debt. It’s not a huge leap to think China will never purchase commodities like it did in the past. I find it easy to imagine that massive build-out was a one-off event. It happened, and now it’s over. And that leaves the world with a huge oversupply of commodities.

We can see the same sort of dynamic with coal. Coal use has done nothing but fall over the last eight years or so. You can blame regulations if you want, but that’s not it. Cheap natural gas has helped the transition away from coal. But so has cheap renewable energy. Look, utility companies are playing the long game. Why burn coal when you can invest in virtually perpetual electricity generation via wind and solar power?

The Trump administration likes to say it can reinvigorate coal use. But it can’t. That era is over.

Which brings us to oil.

I find it easy to imagine oil’s best days are behind it. I don’t think it’s a reach to look at that run to $147 a barrel in 2008 as the blow-off top for oil prices. At that time, Peak Oil was the big catalyst. The world just wasn’t making massive discoveries anymore. But that was before technology unlocked U.S. shale oil. And that was before electric cars started hitting the road. And it was before fuel economy standards took a big jump higher…

Now, perhaps we should be talking Peak Demand for oil…

Oil Is Dead, Long Live Oil 

When oil prices collapsed in late 2014, we may have witnessed the end of the oil age. That’s not to say the world won’t use oil anymore. Of course we will. But oil’s time as a dominant resource may be over. And it would be especially ironic if it was Saudi Arabia that tipped the balance.

When Saudi Arabia boosted supply to crush U.S. shale, it made a huge mistake. It failed to understand a basic tenet of capitalism: that adversity makes you stronger. In the U.S., companies don’t fold up the tent when times get tough. They adapt. They get better, more efficient. U.S. shale oil companies cut their costs roughly in half. That barrel that cost over $60 in 2008 now costs around $30 to bring online.

The Saudis lost control of the oil market. And I don’t think they can get it back. Sure, maybe if they cut production more, we could see $60 a barrel for a little while. But any surge in price will just bring more crude online and pressure prices again.

The real question is, how do you get stronger demand?

For the foreseeable future, I don’t think you can. U.S. economic growth is very weak. Demand for gasoline here in the U.S., the biggest market, is basically static. We’ve already seen a small spike in demand that coincides with better employment numbers and cheaper gas prices, as this Bloomberg chart shows:

oil demand 2017Click Image to Enlarge

But that spike didn’t push prices higher. Demand has been weakening so far this year in Russia, India, and Brazil. It’s not rising here in the U.S.

So again, if oil is ever to make a sustainable run higher in price, we need more than just production cuts from Saudi Arabia. We will need to see demand numbers improve. And I don’t see a compelling case for a solid jump in demand. In fact, it seems more likely that demand for oil will fall.

Urban density is rising, electric cars may account for 20% of miles driven within the next decade, populations are falling in Japan, Europe, and China. For oil, it may be different this time.

Until next time,

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Briton Ryle

follow basic@BritonRyle on Twitter

 



15 Comments on "What if it IS Different for Oil This Time?"

  1. rockman on Mon, 8th May 2017 2:57 pm 

    “Coal use has done nothing but fall over the last eight years…”. According to the IEA global coal consumption peaked 3 years ago and HAS NOT “done nothing but fall”. In fact from 8 years ago until the peak the rate of increase in global coal consumption was the highest ever seen.

    Not a big flubbed but if he can’t correctly read a simple graph I decided to skip the rest of what he had so say.

  2. Plantagenet on Mon, 8th May 2017 3:44 pm 

    Mr. Briton Ryle thinks oil demand won’t grow because US growth is weak.

    Dude—-time for you to travel outside the USA and go to India. There are 1.3 billion people in India, the GDP is growing at 7% per year, and they all want to buy motorcycles and cars.

    Cheers!

  3. Ghung on Mon, 8th May 2017 4:11 pm 

    From the article; “populations are falling in Japan, Europe, and China.”

    Only Japan has seen a small decline in population. While China’s and the EU’s population growth has slowed somewhat their populations continue to increase. Makes me wonder (not really) about the voracity of the rest of the article if this author doesn’t care about such basic facts.

  4. deadlykillerbeaz on Mon, 8th May 2017 5:17 pm 

    The Saudis can get the market back by reducing prices.

    Buy one, get one free will do the job.

    And, no, coal is going to be burned to produce electricity.

    More sophistry from the clueless useless peanut gallery.

  5. rockman on Mon, 8th May 2017 11:42 pm 

    beaz – “The Saudis can get the market back by reducing prices.” They are already selling their oil for about half the price they were a few years ago. As Dr. Phil would as: “How’s that workin’ for them?” LOL.

  6. GregT on Tue, 9th May 2017 12:14 am 

    “They are already selling their oil for about half the price they were a few years ago. ”

    And twice as much as they were a few years before that. All the Saudis would need to do is to cut production by about a quarter. They could bring the entire world to it’s knees, and make a far greater profit than they have for the vast majority of the last century.

  7. kanon on Tue, 9th May 2017 8:15 am 

    Question: We have had a “glut” as shown in storage volumes. However, since petroleum distribution is a flow, how difficult is it to create a storage “glut” by directing the flow into storage? This question is about the idea that the market is rigged and prices kept low for geopolitical and/or macro-economic reasons.

  8. Sissyfuss on Tue, 9th May 2017 9:30 am 

    If the Saudis cut production by a quarter, not only would the world be brought to its knees but the Ponzi debt scheme would be shattered never to be replicated.

  9. rockman on Tue, 9th May 2017 10:20 am 

    kanon – “We have had a “glut” as shown in storage volumes”. Need to understand what those oil storage volumes represent. First, the vast majority is “working storage”. No oil is delivered directly from the well head to the cracking tower at a refinery. All the millions of bbls flowing thru pipelines is counted as storage. And virtually every bbl of oil refined is a blended oil. Most oil is sold to the oil buying blending companies who then sell to refineries. And that oil they hold and blend is counted as storage. As you may know Cushing, OK. is the single largest oil storage facility in the world. But not because they don’t have anywhere to sell that oil: Cushing is the largest oil blending facility in the world. That is why it exists. Remember virtually no oil is refined as it flowed from a well: US refineries are optimized at 32° to 33° API.

    But there has been an increase in storage volumes for other reasons. And an insignificant volume of that oil is stored by the oil producers. Which makes sense: why produce oil that has to have royalties and production taxes paid as well as paying to transport and store it? They can simply reduce production which costs nothing.

    IOW almost every bbl of that additional oil going to storage is oil bought from producers by physical oil speculators…as opposed to oil futures investors.

    IOW for practical purposes every bbl of oil in storage has been bought from the producers. You will not find one report of any US oil producer unable to find a market to sell 100% of its production. There is no “glut” from the perspective of the Rockman and other producers. Selling oil for less they we were a few years ago is not a “glut”. After all we’re still selling all the oil we want to at a higher price then we were a dozen or so years ago. IOW see if you can find anyony saying we had an “oil glut” in 2004 when we were getting paid 25% less then the current price.

    An “oil glut” from my perspective is when I have to shut my oil wells in when I can’t find a buyer no matter how low a price I’ll take. And that has never happened even once in my 41 years.

    If you want to see the details of what I just explained check out this EIA site: “Working and Net Available Shell Storage Capacity”

    https://www.eia.gov/petroleum/storagecapacity/

    “Containing storage capacity data for crude oil, petroleum products, and selected biofuels. The report includes tables detailing working and net available shell storage capacity by type of facility, product, and PAD District. Net available shell storage capacity is broken down further to show the percent for exclusive use by facility operators and the percent leased to others. Crude oil storage capacity data are also provided for Cushing, Oklahoma, an important crude oil market center.”

  10. rockman on Tue, 9th May 2017 10:59 am 

    Manon – This might be easier to digest then working thru that link. Notice first that the US current has a lot of “working storage” capacity left…see curve. Also notice they point out the “contango” dynamic that has pushed speculators to buy oil and send it to storage. Notice last sentence: “The large and continued contango structure prompted many market participants {speculators} to place more crude oil into storage.” From:

    https://www.eia.gov/todayinenergy/detail.php?id=26772

    “The expansion of crude oil storage capacity helped to accommodate the growth in U.S. crude oil inventories, which surpassed 500 million barrels at the end of January 2016…
    Despite the large expansion in crude oil storage capacity, the net effect of capacity growth and increased inventories resulted in high storage utilization rates. Storage utilization at Cushing, Oklahoma, averaged 87% over the past four weeks, compared with 81% for the same period last year. U.S. Gulf Coast region storage utilization rates averaged 72% over the past four weeks, after never being more than 70% in the previous four years…

    Because of generally rising crude oil inventories since the end of 2014, the structure of crude oil futures prices has been in steep contango, where near-term deliveries are priced lower than long-term deliveries. The large and continued contango structure prompted many market participants to place more crude oil into storage.

  11. kanon on Tue, 9th May 2017 12:56 pm 

    Thanks Rockman. It is not the conspiracy theory I was wondering about, but it is not the media babble either. The storage “glut” does have something to do with the market strategies of the players taking advantage of the contango. So it is more along the lines of Goldman or JP Morgan having 365 profitable trading days over the last 12 months. It makes it easier to play the market when the oil is in storage instead of the ground.

  12. rockman on Tue, 9th May 2017 2:05 pm 

    kanon – “It makes it easier to play the market when the oil is in storage instead of the ground.” I’ve never studied the details of the advantage of physical oil players vs oil future players. But I gather a significant advantage is by selling into the spot market which can be extremely volatile over very short periods. With futures you’re stuck with waiting for settlement day to see if you made money or lost.

    I remember a story I read a few years ago about another physical commodity owner (LNG and not oil but same dynamic) that reaped huge profits. Boston got hit with a very bad cold snap and the city utility was going to run out of gas because it couldn’t access more pipeline gas. But being a utility it had to meet demand. So at a time when city gate NG was costing it $6.50/MCF and the contract international LNG was running $16/MCF that Boston utility paid $30/MCF for two tanker loads of LNG. Thanks to averaging out on a price basis it didn’t sting the consumers as bad as it sounds. But the company that owned that LNG made $million beyond what they had projected by simply signing a purchase order.

    And in a different situation I once saw an LNG tanker almost reach a S American terminal but suddenly turned around and sailed back to Europe. It was spot LNG and an EU buyer offered enough to justify that extra transport cost.

    OTOH unlike holding a piece of paper representing a futures contract that disappears at settlement (when they trade with another paper owner) a physical commodity owner is stuck with it (and the maintenance cost) until they cut a deal with a physical commodity buyer.

    For instance I’ve read that those speculators storing oil at Cushing are paying $0.15 to $0.40 per bbl per month for storage. So while they can wait hoping for a good price that waiting isn’t free.

  13. rockman on Tue, 9th May 2017 2:19 pm 

    And here’s something interesting I just now discovered: Crude oil storage space became a tradable commodity on the NYMEX: it began offering oil storage futures contracts in March 2015. Not contracts on the oil itself but the rights to use specific storage facilities:

    “Investors can choose to take profits or losses prior to when the oil delivery date arrives or they can leave the contract in place and physical oil is “delivered on the set date” to an “officially designated delivery point”. In the United States, that is usually to Cushing, Oklahoma. When delivery dates approach, they close out existing contracts and sell new ones for future delivery of the same oil. The oil never moves out of storage. If the forward market is in “contango” (the forward price is higher than the current spot price) the strategy is very successful. While new tanks have been added in Cushing for a storage capacity of 6.6 million barrels, by March 2015 all the tanks were fully leased through 2015. Crude oil storage space became a tradable commodity with CME Group— which owns NYMEX— offering oil-storage futures contracts in March 2015. Traders and producers can buy and sell the right to store certain types of oil.

  14. kanon on Tue, 9th May 2017 8:57 pm 

    I did not know that. So the storage levels are to accommodate trading in storage, or maybe the trading is to move the storage costs off the industry and onto speculators. This is good to know, since the amount of oil in storage appears to have less to do with a “glut” situation than one would assume.

  15. rockman on Tue, 9th May 2017 11:14 pm 

    kanon – Here’s another view of the price vs storage volume dynamic: watch how it changes over time:

    https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=WTESTUS1&f=W

    Notice the slight increase by 2000 after prices dropped to $17/bbl in 1998. And then the huge increase starting in 2014 when oil began it’s 50%+ price fall.

    I know it’s silly but as the old joke goes: making money in the stock market is easy: buy low…sell high. If you were going to buy physical oil with the hopes of selling for a profit when would go after it harder: when oil is $90/bbl or $45/bbl? Of course it’s not that simple: if oil was selling for $90/bbl and you thought it would increase to $110/bbl you might buy some and sock it away.

    But you can buy physical oil if you don’t have a place to store it, right? Which is why for a number of years companies have been building new oil storage tanks especially at Cushing. But here’s another question: if you owned oil in storage expecting to profit frtom higher oil prices but suddenly saw prices begin to drop would you keep paying storage fees or sell to capture what profits (or minimize losses) that would result?

    Not theoretical…look at this chart. When prices started to slide Cushing storage fell from 50 million bbls to 20 million bbls in just 18 months. But in the last two years, as a result of low oil prices Cushing hit a all time high of 70 million bbls. And after dropping by 10 million bbls in 4Q 2016 storage jumped to that new record after OPEC and Russia announced plans to cut production to increase oil prices.

    I suspect you see the patterns that developed. The amount of physical oil stored (above the working volume) tends to be a function of expectations of oil price changes (both up and down). Which leads to the misinterpretation that oil storage increases because there is a “glut” instead of low oil prices offering the possibility of nice profits buying low and selling high later when prices increase. Which you can only do by buying oil and sending it to storage.

    And for the moment it looks like OPEC’s plan has failed and prices have fallen instead of increasing. If the situations persists long enough Cushing storage could start dropping.

    And storage drawdowns in the face of lower oil prices (as happened big time in 2014) doesn’t smell like a “glut”, does it? LOL.

    https://seekingalpha.com/article/4061914-cushing-oil-just-hit-time-high

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