The current consensus is that the OPEC+ supply agreement will be rolled over for at least three months at the group’s next meeting with special emphasis on stricter compliance. It would help a great deal to balance global oil inventories next year. This prevents oil prices from falling. There is still a great amount of uncertainty surrounding the present chapter of the US-China trade talks. This caps any attempt to push oil prices significantly higher.
Based on yesterday’s stock market performance negotiations are heading the right direction. US stock indexes settled once again at their highest levels ever and so did the MSCI Global Equity Index. The main sticking point is the extent of the rollback of the import tariffs. The passage of the Hong Kong Human Rights and Democracy Act in the US Senate and the House of Representative does nothing to help conclude the talks either.
These opposing forces made a relatively subdued trading yesterday with oil moving in a narrow range and registering slight gains. Things, however, are expected to become more active soon; if not today then tomorrow. Tonight, will see the release of the weekly US inventory report by the API followed by the same statistics from the EIA tomorrow afternoon. As the US will start its long weekend after the close tomorrow some massive positioning can be anticipated when the report is released. If the latest Reuters poll is anything to go by then probably bears can give thanks tomorrow evening. It envisages a probable counter-seasonal build in commercial inventories with a slight draw (-300,000bbls) in crude oil stocks and builds of 1.3 million bbls and 1.5 million bbls in distillate and gasoline inventories.
Tightish 4Q is in the making
Historical data suggests that the price of oil is mainly the function of stock levels. If OECD inventories fall prices usually go higher and vice versa. Of course, sentiment also plays a significant part in the formation of oil prices but this sentiment is often driven by changes in stock levels. One of the best examples of this inverse relationship of the recent past can be found between 2Q 2013 and 1Q of 2016. OECD oil inventories stood at 2.661 billion bbls at the end of June 2013 with front-month Brent averaging over $103/bbl that quarter. During the infamous OPEC meeting more than a year later Saudi Arabia declared war on US shale and all hell broke loose. Inventories started to increase breaking above the 3 billion bbls mark by the early months of 2016. The first quarter of that year saw the European benchmark averaging $35.21/bbl.
The problem is that OECD stock data is published every month on a quarterly basis. There is no way to know where current inventories are in the developed part of the world halfway through the fourth quarter of this year. Luckily, help is at hand. This help comes from the Energy Information Administration in the form of its weekly reports on US oil inventories. US commercial stocks show a very strong correlation with OECD inventories (for the latter we use OPEC figures). In fact, quarterly numbers since the beginning of 2007 suggest a correlation of 96% between OECD and US commercial oil inventories. After all, US oil stocks make up around 40%-45% of oil inventories in the developed part of the world.
From this perspective the incumbent quarter looks encouraging. OECD stocks finished the third quarter at 2.945 billion bbls whilst commercial stocks in the US stood at 1.299 billion bbls. Weekly EIA data shows a continuous decline in the US where inventories are more than 30 million bbls lower than at the end of September. From experience we’d say that further depletion can be expected. After all, this is the time of the year when stocks fall in the northern hemisphere. As a matter of fact, US commercial inventories declined in the fourth quarter ten times in the last twelve years. Weekly figures imply that this trend (may be apart from this week) continues in 2019.
The EIA puts a decline of 2% in US inventories quarter-to-last week. Applying the same rate of depletion to OECD stocks one concludes that they will have fallen to 2.886 billion bbls by now, down from 2.945 billion bbls in September. Further drawdowns are anticipated for the balance of 2019. This prediction is perfectly aligned with the predicted calls on OPEC and current OPEC production. Demand for OPEC oil is expected to average just above 30 mbpd for the rest of 2019 whilst the organization’s production is about 29.6 mbpd and is not set to increase drastically.
Falling stocks should, in theory at least, mean higher prices. Brent averaged at $62.03/bbl in 3Q therefore it should beat this level in 4Q. It is also worth noting that inventories will unlikely fall below the 4Q 2017 and 2018 level of 2.854 and 2.863 billion bbls when Brent averaged $61.46/bbl and $68.60/bb. Investors are also keeping a close eye on the developments on trade talks and a failure to cut a deal could easily flip the sentiment. The above exercise, however, indicates that no price melt-down is anticipated as 2019 draws to an end.