FRACTIONAL FLOW

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The Contango Spread Supports The Oil Price And Results In Strong Stock Building

As analysts and pundits keep staring into their crystal balls searching for clues to future moves in the oil price, it may be more helpful to look at some actual developments that may explain the recent strong US stock builds, developments in US total petroleum consumption and what this now may presage about future oil price movements.

In this post I present a closer look at the recent growth in US total petroleum demands split into:

  • Development in US total petroleum consumption (inclusive some selected products)
  • Rate of stock build of US commercial crude oil stocks

Then a look at developments in crude oil supplies from OPEC where several of the big oil producers in the Middle East have had strong growth in the number of oil rigs since early 2014. Recent media reports about increases in oil supplies from the biggest Middle East oil producer.

Figure 01: The chart above shows developments in the oil price (Brent spot), blue line and left hand scale [The oil price has been multiplied by 4 to fit the scaling on the left hand scale]. The thick black line shows the weekly EIA reported total inventory of US commercial crude oil stocks, left hand scale. The thin gray line plotted versus the right hand scale shows the daily changes to crude oil inventories from weekly EIA data. The thick red line plotted versus the right hand scale is a trailing 28 days moving average of changes to the crude oil inventories. Stock draw downs adds to supplies and may moderate price growth for some time. Figure 02 has zoomed in on the recent developments.

Figure 01: The chart above shows developments in the oil price (Brent spot), blue line and left hand scale [The oil price has been multiplied by 4 to fit the scaling on the left hand scale]. The thick black line shows the weekly EIA reported total inventory of US commercial crude oil stocks, left hand scale.
The thin gray line plotted versus the right hand scale shows the daily changes to crude oil inventories from weekly EIA data.
The thick red line plotted versus the right hand scale is a trailing 28 days moving average of changes to the crude oil inventories.
Stock draw downs adds to supplies and may moderate price growth for some time.
Figure 02 has zoomed in on the recent developments.

In Q1 2014 the average daily US stock build was 0.29 Mb/d and during Q1 2015 the average US daily stock build was 1.10 Mb/d.

Demand for US stock build was up 0.8 Mb/d year over year. This stronger stock build temporarily adds to (global) demand and supports the oil price.

What drives this strong stock build is the price spread between contracts for prompt/front month deliveries versus contracts for later deliveries when the futures curve is in what is referred to as contango, refer also figure 3.

The recent strong builds in US crude oil storage may give away some clues about underlying developments in consumption.

Demand = Consumption + Stock changes = Supplies

Figure 01 shows that US commercial crude oil stocks normally move predictably within a band that reflects swings in seasonal demands as from the driving season and the heating season. What makes the recent strong stock build (2014/2015) stand out is the pace and total level, which suggests something about the fundamentals of global supplies and consumption balances.

Figure 02: The chart above shows a zoomed in version of figure 01 on recent developments in the oil price (Brent spot), blue line and left hand scale [The oil price has been multiplied by 4 to fit the scaling on the left hand scale]. The thick black line shows the EIA weekly reported total inventory of US commercial crude oil stocks, left hand scale. The chart shows how stocks are built ahead of the driving season and the heating season of 2014. The thin gray line plotted versus the right hand scale shows the daily changes to crude oil inventories from weekly EIA data. The thick red line plotted versus the right hand scale is a trailing 28 days moving average of changes to the crude oil inventories. NOTE: Scaling of the axes.

Figure 02: The chart above shows a zoomed in version of figure 01 on recent developments in the oil price (Brent spot), blue line and left hand scale [The oil price has been multiplied by 4 to fit the scaling on the left hand scale]. The thick black line shows the EIA weekly reported total inventory of US commercial crude oil stocks, left hand scale.
The chart shows how stocks are built ahead of the driving season and the heating season of 2014.
The thin gray line plotted versus the right hand scale shows the daily changes to crude oil inventories from weekly EIA data.
The thick red line plotted versus the right hand scale is a trailing 28 days moving average of changes to the crude oil inventories.
NOTE: Scaling of the axes.

Figure 03: The chart above shows developments in the oil price (Brent spot, red line), Brent crude futures for January 2016 (BF2016, blue line)  and the spread (green line) between the spot and BF2016 all plotted towards the right hand scale. The thick black line shows the weekly EIA reported total US commercial crude oil stocks, left hand scale. NOTE 1: Scaling of the left hand axis. NOTE 2: The chart shows only the developments in price for the futures for January 2016 (BF2016) to avoid crowding the chart with information.

Figure 03: The chart above shows developments in the oil price (Brent spot, red line), Brent crude futures for January 2016 (BF2016, blue line) and the spread (green line) between the spot and BF2016 all plotted towards the right hand scale.
The thick black line shows the weekly EIA reported total US commercial crude oil stocks, left hand scale.
NOTE 1: Scaling of the left hand axis.
NOTE 2: The chart shows only the developments in price for the futures for January 2016 (BF2016) to avoid crowding the chart with information.

The way the contango works, for those playing it, is that those who bought oil on the spot in January 2015 (when the spread to BF2016 was $11/Bbl), turns around and sells it in the futures market (BF2016 with delivery in January 2016, [12 months storage]), store it and pocket the difference between the sales price and (purchase price + storage costs [at Cushing in Oklahoma presently storage costs are at around $0.40/Bbl per month and floating storage may be as low $0.60/Bbl per month]).

Playing the contango spread requires a certain size of this that will cover the storage costs and offer some return.

Developments in total global crude oil stock will depend on the contango spread and costs of available storage.

Development in US total petroleum consumption and some selected products

Figure 04: The grey line in the chart above shows developments in US total petroleum supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the green line, both left hand scale. The blue line shows developments in the oil price, Brent spot and right hand scale. NOTE: Left hand scaling.

Figure 04: The grey line in the chart above shows developments in US total petroleum supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the green line, both left hand scale. The blue line shows developments in the oil price, Brent spot and right hand scale.
NOTE: Left hand scaling.

US total petroleum consumption is up from 18.71 Mb/d in Q1 2014 to 19.52 Mb/d in Q1 2015 or 0.81Mb/d (more than 4%) year over year.

US total petroleum demand (changes in consumption and stock build) is up 1.54 Mb/d from Q1 2014 to Q1 2015.

Note that the year over year growth to build storage inventories during Q1 2015 was about as strong as the growth in consumption.

Econ 101 says that there is a relation between price and demand/consumption. The recent collapse of the oil price has again demonstrated that a lower price stimulates consumption. With the oil price collapse in 2008, US consumers responded rapidly by increased consumption, refer also figure 04. This growth in consumption cooled as of mid 2009 as the oil price started to grow.

During the recent collapse in the oil price the fluctuations of US total petroleum consumption have been smaller than in 2008/2009.

The recent growth in US petroleum consumption started as household debt started to grow again in early 2013 when oil prices remained above $100/Bbl and before the oil price collapsed.

The recent oil price collapse accelerated the growth in US petroleum consumption.

Figure 05: The blue  line in the chart above shows developments in US gasoline supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in all grades retail gasoline price and right hand scale. NOTE: Left hand scaling.

Figure 05: The blue line in the chart above shows developments in US gasoline supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in all grades retail gasoline price and right hand scale.
NOTE: Left hand scaling.

US total gasoline consumption is up from 8.45 Mb/d in Q1 2014 to 8.81 Mb/d in Q1 2015 or 0.36 Mb/d (more than 4%) year over year.

Note that US gasoline consumption started to grow in 2013 and before the recent oil price collapse.

Figure 06: The green line in the chart above shows developments in US distillate, including diesel, supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the diesel retail price, right hand scale. NOTE: Left hand scaling.

Figure 06: The green line in the chart above shows developments in US distillate, including diesel, supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the diesel retail price, right hand scale.
NOTE: Left hand scaling.

US total distillate consumption is up from 3.74 Mb/d in Q1 2014 to 4.00 Mb/d in Q1 2015 or 0.26 Mb/d (around 7%) year over year.

Note that US distillate consumption started to grow in 2013 and before the recent oil price decline.

Figure 07: The green line in the chart above shows developments in US kerosene supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the kerosene price, right hand scale.

Figure 07: The green line in the chart above shows developments in US kerosene supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the kerosene price, right hand scale.

US total kerosene consumption is up from 1.41 Mb/d in Q1 2014 to 1.51 Mb/d in Q1 2015 or 0.1 Mb/d (around 7%) year over year. Also kerosene consumption started to grow before the recent oil price decline.

Figure 08: The green line in the chart above shows developments in US propane/propylene supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the propane price, spot, Mt Belvieu TX, right hand scale.

Figure 08: The green line in the chart above shows developments in US propane/propylene supplied (a proxy for consumption) with a trailing 52 week moving average (52 WMA), the orange line, both left hand scale. The black line shows developments in the propane price, spot, Mt Belvieu TX, right hand scale.

US total propane consumption is unchanged from Q1 2014 to Q1 2015 at 1.41 Mb/d.

This is noteworthy, as the rapid decline in the propane price so far has not materialized in increased consumption. This may illustrate that all liquid energy is not equal and that the longer chained hydrocarbons are in greater demand due to their higher volumetric energy density and wider range of applications.

In recent years propane has on a volumetric basis been trading at 40% – 50% of the WTI (Western Texas Intermediate) price, while historically and based on volumetric energy content propane has been trading around 70% of WTI.

OPEC supplies of crude oil and condensates

Figure 09: The stacked columns in the chart above shows developments in crude oil and condensates supplies from the 12 members of OPEC, right hand axis. The yellow dots connected with a black line shows development in the monthly Brent spot price, left hand axis.

Figure 09: The stacked columns in the chart above shows developments in crude oil and condensates supplies from the 12 members of OPEC, right hand axis. The yellow dots connected with a black line shows development in the monthly Brent spot price, left hand axis.

The price trajectory from the recent oil price collapse has so far some similarities with that after the Global Financial Crisis (GFC) of 2008.

Total crude oil supplies from OPEC were as of October 2014 at the same levels as in the summer of 2008, and there are reasons to believe that OPEC has potential to increase these, refer also figures 10 and 11.

Some analysts have suggested that OPEC’s motives back in November 2014, to maintain their quotas, may have been shaped by their experiences in the mid 1980’s, but looking at how OPEC responded with cutbacks as the oil price collapsed in 2008, and what that unleashed (ref LTO; Light Tight Oil/shale oil, deepwater developments), may have given OPEC a more recent reminder about who benefits if OPEC unilaterally takes on the role as the global swing producer to influence the oil price.

Looking at figure 09 it should not be hard to envision that it would have taken the oil price longer to recover if OPEC had kept the spigots open after the oil price collapse in 2008/2009.

Developments of LTO really took off after the oil price moved above $70/Bbl in 2009.

Figure 10: The chart above shows developments in Saudi Arabia’s supplies of crude oil and condensates (green area and left hand axis). The pink line shows development in the oil price, Brent spot, the black line total number of rigs, the dark blue dotted line number of oil rigs in Saudi Arabia all plotted versus the right hand scale. NOTE: Rig counts and oil price as of March 2015. Crude oil and condensates production data as of October 2014 from EIA.

Figure 10: The chart above shows developments in Saudi Arabia’s supplies of crude oil and condensates (green area and left hand axis).
The pink line shows development in the oil price, Brent spot, the black line total number of rigs, the dark blue dotted line number of oil rigs in Saudi Arabia all plotted versus the right hand scale.
NOTE: Rig counts and oil price as of March 2015. Crude oil and condensates production data as of October 2014 from EIA.

The chart shows that oil production in Saudi Arabia has been in (and with a time lag) a general upward trend with the increase of oil rigs.

Similar developments are found in Kuwait, refer also figure 11 below, and UAE.

Figure 11: The chart above shows developments in Kuwait’s supplies of crude oil and condensates (green area and left hand axis). The pink line shows development in the oil price, Brent spot, the black line total number of rigs, the dark blue dotted line number of oil rigs in Kuwait all plotted versus the right hand scale. NOTE: Rig counts and oil price as of March 2015. Crude oil and condensates production data as of October 2014 from EIA.

Figure 11: The chart above shows developments in Kuwait’s supplies of crude oil and condensates (green area and left hand axis).
The pink line shows development in the oil price, Brent spot, the black line total number of rigs, the dark blue dotted line number of oil rigs in Kuwait all plotted versus the right hand scale.
NOTE: Rig counts and oil price as of March 2015. Crude oil and condensates production data as of October 2014 from EIA.

OECD and non OECD total petroleum consumption

Figure 12: The chart above shows developments in OECD total petroleum consumption, blue area, non OECD implied total petroleum consumption, yellow area, both right hand scale. The black line shows the development in the oil price, Brent spot and left hand scale. Data as of October 2014.

Figure 12: The chart above shows developments in OECD total petroleum consumption, blue area, non OECD implied total petroleum consumption, yellow area, both right hand scale. The black line shows the development in the oil price, Brent spot and left hand scale. Consumption data as of October 2014.

Following the collapse of the oil price post GFC in 2008, OPEC reduced supplies by about 3 Mb/d from July 2008 to March 2009 (refer also figure 09), which coincided with an aggressive credit/debt expansion in EMerging Economies (primarily China), that also allowed for growth in oil demand and support for the oil price.

Advanced Economies (primarily OECD) responded to the GFC by increased deficit spending, lowered interest rates and QEing (“printing money”) to bring the economies back on their growth trajectories and which (broadly speaking) contained their decline in petroleum consumption. As the oil price started to grow, primarily driven by demand growth from EMerging Economies, OPEC gradually increased their supplies (refer also figure 09).

The higher oil price, as from 2010, stimulated a rapid expansion in the extraction of costly oil (like LTO in the US, expensive deepwater developments) that sowed the seeds, through aggressive use of debt, for a period with global oversupplies of oil.

When and how the market will obtain a better balance between consumption and supplies, thus giving sustained support for a higher oil price, depends on several factors.

So where is the oil price headed?

This post has given a glimpse into some of the lots of moving parts that determine the future oil price.

  • The recent collapse in the oil price has stimulated more consumption in the US.
  • The recent broad spread from the contango has encouraged a rapid US stock build which added to demand and supported the oil price. Developments in stock changes will continue to reflect the strength of the contango spread.
  • High stock levels may for some time moderate the pace of any oil price growth when the supply/demand balance tightens.
  • Several of the big OPEC producers have been increasing their use of oil rigs and increased their oil supplies according to recent reports. OPEC is believed to still have some potential for growth in their supplies.
  • The collapse in the oil price has led to a reduction in developments for more costly oil, like LTO and deepwater, which with time will result in a decline in supplies from these sources. A sustained low oil price will also affect producers (like stripper wells) that now are at the margin.
  • The big unknown continues to be development in consumers’ affordability for expensive oil.

What is documented is from transparent sources, what remains to be seen is how consumption/demand develops in other Avanced Economies and not least in EMerging Economies, whose rapid economic growth was fueled by rapid credit/debt expansion.

The EME’s drove oil demand and the oil price as the AE’s post 2008 have been coping with the aftermaths from the GFC. The EME’s economies are subject to the same financial mechanisms as the AE’s, and several of the EME’s economies are now testing their sustainable debt levels.

The oil price and the futures curve will continue to be good indicators of how the global supply and demand balance develops.

Predicting the oil price has a lot to do about understanding the economic undertows that drives the oil supply and demand/consumption balance. Developments to demand/consumption appear now to be the one that is very hard to predict.

2 Responses

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  1. Great report! The only information missing is the development of oil consumption / demand in the EU. I believe that there was a substantial decline which has still not recovered and is hovering around the bottom. This ongoing low consumption is contributing to the still weak OECD oil demand in comparison to the emerging markets. Any chance to add a corresponding graph?

    Florian Schoepp

    Monday, 27 April, 2015 at 14:50

    • If I had the data available for EU or OECD Europe I would have added those. The most recent data I have available for EU/OECD Europe (actual) consumption are as of September 2014 (from EIA).
      I agree that to see actual recent developments in the important consumer regions would be helpful.
      I would particularly like to see the recent data on Chinese oil consumption and stock changes.

      Rune Likvern

      Monday, 27 April, 2015 at 15:03


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