Inventories and the Price of Oil

Over the past decade two blindspots have consistently marked popular oil price forecasts, of the kind you see each day on TV. First, there is the ongoing misunderstanding about inventory measurement as an absolute number, rather than on a days supply basis. I would agree that at the extremes, when oil inventories are very high or very low, it does make sense to consider the absolute measure. But outside of these extremes, relative inventory on a days supply basis is a much stronger price determinant because the oil price will guide itself on a 6 month basis towards those conditions. Most of the oil price forecasts and analysis you hear on TV is about the 30 day market, which has as its only focus the price needed to clear smaller changes in under or oversupply on a local basis.

This brings us to the next blindspot: United States inventories vs Global inventories. US inventories at Cushing, OK will tell you alot about the oil price over the next 30 days. This will be the focus of floor traders at the NYMEX, the subject of discussion on TV, and the basis for daily subscription products. This is where alot of US based oil analysis is concentrated and its impressive they are able to sell the the daily and weekly forecasts to so many customers. I think this is what Nicholas Taleb refers to when he says people are so desperate for a map that they’ll be willing to buy any map at all, just for the sake of holding an object in their hand.

Putting these ideas together, what an investor or policy maker should be paying attention to is not US inventories exclusively but OECD inventories. OECD inventories flashed a potential peak this Spring, on both an absolute and days supply basis. Even though OECD inventories built substantially during the global industrial collapse, what started to become clearer by June and July was that Total OECD inventories were starting to flatten out, as Asia-Pacific OECD and Europe OECD inventories started falling dramatically. Thus, starting in June, an observer could have formed a view of a more sustainable price of oil that would emerge over the following six months. In other words, the price that really matters.

One can also pair this view of broader OECD inventories, however, with both absolute and days supply analysis for US based products like Distillates, which can drive the price of oil on a seasonal basis. From the Supply Data Review section of my latest newsletter |see: discounted price on current issue as part of the 2009 Annual:

While USA crude oil stocks have been falling like their broader OECD counterparts since Spring, it’s been the refusal of Gasoline and Distillate stocks to show clear evidence of sustained falls that has kept oil restrained below 80. Oil pricing on a short term basis remains very much in control of New York. Since the Spring peak in global crude oil inventories, there have been several false starts in both Gasoline and Distillates causing the price of oil to rise, only to fall back again. At the NYMEX, they have been skeptical. Thus, oil has been halted at the 80 dollar level more than several times. But we can see why that is about to change.

The final tipping of Distillate stocks on both an absolute and on a days supply basis has only come in just the past 8 weeks. We now have a plausible explanation for oil’s rather oddball, contra-seasonal strength in December. Again, 100 dollar oil is only 10 trading sessions away, once price starts dancing around 80. December’s price action strongly favors much higher prices in Q1 of 2010.

For those of you who want to follow along at home, so to speak, you can always take the free version of the IEA Paris Oil Market Report, which releases itself in abridged form each month, and then frees the entire document to public reading generally about 14 days later. You’ll want to dig deeply into the full document, and look at OECD inventories in North America, Europe, and Asia.


  • ugh

    this blog is a one-way street on oil

  • ugh

    proof positive from a post back in Sept 08: “at the level of 100.00, it’s my view that the price of the incremental barrel has been discovered. In other words, at 100.00, new deepwater or new oil sands projects are slowed down, or canceled. At 100.00, Russian exporters see their profit margin go close to zero, after duties and taxes. While many small projects can go forward easily at 100.00 or below, it’s clear that the threat of oil going below 100.00 has implications for the large projects, that make a difference to supply.”

    russia has reached record levels of output. you will say anything to make people think oil is only going to go up. even if it means telling them $100 is cheap as it tanks to $30. Listen to this blog at your own risk. Yikes.


    Thanks for the comments. I can't find anything in what you cite that is not accurate. Global supply fell, Non-OPEC fell. All new Alberta Tar Sands projects were cancelled. Russia had to lower all the taxes and duties on some wells to zero. The post does not claim that Russia peaked. The post claimed what would happen to global supply as a result of price. Not sure why you interpreted it that way.

    You should have instead just found straight passages on price alone. For, I was wrong alot on price.

    But everything you cite here is on supply. The data has come in quite clearly on that, wouldn't you agree? I assume you are aware of the supply data.



  • Gregor – I agree with you. Your comment on the price falling below the marginal cost of production for many producers is correct, and fairly widely accepted as fact throughout the industry.

  • So where do you get chart of OECD oil inventories

  • So where do you get chart of OECD oil inventories

  • Having an insiders view on the industry I have to agree. The oil industry doesn't exist outside the normal economic factors that need to be considered when assessing the viability of production.