The Fundamentals Behind The Recent Rise In Crude Oil

Posted by jbrumley on August 5, 2016 7:43 AM

6 Charts That Tell the Whole Current Story of Crude Oil

On Wednesday of this week, crude oil prices (USO) decidedly reversed what was becoming a prolonged downtrend. Between the end of June and Tuesday's close, oil had lost 18% of its value. Wednesday's 3.3% bounce was the best day oil had seen in over a month, snapping crude out of its recent bearish rut.

The prompt? The Energy Information Administration's (EIA) weekly report of oil imports and exports, gasoline consumption, and perhaps most important of all, the amount of crude oil and gasoline the nation has stockpiled. Falling stockpiles means less supply, and therefore higher prices. Last week, although crude's stockpile level actually edged up from 521.1 million barrels to 522.5 million barrels, reversing a shallow month-long lull in supplies after a multi-decade peak just a few weeks ago.

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Higher inventory levels spurred a price increase in oil? As they say, it's complicated, and traders are working with other data, and filling in the blanks with assumptions as needed.

The crux of Wednesday's big gain was driven by the 3.26 million barrel drop in gasoline inventories, to 238.2 million barrels. Gasoline production also fell. Presuming oil from the existing inventory will be used to make more gasoline, oil's stockpile levels should be dropping correspondingly in the foreseeable future.

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Even then, though, the picture is incomplete; there are many facets of what drives the price of crude oil higher and lower.

First, though not foremost, it has to be noted that the Baker-Hughes total -- the number of rotary rig counts currently in use and therefore a measure of U.S. oil production -- ticked slightly higher again last week, to 463. That's the fifth straight week of rising rig counts, arguably reversing a stunningly steep downtrend between mid-2014 and mid-2016.

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The Baker Hughes number implies the United States should be able to, and had been, ramping up its oil production.

And yet, that certainly wasn't the case last week. Crude oil production fell by 55,000 barrels per day -- an average -- last week, marking the first decline in four weeks.

That data doesn't jive with other data. Imports of oil into the U.S., as opposed to drilling and refining it domestically, hit a multi-week high of 8.7 million, suggesting the nation's capacity to extract and then refine oil (XLE) has finally been crimped. The amount of oil drillers (XLE) (XOP) are taking to refineries and the amount of capacity refiners are utilizing have also both been on the rise since the beginning of the year. Clearly some of that oil has to be sourced overseas, considering the U.S. has been cutting into its stockpiled supply since May, and imports have been growing.

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Moreover, despite OPEC's verbal posturing, low oil prices have forced some of its members partially if not completely out of the market. Though OPEC's output growth remained steadily above 1.0% between early 2015 and early 2016, that growth pace has been whittled down to about 0.6% since April. Even Saudi Arabia and Iraq have pared back their production increases, while some countries have outright reversed their growth and started reducing their output; Iran is the only OPEC member nation to be completely stubborn.

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To be clear, even modest growth is still growth, so the global supply is still being prodded upward because of OPEC's insistence. It's finally starting to peak, however. The end result? When pairing OPEC's production-growth slowdown with the rest of the world's production-growth reversal, the supply does indeed begin to shrink. It's been negative for the past four months.

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The data is admittedly conflicting, but there is an explanation. The data is conflicted mostly because of timing and a lack of synchronization.

It's difficult to account for, but gasoline and crude oil in transit doesn't always have a proverbial "home" where  it's counted in any of the above measures. It's also worth understanding that for as much effort put forth to gather data, not all the relevant data is gathered.

Case in point? Oceanic supplies of oil are not counted as inventory until they're brought onto actual land, though there could be millions of barrels en route to land at any given time. Or, there could be very little oil about to be received from maritime vessels. 

There are also unknowns that may speculatively impact the price of oil. The aforementioned consumption of gasoline last week is one example. Traders presumed existing oil will soon be converted to oil, but there's no assurance this will happen, but even if it does it could take more than a week to begin the process.

In the meantime, refiners are already starting to gear up for the winter season, shifting their refining focus from summertime-friendly  gasoline to a so-called winter blend, and even to the production of heating oil. Moreover, the current gasoline stockpile may well need to be culled rather than replenished, as its shelf life isn't indefinite and room needs to be made for winter-blend gasoline.

So what's the call? Though there's not a great deal of empirical evidence to this end, Energy Aspects chief oil analyst Amrita Sen recently concluded "We are dropping supplies like a stone, non-OPEC supplies have fallen by over a million barrels per day over the last three to four months and it just takes time. The market always wants things very quickly."

In other words, all the production cuts and well-shutterings witnessed over the past few months haven't dished out a tremendous impact yet. But, it's coming. There's just some lag time between the cause and the effect.

As for traders, the mixed data -- most of which is weekly -- underscores to what extent that a short-term view on oil is only a trading point of view, driven by headlines.  A long-term view of oil requires a trader to look past the near-term noise and keep tabs on the monthly, global figures. The U.S. oil supply always eventually finds an equilibrium with the bigger global picture. And right now that bigger global picture says the glut is abating, perhaps at a faster pace than it seems on the surface.

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