For the week ended July 28th, Crude Oil logged its biggest weekly gain of 2017, with WTI up 8.6% and Brent up 9.3%, resulting in the market’s best month since April 2016.
Should we be surprised that the tone of the energy market appears to be improving, or that prices are recovering and global oil supplies are declining?
Well, in May we wrote about the dramatic shifts that were occurring on the supply side of the global oil market due to the severe decline in price. We pointed out that investors should focus on oil companies’ significant global capital expenditure cuts, the decline in conventional oil production, and the limitation of shale production when considering the potential for oil to mean revert.
Blog Post: THE CURE FOR LOW CRUDE OIL PRICES…IS LOW PRICES (May 11, 2017)
Investors should also consider that any large liquid market that has experienced the dramatic volatility that Crude Oil has had over the past couple years typically attracts an increasing amount of institutional capital focused on shorter-term trend analysis and algorithmic trading. Today’s oil markets are subject to massive amounts of trading capital influencing the direction of prices on a daily basis which is met by a barrage of media coverage trying to explain the fundamentals behind every move! This creates a tremendous amount of “noise,” and we suggest the longer-term investor or asset allocator would be wise to discount.
Just three weeks ago the Wall Street Journal published an article highlighting the expanding influence of institutional trading on the short-term moves in oil prices.
With all this in mind, we thought it might be informative to consider the following data points that that have occurred since our mid-May blog post that we believe have longer term implications for Crude Oil prices:
- The American Petroleum Institute (API) reported a much larger than expected draw of 23 million barrels in United States Crude Oil inventories, compared to S&P Global Platts survey of analysts who expected a draw of only 2.5 million barrels for the week ending July 21. All of the build-up in inventory between January and April has now been erased! (Oilprice.com 7-25)
- The U.S. Energy Information Administration confirmed this larger than expected draw by reporting that U.S. oil stockpiles fell by 7.2 million barrels last week. This was the fourth straight weekly drop in domestic stockpiles. (WSJ 7-26).
- Output at conventional fields from China to North America — making up a third of world supply — fell 5.7 percent last year, the most since 1992, according to Rystad Energy. (Bloomberg 7-10)
- Data out of the U.S., Europe, Singapore and Japan point to overall global inventory declines of 83 million barrels since March, according to Goldman’s data. (CNBC 7-28)
- Saudi Arabia’s domestic crude stocks declined in 16 of the past 19 months between November 2015 and May 2017 and have fallen to 259 million barrels at the end of May 2017, which was the lowest level since January 2012. (Reuters, 7-19)
- Saudi Arabia vowed to limit its crude exports to a level that is almost 1 million barrels a day less than a year-ago. (Reuters, 7-23)
- Saudi Aramco Chief indicates that insufficient investment in oil production threatens a global shortage that won’t be met by US Shale. (WSJ 7-11)
- Shale oil companies are cutting spending as indicated on recent earnings conference calls by the likes of Andarko, Hess, Whiting Petroleum, and Sanchez (CNBC 7-27)
- David Lesar, Halliburton Co.’s chief executive officer and president, said in an earnings call that “rig count growth is showing signs of plateauing and customers are tapping the brakes.” (Reuters 7-24)
- Continental Resources CEO Harold Hamm warned oil prices below $50 a barrel is not sustainable. A drop below $40 would cause many American producers to reduce drilling activity.
The timing and exact path of the recovery in oil prices is impossible to predict but sustained low prices are certainly having their effect on the supply side just as they have had on the Metals sector. Both Metals and Crude Oil enjoyed a strong increase off of their 2016 lows, however the Metals sector has experienced a steadier path to recovery as it is up an additional 8% in 2017. Major capital expenditures and the closing of excess capacity by mining companies led to tightness in supplies which is driving the continued appreciation in many of the Metals’ components.
Blog Post: COMMODITIES: FOCUS ON METALS (June 29, 2017)
We believe there are similar fundamentals happening in the Crude Oil sector and, although the price path has been more volatile, the long term result should be the same as the asset class experiences a multi-year reversion to the mean. The cure for low prices is low prices…and it’s working!