Oil Prices: Supply Glut Could Send Oil Prices to $20

Oil PriceSupply and Demand Imbalance, Rising Oil Stockpiles to Blame

The oil price rally everyone has been talking about has not materialized. And if recent reports are to believed, we may not see a balancing out in oil markets for a long time to come.

It always comes down to the economic fundamentals and global oil prices are still stuck in an extreme imbalance. The amount of crude oil out there, including what’s being extracted, what’s in transport aboard tankers, or what’s part of a worrying increase in stockpiles, is growing.

The latest reports indicate that there could be as much as 100 million barrels of crude oil in tankers. If the nautical traffic jams in the Gulf of Mexico and Shanghai’s port are any indication, global energy markets could be in big trouble heading into 2016. (Source: “Oil slides 3 percent; hits 2-1/2-mth low on U.S. stockpile, Iraqi supply,” Reuters, November 11, 2015.)

Global Oil Glut Highest in a Decade as Inventories Soar

Would you be surprised to discover that the total volume of crude oil at sea today is approximately twice what it was in the first half of 2015? While onshore storage capacities remain robust and flexible, there is a growing worry among analysts and investors that we could simply see a real end to available storage space in which to put the oil.

While you might be tempted to conclude that this is a case of greedy energy traders stockpiling oil in an effort to make profits when the rally comes, this really isn’t the case. Instead, the current crisis in storage is indicative of the supply-and-demand imbalance present in today’s oil markets. If you need proof, consider that the cost of tankers has increased this year, which would render the above hoarding strategy irrational.

While daily tanker rates have dropped from their October highs of $111,000 daily, they are still in the range of $60,000 per day. (Source: “Asia Tankers-VLCC rates to rebound but likely capped on too much tonnage,” HSN, November 2, 2015.) This is still much higher than the $20,000-per-day rates seen in recent years, which clearly nullifies the stockpiling accusations. (Source: “Oil Tanker Rates Soar Above $100,000 a Day as China Hiring Jumps,” Bloomberg, November 2, 2015.)

This has led to a worrying development in global crude oil markets, with deep implications for the oil price forecast in 2016.

Oil Markets Are in Contango, Rising Stockpiles to Blame

“Contango” is a term used to describe a situation in which front-month contracts for oil are less expensive than delivery in a futures contract. This underlines a dangerous imbalance in oil markets. With contango growing, the gap is widening, but it’s still not enough to rationalize mass storage aboard tankers. (Source: EIA, last accessed November 13, 2015.)

But what’s the onshore situation like and how did we get to this point?

As mentioned, rising onshore crude oil storage levels are a broad global pattern now; they’re not specific to North America. This means that there are global macroeconomic trends at play here, rather than local U.S. ones.

American crude oil storage topped about 487 million barrels back in early November, which sits uncomfortably close to the eight-decade record of 490 million barrels we saw earlier in 2015. (Source: EIA, last accessed November 13, 2015.) With OPEC announcing that its oil stockpiles are 210 million barrels above the five-year average, things are definitely heating up. (Source: OPEC, last accessed November 13, 2015.) While there is a time lag to consider, as well as estimates often requiring revision, it appears that total global oil stockpiles are higher than they have been in at least a decade.

The reason behind this is simple: there is an imbalance in supply and demand, with the former clearly outpacing the latter at an alarming rate.

Let’s face facts here. The fact that this supply glut is still hanging over our heads means there will be no oil price rally anytime soon. If I were to hazard a guess, surging production from places such as Iraq, not to mention the looming return of Iran to crude markets, will exacerbate that glut by an even wider margin.

The much-vaunted talk concerning a reduction in U.S. shale production will not only be offset by this incoming new production, but it may actually be outpaced. For example, Iraq will ship more oil to the United States in November than it has since June 2012 and 40% more than it did in October.

The Bottom Line on the Oil Price Forecast

The continued low-oil-price environment will inevitably lead to a further drop in total U.S. oil production. In particular, rig counts will continue their steady decline, as dwindling profit margins force many companies to either stop drilling or close up shop entirely.

The ongoing imbalance in the crude supply-and-demand dynamic will continue to keep oil prices low, while surging production will push up existing stockpiles. The resulting self-perpetuation of this situation will lead to a market correction, and likely a huge one. However, I don’t think it will occur in the near-term. It’s for this reason that I remain highly bearish on the oil price forecast through 2016.

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