Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

If the late, great Charles Schulz could ever have been persuaded to draw a chart of the oil price, it would have looked something like this:

AAUGH!
Intraday Nymex crude oil price
Source: Bloomberg

Why? Because if you squint hard enough, you can just glimpse Lucy pulling the ball away as Charlie Brown sets himself up for another crash.

This past week, the oil market has been following Charlie Brown's playbook, with front-month futures rallying as much as 22 percent from last Thursday's low point. Lucy, meanwhile, has taken a variety of forms: Russia, Saudi Arabia, the American Petroleum Institute, to name a few.

The big news, at least in terms of drama, has concerned the freeze on oil production proposed -- sort of -- by Russia, Saudi Arabia, Venezuela and Qatar. That oil bulls have latched onto the idea of Moscow as a savior gives you a sense of how desperate things are in this market.

The reality is that a freeze by OPEC and Russia at current levels, while symbolic, would actually make things worse in terms of the balance of supply and demand, mainly because of Russia.

Russia produced 11.22 million barrels a day in January. But the International Energy Agency projects the country's output for the whole year to average only 11.09 million barrels. So Russia would actually make the world's oil glut worse by holding still at January's pace.

In all likelihood, it can't keep up that pace anyway. So Russia's willingness to engage with OPEC looks more like an attempt merely to push rival producers to cap their supply while its own is falling of its own accord. And yes, like Charlie Brown punting thin air for the umpteenth time, the idea that Moscow might engage in such chicanery may come as a shock.

When it comes to a coordinated freeze, Iran is the whole ballgame (to slightly mix sport metaphors). Based on current IEA projections -- which have Russia's output declining through 2016 -- and assuming supply from OPEC stays flat, global oil inventories should peak around the middle of the year and then start to fall. But if Iran raises production by the end of the year to 3.6 million barrels a day from the current level of about 3 million, then that pushes the rebalancing process further out.

Iran, no friend of Saudi Arabia and a price taker for any extra barrels, as each one represents cash it wasn't getting, has understandably demurred with regards to joining any freeze. Just for good measure, Iraq has also signaled its ambivalence.

Despite this, oil prices kept pushing higher through Thursday morning, in part because the API's weekly inventory numbers, released on Wednesday, showed a drop in U.S. crude oil stocks. When the Energy Information Administration released its more closely-watched numbers the following morning, the ball got snatched away.

It isn’t just that commercial crude oil inventories, at more than half a billion barrels, are at levels last seen just as the Great Depression was getting underway.

Stocks of gasoline also climbed last week and are now back to where they were at another not-very-fun time, the early 1980s. Roughly halfway through February, gasoline stocks have risen by about 4.3 million barrels already, against an average draw of 2.6 million barrels for that whole month in the preceding 25 years, EIA data show.

Spring Looks Loaded
February changes in U.S. gasoline stocks
Source: Energy Information Administration
Note: 2016 data are through Feb. 12

This matters because, with spare storage capacity running out, oil producers and refiners could be forced to make painful choices soon.

Both Goldman Sachs and Citigroup have recently published reports expressing hope that summer gasoline demand in the U.S. will prove strong enough to help empty the storage tanks, providing a lift to the oil market just as it did last year.

Summer usually helps on this front. Still, it is worth noting that Goldman’s expectations rest in part on U.S. gasoline consumption rising by 130,000 barrels a day this summer, against IEA and EIA forecasts of 40,000 and 70,000, respectively. Meanwhile, the OECD just cut its economic forecasts for a swath of countries, the U.S. included.

If demand doesn’t rise fast enough to work off the gasoline glut, then shrinking storage space will force refiners either to cut production -- reducing oil consumption -- or demand discounts on that crude in order to preserve their own profits. With storage for crude oil also tight, cash prices for crude would then need to drop sharply to force producers to shut in wells -- which is pretty much where Saudi Arabia’s strategy has been driving for the past 15 months or so.

Benchmark cracking margins are already at their lowest level for this time of year since 2010, and some U.S. refineries have already eased back on processing crude oil. 

Something's Gotta Give
Generic Nymex WTI 3:2:1 crack spread
Source: Bloomberg

If they keep that up, expect the crude oil market to land on its back again.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net