Inventories of crude oil and refined products have soared, but seem to be having little impact on prices.
Measured in terms of the number of days of demand that could be met by the stored oil, OECD commercial inventories have risen from 57 days at the end of 2013 to 67 days at the end of March this year. They exceed by 5 days the volume of oil in storage at the depth of the financial crisis, after global oil demand had collapsed.
Surging oil inventories are normally associated with falling oil prices, because they're seen as a signal that there's too much oil about. Until early this year, this time was no different. The 76 percent drop in crude oil prices that accompanied the rise in inventories is well known.
But the recent surge in prices, which have jumped by more than 75 percent from their mid-January low, has not been accompanied by a drop in the volume of oil in storage. Quite the opposite.
The relationship between stockpiles and prices has broken down because higher inventories are now needed to meet surges in demand or disruptions to supply. That's very different to what the global market had got used to over the past two decades, when these changes were met by a pickup in production, made possible by OPEC's spare production capacity.
Companies hold inventories for a variety of reasons, which can be broadly defined as logistical, speculative and security. Oil is needed to fill pipelines, refineries and the supply chain; that's the logistical inventory. Varying volumes may be held to profit from expected future movements in prices; the speculative inventory. Oil is also held to provide a cushion against both anticipated and unexpected fluctuations in supply and demand, this is the security inventory. All of these factors have contributed to the growth in the oil stockpile since the end of 2013.
OPEC spent much of the 1990s and the 2000s trying to convince the global oil industry that it did not need to hold large, expensive stores of oil. Instead, we could all rely on OPEC producers to anticipate market needs and alter supply as required, making use of their spare production capacity.
As Gadfly argued recently, that spare capacity has largely disappeared since Saudi Arabia abandoned its role as swing producer in November 2014 and raised production. With almost everybody else producing as much oil as they can, room to boost production is now all but non-existent outside the kingdom. Much of the reported spare capacity is the result of disruptions to supply that can't be restored without improvement in some underlying political problem -- whether the unrest in the Niger River delta, or the chaos engulfing Libya.
The situation has worsened since the start of the month. A series of unforeseen supply outages, most notably from Canada and Nigeria, has removed at least 2 million barrels a day of supply from the market. But oil prices haven't moved much, because the growing stores create a sense that there's plenty of crude available.
But in the absence of spare production capacity, companies will have to keep inventories that they can dip into to meet fluctuations in demand instead of relying on OPEC to ramp up production like it normally would.
The normal relationship between inventories and prices may yet reassert itself.
But for now, so long as higher stockpiles are needed in place of spare production capacity to meet spikes in demand, or disruptions to supply, high levels of inventory need not mean downward pressure on prices.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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