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.

Houston's tycoons are just like those in Silicon Valley: They love a dose of disruption -- provided it happens to someone else, of course.

There is a lot of disruption going on in oil, and it's got nothing to do with unicorns. We're talking wildfires and war. The Energy Information Administration calculates that unplanned supply outages, such as those in Canada and Nigeria, reached just over 3.6 million barrels a day in May, the highest since the EIA started tracking them in 2011.

No wonder oil is back above $50 a barrel. Or, from another perspective, how the hell is oil only at $50?

Conflicted
Brent crude oil price
Source: Bloomberg

In a recent report, energy economist Phil Verleger pointed out how, despite the rally of the past few months, oil looks pretty subdued relative to earlier periods of strife.

But then, you'd probably be a bit subdued too if you had a few hundred million barrels of oil dumped on top of you. Spencer Dale, BP's chief economist, made a good point in a speech on Wednesday when he talked about bringing oil supply and demand back into balance:

The adjustment to lower prices has continued this year, with indicators pointing to solid demand growth and a decline in non-OPEC supply. Based on current trends, it seems likely that the market will move broadly into balance in the second half of this year. But to be clear: that doesn’t mean the problem is solved, it simply means the problem in terms of accumulating oil stocks stops getting worse!

On the same day, oil jumped the most in 2 weeks on news that U.S. crude inventories had dropped by a larger-than-expected 3.2 million barrels -- despite the fact that almost 9 out of 10 of those simply got refined and then flowed into storage tanks in the form of gasoline and diesel. That's a bit like sweeping dust under the rug.

Dale said commercial oil inventories in OECD countries ended 2015 about 350 million barrels above their five-year average. Clearing that blob is the chief obstacle to a sustained rally from here. In the past, OPEC would take the strain by cutting supply. But with the cartel about as useful as a chocolate teapot these days, oil producers have to rely on a Hunger Games scenario of rivals falling by the wayside.

Unforseen disruptions are, understandably, hard to predict. The EIA does factor them into its projections, like the ones it released this week, but doesn't publish the underlying numbers. Still, the EIA assumes that supply outages rooted in political strife, such as Nigeria's, tend to be persistent, unlike those due to natural disasters, such as Canada's fires. The former accounted for about 2.8 million barrels a day in May. Round it up to 3 million a day and it provides an educated guess of ongoing disruptions.

The EIA has a more bearish view than many, expecting supply and demand won't balance until the second half of 2017. Assume this projection already factors in 3 million barrels a day of disruptions.

Now what happens if the world turns out to be a bit less or a bit more unpredictable? On the optimistic side, say Libya and Iraq enjoy a bit more peace later this year, with disruptions down to just 2.5 million barrels a day, dropping further to just 2 million in 2017 as Nigeria's crisis eases.

On the pessimistic side, say Canada's supply doesn't recover fully until next year, Libya's outages blow back out to levels seen in 2011, and Iraq loses another couple of hundred thousand barrels a day. Above all, factor in the one big wildcard absent from the EIA's disruption table: a Venezulan collapse. Factor in 1 million barrels a day offline for that one and suddenly you've got about 4 million barrels a day off the market.

Boom
Using the EIA's projections, it will take persistent, severe disruptions to shift the balance of supply versus demand into negative territory
Source: Energy Information Administration, Bloomberg Gadfly analysis
Note: Optimistic case assumes outages average 2.17 million barrels a day, weighted to the second half of 2016. Pessimistic case assumes 3.85 million, weighted to 4Q 2016.

Any armchair oil baron can, of course, imagine any number of disaster scenarios. And these numbers don't move in isolation: A crisis-induced spike would tend to encourage unaffected producers to work harder, and vice versa.

Three broad conclusions can be drawn, though.

First, reinforcing Dale's observation, clearing the glut will take time. The pessimistic scenario above implies about 200 million barrels of oil flowing out of inventories through the end of next year -- the right trend, but still slow.

This leads into the second point: That glut will keep oil yo-yoing up and down, but essentially capped, until the tanks start draining consistently. This fall, after driving season ends, will be an important test.

The third point concerns OPEC. Unable to coordinate supply cuts to support prices, OPEC is instead doing it haphazardly. It accounts for about 40 percent of global oil production, but about 80 percent of unplanned disruptions so far this year. Low prices themselves feed destabilization in the cartel's largely undiversified economies.

Let's Take This Offline
OPEC certainly leads when it comes to unplanned oil outages
Source: Energy Information Administration

While no doubt expressing deep sympathy for their compadres' woes, more stable members also reap higher prices for their own barrels. But that also underscores OPEC's widening divisions as the oil market turns into a free-for-all. What's more, those higher prices help anyone with the wherewithal to exploit them -- including one truly disruptive constituency: shale producers.

Back to Work?
The U.S. oil-rig count has shown tentative signs of bottoming out as oil has climbed back above $50
Source: Baker Hughes

 

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