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.

With OPEC & Co. having announced supply cuts, the International Energy Agency's latest monthly oil report suggests the market could re-balance in the first half of 2017. So all eyes will be on one of the most near-time sets of figures out there: weekly U.S. oil inventories, the latest set of which are due later on Wednesday.

Really, though, your best approach to December oil data is something like this:

Thinking Face on Apple iOS 10.2

There was a clue as to why in last Wednesday's numbers, for the week ending December 2. Commercial crude oil inventories fell by 2.3 million barrels overall. By far the biggest drop was recorded in storage tanks on the Gulf Coast. Yet stocks at the Cushing, Oklahoma, oil transportation and storage hub inland jumped by 3.8 million barrels. 

This is a familiar pattern. Crude oil is nearly always drained from storage tanks in the U.S. in December, and particularly in Texas and Louisiana, because December 31 is usually when taxes are assessed on whatever barrels refiners hold on that date. Looking back to 1980, inventories have only gone up in 5 of the past 36 Decembers.

Let It Bleed
U.S. crude oil stocks are typically drained by a lot in December
Source: Energy Information Administration
Note: Average change in U.S. commercial crude oil inventories for each month since 1980.

This month, there's even more reason to drain the tanks, with oil prices rising strongly into year-end. Because barrels are usually accounted for on a last-in-first-out, or LIFO, basis, filling stocks in this environment amplifies the taxable value of inventories. Notice how inventories typically rebound in January.

There are a number of ways refiners can keep their stocks lean at this time of year, such as delaying imports or processing more crude oil into products. Another way is to shift oil elsewhere -- say, for example, to Cushing. The monthly data for stock movements there don't go back as far as the overall data (only to 2004). Still, you can see the glaring difference with the figures for the U.S. overall:

The Outlet
While oil inventories overall tend to drop in December, tanks in Cushing usually fill up a bit
Source: Energy Information Administration
Note: Average change in crude oil stocks at Cushing, Oklahoma in each month since 2004. Data for October and November 2016 inferred from weekly estimates.

Keeping all of this in mind is especially useful now because inventories determine how quickly the oil market is re-balancing after the glut of excess supply that has characterized the past couple of years.

The most obvious conclusion to draw is simply that you shouldn't draw much of a conclusion from what happens with U.S. oil inventories this month; the taxman rules for the next few weeks, not OPEC.

The less obvious conclusion concerns those Cushing stocks. The increase in early December coincided with a slight steepening in the oil futures curve.

The Spirit of Christmas Futures
The spread between near-dated oil futures and prices further out widened in early December
Source: Bloomberg
Note: Data show the generic 1st-month WTI futures contract price minus the 6th-month price.

Rising stocks at Cushing, indicating ample supply, tend to push down the cash, or near-dated, oil price. Moreover, as that spread widens, it offers more of an opportunity for traders to lock in a profit by buying physical barrels, putting them into storage and selling them at the higher futures price (see this for further explanation).

As energy economist Phil Verleger has written in several recent reports, OPEC and others seeking to drain the inventory glut need to make this trade uneconomic. By cutting production, they hope to tighten up supply so that cash prices rise, ideally to where they are higher than futures prices (something not seen in WTI crude oil in the past two years). Thus far, the promise of cuts has raised the overall futures curve but hasn't tightened it by much. Verleger calculates the carry trade is still economic, especially for those able to secure storage at favorable rates, such as large commodity trading houses.

The flows into Cushing back that up, although the picture is also muddied by December's distortions. January, when production cuts are due to actually kick in, should offer more clarity on where spreads and inventories are going. In the meantime, enjoy the holidays.

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

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

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