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.

The International Energy Agency indulged in a little trolling on Wednesday.

The title of the executive summary of the IEA's oil report this month -- "Whatever It Takes" -- was a direct reference to the Saudi Arabian energy minister's portentous description of OPEC's resolve to drain bloated oil inventories. While he wasn't mentioned, there's little doubt the summary's final line was aimed at him:

"Whatever it takes" might be the mantra, but the current form of "whatever" is not having as quick an impact as expected.

Sick burn and all that. But there's no denying the truth of it.

At first glance, the actual headline numbers in the report offered some encouragement for Saudi Arabia and its associates. The IEA's initial projection for global oil demand in 2018 is for it to grow by a healthy 1.43 million barrels a day, faster than this year and not far short of 2016's big gain. By the end of 2018, demand should top 100 million barrels a day for the first time ever.

So what's not to like? As the snarky summary said, it's all just taking too long.

 

The sucker punch to that strong demand forecast was an even stronger estimate of how much supply from non-OPEC countries would rise next year: 1.5 million barrels a day. So while OPEC and key partners such as Russia have extended their supply cuts out to the end of next March, rival producers in U.S. shale, Canada, Brazil and elsewhere are stepping in to blunt the impact.

As if on cue, the U.S. Energy Information Administration reported later on Wednesday morning a surprising build-up in gasoline inventories last week, more than offsetting a drop in crude oil levels. It was the second bearish inventories report in a row and helped push Brent crude below $47 a barrel and almost back to where it was before OPEC announced the supply cuts last November:

Whatever
Brent crude is almost back to where it was before November's deal on supply cuts
Source: Bloomberg

As at the end of the first quarter, commercial inventories of oil in the OECD -- as opposed to strategic stocks held by governments -- had actually risen versus the end of December, despite supply cuts having begun during that period. With those inventories now back above 3 billion barrels, even the extended schedule of cuts announced by OPEC last month looks inadequate.

The IEA's baseline for determining when oil stocks can be considered as having rebalanced is when they return to their five-year average, or 292 million barrels below where they are today. Yet this may understate the scale of what's required.

Rather than absolute levels, the way to think about stocks is relative to demand. Dividing commercial stocks at the end of each quarter by demand over the following one in the OECD gives a better sense of how bloated they really are:

We Got You Covered
OECD oil inventories remain stuck at around 66 days of demand versus the levels of 57 to 58 days that prevailed before the crash
Source: International Energy Agency, Bloomberg Gadfly analysis
Note: Commercial oil inventories in the OECD divided by demand over the following quarter. Data for 1Q 2017 uses projected demand.

If inventories do drain by 292 million barrels by next March, then, on current projections, coverage will have fallen to just over 59 days by then. That's below 60, which is good. But given the projected growth in non-OPEC supply next year, as well as the latent spare capacity due to OPEC's own cuts (and Russia's), it would probably be better for Saudi Arabia to err on the side of less (especially with an IPO of Saudi Arabian Oil Co. supposedly imminent by then).

Getting back to, say, 57 days of cover, implies cutting more like 393 million barrels by next March from where inventories stood the end of the first quarter. On that basis, stocks would need to drain by more than a million barrels a day between now and then, roughly double the current deficit in global supply as reported by the IEA.

There's troubling news buried in that bullish demand projection, too.

Of the 1.43 million barrels a day of growth forecast for next year, 35 percent of it consists of liquefied petroleum gas, or LPG, which includes stuff like ethane and that propane you use to fire up your grill. LPG forms part of oil demand, broadly defined, but it doesn't eat into crude oil stocks and is worth much less. U.S. propane, for example, trades at the equivalent of about $25 a barrel. And LPG's share of global oil demand growth has been rising in recent years as it takes share from rival products such as naphtha, especially in emerging markets, according to Francisco Blanch, a commodity strategist at Bank of America Merrill Lynch:

Fire Up Those Grills
LPG's share of incremental oil demand is rising
Source: International Energy Agency
Note: Data for 2017 and 2018 are projections.

The flip side of that chart is that demand for more traditional oil products derived from crude oil -- such as gasoline, diesel, and jet-fuel -- isn't rising quite as fast as the headline numbers suggest:

Crude Math
After 2015's spike, induced by the price crash, demand growth for crude oil other than LPG has slipped back below 1 million barrels a day
Source: International Energy Agency
Note: Implied growth in non-LPG oil demand. Data for 2017 and 2018 are projections.

The upshot is that Saudi Arabia will have to drag out its strange romance with Russia as long as it possibly can in its mission to drain the tanks. The pressure on oil prices may help in reining in rival U.S. shale output, though there is scant evidence of this as yet. And in the meantime, OPEC's fragile cohesion is sorely tested by much-diminished revenues.

Don't you just hate it when trolls actually have a point?

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