My weekly column in the UAE's National
The world is awash in oil. A lot of oil.
Europe’s International Energy Agency (IEA) expects a surplus of 1.7 million barrels per day in the first quarter. Opec thinks it’s even more – 2.5 million bpd. That is more than a year’s worth of demand growth, which is expected to be only middling this year and up barely more than 1 million bpd, according to both Opec and the IEA.
What happens to the surplus of oil? It goes into inventory, first in onshore storage tanks, and when that is full, into floating storage such as very large crude carriers.
But how much storage do we need? Consider: when sanctions began to bite on Iran last year, the Iranians contracted perhaps 20 large tankers to absorb the excess oil. This time around we’ll need more. Much more.
By midyear, Opec and IEA forecasts suggest excess inventory on the order of 400 million barrels, enough to fill 200 supertankers. And that’s just in the first two quarters of the year.
Indeed, if such forecasts are to be believed, supply and demand will not rebalance this year at all. Production exceeds consumption for the entire year, even if the surplus is much smaller after the summer.
All that excess inventory will be out there by midyear, and it doesn’t go away. This will affect oil prices, which will have gone into a steep contango, meaning that the spot price is much lower than the futures price.
It costs $1 to $1.20 per barrel to store oil on a tanker every month, so we would expect to see that differential every month in oil futures prices.
And we do. The market is already willing to pay traders to hold oil on tankers.
But are 200 supertankers actually available for storage? The gross tonnage is there, with the global floating crude capacity in excess of 2 billion barrels. However, many of these tankers are already involved in the daily oil trade, and may not be available as storage units.
On the other hand, the futures curve is also telling us that floating storage may not be needed after the end of the year. The monthly futures price differential falls to $0.60 from early next year, not enough to contract a tanker. Why would that be?
Perhaps the market does not believe the storage will be necessary, that the excess inventory will dissipate by that time. If so, then Opec and the IEA are wrong. And we do, in fact, have some reason to think they might be.
In 1986, the price of oil collapsed just as it did in the last few months. In a short period of time, demand surged, rising by nearly 2 million bpd in a matter of months. And US conventional onshore production fell by 800,000 barrels per day during the course of the year.
If we saw a comparable response this time around, the current surplus reverts to a deficit in the second half of the year, and the floating inventories are largely consumed by early next year. In such a scenario, the need for floating storage does not extend materially into 2016.
Which story plays out matters to Opec. If it believes its own, or the IEA’s, forecast, then the world will remain awash in oil for the balance of the year. In such an event, cutting production makes little sense, particularly for Saudi Arabia, which will be asked to take the brunt of any adjustment.
While such a cut would surely raises prices and net revenues to the kingdom, a premature return to higher prices could re-start the shale business even before it winds down.
In such an event, the kingdom is offered no immediate way to re-inject its diminished volumes and a temporary cut might become permanent, something the Saudis are keen to avoid.
On the other hand, if demand is strong and supply falters, just the opposite risk threatens: Saudi Arabia waits too long to cut production, allowing too much demand to develop around cheap prices and too much production elsewhere to fall off.
If one believes – as I have consistently argued – that we are only now exiting two sequential oil shocks, and if one accepts the view that the conventional supply has peaked out, then a laissez-faire attitude from Opec could spell disaster a year out.
Other than shales, the oil supply is not healthy. A collapse of the oil price did not make finding and delivering other kinds of oil much cheaper or easier (although it has reduced the cost of services to an extent).
A delayed response by Opec could result not only in hundreds of billions in lost revenues to the group, but also in another oil shock for a global economy barely emerging from the last one. Waiting too long could prove both bad policy and bad politics.
We will know which way the scene will play out by early summer. In the meanwhile, Opec needs to stay alert.
That glut may pass sooner than we think.