Phil Flynn is writer of The Energy Report, a daily market commentary discussing oil, the Middle East, American government, economics, and their effects on the world's energies markets, as well as other commodity markets. Contact Mr. Flynn at (888) 264-5665
The crude oil price broke out to the upside as European Union manufacturing data stunned analysts and give us a surge in oil. The February PMI gauge of Euro zone manufacturing activity came in at 56.0, compared to 54.3 that was the expected read. The rally happened despite a roaring dollar that was pumped on Fed talk that is trying to tell the market that a rate hike may be on the table at the next FOMC meeting. We will get U.S. manufacturing data today as well as more Fed speak but for now, the charts on oil are speaking for themselves.
The move higher comes as traders are looking past the U.S. oil and gas glut and focusing on the rising demand expectations that have increased in part because of this strong data. As OPEC compliance to production cuts are good, the global oil market is well on its way to being balanced and as U.S. refiners come out of maintenance, we should see the global oil supply be less than demand. Even Russia has set up its own system to monitor compliance.
Our lonely prediction of a market supply balance and record compliance to OPEC cuts is coming true, setting the stage for what should be a very strong oil market for 2017 and 2018. We had one of the most bullish calls on the street last year and turned out to be correct after a wild swinging and volatile year. Now many others are getting on the bull oil bandwagon as we are on target for oil to test near $73.00 a barrel this year.
Dow Jones reports that the Organization of the Petroleum Exporting Countries wants the recent initiative to cut production to be the starting point for a new era of cooperation in the oil industry, according to Mohammad Barkindo secretary general of cartel. Speaking at the International Petroleum Week being held in London, the executive said that it was very positive to see other non-OPEC producers such as Russia to agree to join in with cuts and this type of congenial approach was something that needed to be built on for the future well being of the industry. OPEC pledged to cut production by 1.2 million barrels a day on Nov. 30 last year in order to hasten the rebalancing of the oil markets.
We still must work through record U.S. petroleum supply and based on market action, that is expected to happen. U.S. oil exports, already at a modern historical high, will continue to expand and we should see product exports surge to near records as well. We still will see another 10 million barrels sold from the Static Petroleum Reserve here in the U.S and that will happen this month. It appears this oil will show up in commercial inventories when the buyer takes possession.
The Energy Information Admission may be giving the impression that supply may be a little bigger than it is. One loyal Energy Report reader says that one reason for the crude oil build is what is called “line fill” in the pipelines and storage tanks that were built by the MLPs to get the new shale oil production from the various fields to the refining markets. The oil is not “usable”. In fact as is the case for the past several years, refinery inventories are virtually unchanged. Meanwhile the change in pipelines and tankage storage fits the change in total inventories perfectly. That is where all the inventory build is and it will not go back to previous levels.
My purpose for writing is to gain public exposure on the confusion in counting and reporting of domestic inventories and the direct impact of that process on the size of inventories reported by the EIA. And very importantly, to extend this understanding to the markets. I am convinced this would go a long way toward dispelling the misunderstood claim of an oil glut in the U.S. and worldwide now, and in the future.
More importantly, I want to explain to you how EIA counts and reports domestic inventories of crude oil and how this process can and does grossly mistake inventory levels in a way that confuses investors and ultimately can lead to very bad and even harmful mispricing of oil – particularly in the huge and controlling paper market. It is simple, increased domestic production causes exponentially larger inventory “counts” as compared to oil that is sourced from imports. Where crude oil is sourced from has a huge impact on the size of inventory reported by the EIA. As domestic production increased in 2010 to 2015, inventory levels had to increase even though we were reducing imports.
And the EIA knows about all of this. They agree with me. I have communicated my concerns to the EIA and I am convinced they are sympathetic with my argument, but I am equally convinced they will do nothing about it. Sure, because of my “hounding” they removed that ridiculous outdated statement about “the highest inventories in 80 years”. Clearly, that does not contend with the issue that causes me great concern. That is why I am contacting you! In the end, the EIA called the very large increase in inventories caused by the counting of domestic production logistics (collection, storage and transmission) as compared to imports, “an accounting issue”.
If you choose to consider my claims of “misreporting” by the EIA, during my research regarding the so- called glut in domestic oil inventories that carried over to the entire non-OPEC market, I discovered a very interesting article written by John Kemp, in which he came to some of the same conclusions. But, in the end he wandered into a delta in the contango in the futures market, and the reporting issue lost impact. Here is his article, if you choose to read. Reuters wrote, “The basis of my argument is simple – in the last 5 to 7 years the midstream MLP industry has made a huge amount of capital additions totally purposed to get our new shale oil production gains to refining markets. Obviously, this means adding a lot of new gathering and transmission pipelines and along with them very large amounts of tankage/storage. I spent several years as a senior financial executive of two domestic and international trading companies and one domestic merchant refinery. When I saw this, it seemed to me that this would have the effect of adding a lot of inventory to our system. So, with all this talk about the oil glut from every “expert” you could possibly hear from, I decided to visit the EIA web site once again and check it out.
Kemp continued, “As you know, there are now two types of crude inventory; (1) refinery inventories, and (2) tank storage and pipeline inventories. When I looked at the data, I think it supported my suspicion as to why inventories are so high, and why they will not likely go back to prior levels. Along with the data history, the historical graphs paint an overwhelmingly convincing picture of how the growth in total inventories comes almost entirely from pipelines and tankage/storage associated with collecting and transmitting domestic production to refinery markets. To simplify the data presentation for this note, I looked at two data points – March 2011 and March 2016. – in 3/11, refinery inventory was 93.9 mm bbl, while in 3/16 refinery inventory was 101.2 mm bbl; a very small increase of 7.3 mm bbl. – in 3/11, tank storage and pipeline inventory was 240.8 mm bbl, while in 3/16 tank storage and pipeline inventory was 395.1 mm bbl; a very large increase of 154.3 mm bbl – explaining all the increase in crude inventories and quite frankly all the crude oil glut. The key to the problem is where the crude is sourced from. When one looks at these numbers, I think it makes it very clear that the inventory increase and oil glut was caused by the increase in domestic production and the new pipelines and tankage that were built to accommodate it. The heart of the issue is what the source of the crude oil is. This will significantly determine the relative level of inventory – and whether there’s an “oil glut” or not. Given the way the EIA accounts for foreign waterborne crude imports (which are counted at discharge near refinery tanks), I would guess they would be at the refinery gates in about 10 days’ max after being picked up as inventory by the EIA.
On the other hand, domestic production must go through gathering pipelines to storage at transmission locations or input sites. Once it is in storage at input, it is then transferred in 30 day batches starting at the beginning of the next month. But, the oil is not available to the receiver until the end of the month, at the output location. So, it could be in tank storage and pipeline inventories for 40 to 60 days (or more) IMO, and based on my experience – but it is clearly not usable inventory. But, the important factor is – this not USABLE INVENTORY, any more than the oil on the ships headed to discharge from distant foreign suppliers! Why would you count oil in transit and related storage for domestic production, but not count oil in transit on vessels from foreign ports even though the oil on board is likely owned by the refiner and the vessel is likely controlled by the refiner? Clearly, as we shift from imports to more domestic production for refinery demand, total inventory will increase dramatically, but usable inventory won’t change!
With the detail of that earlier email I sent to you, and your understanding of what is really happening, you have all that is needed to clear up the confusion about inventory levels in the U.S. As I was concerned, prices are not increasing to a level of acceptable returns for anybody. This talk about shale producers lowering their breakeven costs is just a bunch of undeserved chest pounding. As services start to raise their prices back to a profitable level, well costs are going right back up. And needed deep water projects are being canceled.
That should help put the so-called glut into perspective!
Questions? Ask Phil Flynn today at 312-264-4364
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