Oil! The Supply Side (Pt. II)
In my previous post, we discussed just one of the geopolitical factors that could cause oil prices to spike. Why do these geopolitical issues matter? Because they have the potential to affect the supply of oil. Let’s have a rundown of what we know so far about oil’s supply right now and what the future projections are.
The Inventory Numbers
Most of the pundits are saying that oil’s rise from $70 to the $95-$96 range has been driven by things like a declining dollar (which oil is denominated in) and the geopolitical risk abroad. However, the inventory numbers we saw just a couple weeks ago indicate that there may be something more which is affecting the fundamentals. The US inventory numbers have come out a bit on the short side, which is helping the bullish case on oil.
The stockpiles have dropped 3.89 barrels to 312.7 million. We haven’t seen a number like this since October of 2005. This is below the Energy Information Administration’s projection of a 0.4 million barrel addition. Refinery activity also declined, from 87.1% to 86.2%. Again, this is below expectations.
Overall this gives us inventory levels that are 7.5% lower YoY
Below is a graph illustrating YoY changes in % of crude inventories for the last 3 years. As you can see, there’s a steady decline.
The decline in stockpiles will be of definite interest as demand continues to climb. Payroll numbers are indicating that the US economy is still strong, which means we should not expect a slow down in industrial activity – the kind of activity which uses oil. This means that demand can be consistent with where it’s been in the past but will be paired with a shrinking available supply.
What OPEC Is Saying
“In spite of this, OPEC is being usually accused for oil price changes and the expectation from OPEC to increase (its oil) production is an illogical expectation.”
-Acting head of the Iranian oil ministry, Gholamhossein Nozari said news agency Shana reported Friday. He said that the world should not anticipate OPEC to increase crude oil production and said that heads of OPEC states would not confer on skyrocketing oil prices in an upcoming Riyadh summit.
The supply numbers here, are again, not exactly positive. For Non-OPEC numbers, the aggregate supply projections are expected to increase by around 0.81 mb/d over the previous year to reach 50.29 mb/d which represents a minor downward revision of 28,000 b/d compared with last month’s assessment.
Downward revisions made to Mexico, UK, Brazil and Sudan are fueling the shortfall.
Mexico issued a downward revision for the third and forth quarter of roughly 105,000 b/d and 80,000 b/d. This is believed to be a result of pipeline sabotages, projected hurricane activity, and a decline in production from the Cantarell field. Annual figures are expected to be at 3.54 mb/d representing a decline of roughly 147,0000 b/d from 2006.
Latin America’s broad production numbers indicate a growth of 44,0000 b/d over 2006 but a downward revision of 42,000 b/d compared to OPEC’s assessment last month. Out of the Latin American oil producing nations, Brazil is the only one issuing projections for growth.
Africa is similar to Latin America, in that oil production is projected to rise 83,000 b/d from 2006 but has been downwardly adjusted from last month’s estimates. Growing oil producing nations in Africa are Sudan and Equatorial New Guinea.
The Middle East is expected to see a decline this year of around 87,000 b/d attributed to Oman, Syria and Yemen. Oil supply in the Middle East is expected to average around 1.68 mb/d, with a quarterly distribution of 1.70 mb/d, 1.69 mb/d, 1.67 mb/d and 1.66 mb/d respectively.
The Future
The following is what I’ve gleaned from reading a report by the Energy Information Agency’s International Oil Outlook report for 2007:
The EIA has estimated that by 2030 we’ll see the world liquids production
in 2030 exceed the 2004 level by 35 million barrels per day. OPEC is expected to produce 57 million barrels per day and non-OPEC producers 61 million barrels. 65% of the increase will be attributed to a rise in production from OPEC member nations. Now normally, any increase in supply would be beneficial, especially as we have all these emerging players in the global economy that are ready to grow. An increase such as this will force more reliance on production by OPEC nations, which could create potential problems in the future because the region is not geopolitically stable.
The EIA is forecasting this change in reliance due to the investment activity of oil producing nations. For example, the EIA believes countries like Mexico, Venezuela, and regions such as the North Sea are going to slow or at least postpone investments in the oil producing capacity until 2015 when it’s more economically viable. In Mexico and the North Sea’s case, investment and production is expected to decline.
These types of decisions will undoubtedly slow production from regions like Latin America. On the other hand, nations like Saudi Arabia and Angola are currently making investments to expand their oil production capacity right now. The investments of these nations and several other OPEC members will increase production capacity to make up for the gap created by a lack of investment by non-OPEC members.
Tradable Ideas
A lot of this post consists of data and future projections. How can you profit off of it?
In a recent interview with Bloomberg, Boone Pickens mentioned that he’s still bullish on oil. He said that he expects we’ll see oil hit $100 by the end of the year. It’s important to note however that Pickens is a believer in “Peak Oil Theory”. Peak Oil theorists believe that our production capacity has peaked and we’ll see a continued rise in the price of oil as a result.
Additionally, Pickens has billion dollar investments in the wind energy space, he expects that as oil rises, we will increasingly look for new and alternative ways to generate energy. So it seems like a direct play on the rise in commodities, either through futures or an ETF would be advisable. Also, companies that are developing wind technology to harness energy may be of some interest, albeit a bit more speculative.
Some of you may be wondering why wind instead of Ethanol which is ever so popular with the media.
I think that the problem with ethanol stems from the fact that it comes from corn. We use corn in practically all our foods due to high fructose corn syrup. A rise in the use of corn to make ethanol will cause a rise in corn’s price. This will make food cost more and put a greater strain on your average consumer. In addition to this, there’s no real distribution network set up for ethanol. It’s my understanding that it’s extremely dangerous to transport the liquid, making the process expensive on all ends.
Tomorrow I’ll have a piece on the demand side of oil.
