Oil Markets Tilt Bullish (Commodity:CL1:COM)

The current oil situation can only be described as interesting. Although both WTI crude and Brent crude prices have pulled back from their highs earlier this year, they are still quite elevated. In fact, using the most recent data available, Brent crude prices are up about 13% compared to where they were at the same time last year. WTI crude, meanwhile, is up a robust 14.5%. This is in spite of broader economic concerns and the looming specter of a production hike from OPEC+ nations that’s expected to occur later this year.

My own long-term view has been that WTI crude prices typically belong between $60 per barrel and $80 per barrel. But like anybody else who has been invested in the oil patch for the last decade, I know full well the prices can come in both materially higher and materially lower than this range. At the moment, we’re a bit above that. And that may be surprising to those concerned about rising output. But when you look at the data, whether or not you’re bullish should depend on which source of data you trust. At the end of the day though, I would argue that the forces in play will very likely tilt this in the direction of a bullish outcome where prices remain elevated.

A look at the EIA

In this article, there are two primary sources that I’m using when it comes to looking at global oil supply and demand data. The first of these is the EIA (Energy Information Administration) in the US. Each month, the EIA releases what it calls the STEO (Short-Term Energy Outlook). This looks at global supply and demand trends for oil and other energy sources as well as pricing data and more. For this year, the general belief has been that there will be more demand than supply, thereby creating a shortage of sorts. In the first quarter of this year, the EIA estimated that global supply was 101.84 million barrels per day. Global demand, meanwhile, was pegged at 102.17 million barrels per day. This creates a shortage of 0.33 million barrels per day.

As you can see in the chart above, the overall trend for both supply and demand has been forecasted to rise throughout this year. And in any given quarter, we’re looking at a shortfall of between 0.27 million barrels per day and 0.56 million barrels per day. The organization also provides data covering entire years. In 2023, for instance, global demand was 101.90 million barrels per day, while global supply was 101.79 million barrels per day. This year, global demand is expected to average 102.98 million barrels per day compared to the 102.57 million barrels per day forecasted for supply. Next year, however, the expectation is for the picture to switch. Instead of there being a shortage of supply, there should be an oversupply situation if they are correct. This should amount to excess output of 0.22 million barrels per day.

This might not seem like all that much. But historically speaking, whenever OECD inventories get outside of a specific range in terms of the days of supply that they have on hand, significant price movements in the oil space can be seen. This range is typically considered to be between 55 and 60 days. Even small movements outside of this range can have a devastating impact on the price of oil. In an article that I wrote earlier this year, I touched briefly on this. Back in 2016, excess supply was expected to be 0.29 million barrels per day, while total OECD inventories were estimated to be at 63.47 days of consumption. This brought oil prices down from over $100 per barrel to $26.68 per barrel at the bottom. When in 2020, we saw days of inventories hit 72.06, WTI crude prices even at one point turned negative to the tune of $36.98 per barrel.

One reason that investors have to be optimistic here is that, if current forecasts hold, even in 2025, we should be at 59.32 days worth of inventories. That’s up slightly from the 58.95 days estimated for the 2024 calendar year. However, the devil is in the details. As I mentioned at the start of this article, come October of this year, OPEC+ nations are expected to begin curtailing 2.2 million barrels per day worth of production cuts. The good news is that this won’t occur in the span of a short window of time. Instead, they plan to phase these cuts out over a window of one year.

For its part, the EIA has forecasted production increases from OPEC and other nations tied to this agreement. But if we compare OPEC output today to where it should be by the end of 2025, that increase is only 0.52 million barrels per day. Other nations that are part of this agreement are not expected to increase their output materially either. Russia, for instance, is expected to increase its output by only 0.16 million barrels per day from today to the end of next year. This might not be entirely comparable, however, since this factors in changes in NGL output as well. Unfortunately, OPEC does not forecast what the production of its members or the other nations tied to its agreement will be. But if the data is correct, Russian output actually fell from 9.476 million barrels per day in March of this year to 9.182 million barrels per day in May.

A look at OPEC

If production cuts made by OPEC+ are truly curtailed as the organization says they will be, and if the EIA is correct in its assumptions, there’s definitely a scenario where we might see a glut of crude oil come onto the market. However, not everybody is in agreement with this scenario. For its part, OPEC calculated that, in the first quarter of 2024, there was a global shortage of oil totaling about 1.4 million barrels per day. Over the next three quarters, that number is expected to grow, eventually hitting 2.7 million barrels per day in the final quarter of this year. If the estimates are correct, curtailing their production cuts won’t even stop global inventories from rising.

Even though the organization does not project out production levels from it or the other nations tied to its arrangement, it does estimate how much output, on a daily basis, will be needed for 2025 from OPEC+ in order to meet global demand. That forecast calls for additional crude production of 2.7 million barrels per day. One could of course argue that OPEC is more likely to be biased in its calls. But the data doesn’t seem to support that from what I can see.

As an example, I looked at the reports provided by both OPEC and the EIA that were published in the month of December 2022. I looked at what projected data would be for 2023 and then compared it to what ultimately transpired. The EIA forecasted global supply for 2023 of 101.06 million barrels per day. Ultimately, global supply would come in at 101.79 million barrels per day for an underestimation of 0.73 million barrels per day. However, they also underestimated global demand. They called for this to be 100.82 million barrels per day in 2023. Ultimately, it came in at 101.90 million barrels per day. That’s an underestimation of 1.08 million barrels per day, with the organization ultimately underestimating how strong net oil demand would be in the amount of 0.35 million barrels per day.

Because OPEC does not project its own output, we only know that in December 2022 they predicted that global demand in 2023 would be 101.77 million barrels per day. Ultimately, it ended up being 102.2 million barrels per day for an underestimation of 0.43 million barrels per day. Interestingly, while they estimated that global demand would be weaker than it ultimately was, they overestimated how much of their own supply the world would need in order to see markets remain balanced. The estimated output needed would be 29.22 million barrels per day. Ultimately, they ended up supplying 27.02 million barrels per day.

This tells us a couple of things. For starters, both OPEC and the EIA have a history of underestimating global demand. In particular, the EIA underestimates demand more than it does supply. As for OPEC, it also overestimates how much demand there will be for its own production. So it’s possible that they’re doing the same thing here. But this also shows a willingness to continue curtailing its own output if it means keeping prices elevated. As I detailed in another article, even though US shale output is at all-time highs, a decline in DUC wells means that an eventual supply crunch here at home is more likely than continually growing output. I would argue that OPEC+ nations are well aware of this data. So there’s no reason to believe that they would choose to hike output materially if they come to realize that the market will not be able to handle it as they are currently projecting it can.

Takeaway

Oil markets can be incredibly confusing. And this is not only because of volatility, but also because of the many different driving forces that operate within them. If we’re to take the EIA as a barometer of how things will go, and if we assume that OPEC+ will ultimately follow through on its pledge, the end result could be some pain in the market. Even though OPEC has, in the past, overestimated the demand for its own crude, it has also expressed a willingness to sacrifice output in favor of higher pricing. With shale no longer an existential threat to this space and the group’s hegemony, I see no reason why OPEC+ won’t reassess its position and change it accordingly if they are in the wrong. And if they aren’t in the wrong, then the outcome is undeniably bullish. This, to me, creates a favorable risk-reward scenario that should justify a degree of bullishness.