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ESAI Energy: demand not inventories should drive OPEC+ decision

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World Pipelines,

As the OPEC+ meeting, now delayed until July 7, approaches, the question of inventory levels will gain considerable attention. As we have written before, we believe global (OECD and non-OECD) crude oil and product inventories are adequate, but not excessive. This month, however, we parse just the OECD stock picture, which will shape impressions of over or under supply before and during the OPEC+ meeting. Although we are not supporters of the five-year average measurement, that approach (when corrected for demand) shows crude inventories are in the middle of the historical range, and product stocks are actually at the low end of the range. We do not believe inventories will or should be justification for further production restraint. But, we are concerned about weak underlying demand growth as discussed in our Global Oil Balance analysis.

For several years, OPEC and, later, the declaration of cooperation countries, in an effort to measure oversupply, have compared the current level of oil inventories against an historical five-year average. In this case, inventories refer to those held in OECD countries where inventory data are carefully tracked. Based on press reporting, it is less certain if the inventory measure refers to just crude or crude and products, and if the latter, do products include anything besides gasoline, distillate fuel oil, LPG, and naphtha? Finally, this measure should refer to commercial inventories and not include government strategic stocks even when held by private companies. This last point is complicated by the fact that the IEA’s oft-quoted inventories in Europe actually include strategic stocks equivalent to 200 million bbls of crude oil and almost 300 million bbls of petroleum products.

The volume most closely watched and quoted in the press seems to be OECD crude oil inventories. The chart below presents OECD crude oil inventories, stripped of all stocks held to meet strategic stocking requirements. Moreover, it compares 2019 stock levels with the high, low and average levels for the five-year period from 2014-18. Our May estimate indicates that current inventories are about 23 million bbls above the five-year average, 47 million bbls below the five-year high and 98 million bbls above the five-year low. This measure, alone, indicates crude stocks are at about the 68th percentile relative to the previous five-year period. One could easily interpret these as “high” stocks.

Absolute stocks are a poor measure

As we have written before in these pages, however, we believe absolute stock levels that reference a period as long as 5 years is a poor measure of relevant over or under supply. The global oil industry has grown during the last five years, and higher operating inventories reflect that growth. As a result, a more powerful measure is stocks in days of demand or, in the case of crude oil inventories, stocks in days of throughput. The following chart takes the same absolute stock levels and divides them by current throughput levels (an alternative would be forward cover or throughput over the next 3 months).

The resulting measure for 2019 shows current OECD crude inventories at about 30.5 days. This is about one-half day above the average and 1.7 days above the five-year low and below the five-year high. This suggests May’s crude oil stocks are almost exactly in the middle of the five-year range, sitting at just about the 50th percentile when adjusted for refiner demand. With this measure, one might not interpret stocks as “high".

Product stocks are lean

There are many ways to measure petroleum product stocks even in the quite transparent countries of the OECD. The following chart presents OECD product inventories for gasoline, distillates, fuel oil, LPG and naphtha. Based on our estimates for May, total inventories (inc. products held by companies to meet strategic stock holding requirements) are low. They are approximately 55 million bbls below the five-year average, 52 million bbls above the five-year low and 133 million bbls below the five-year high. This means these stocks only reach the 28th percentile of the five-year range. Notably, if one strips out all products held by companies under strategic stock holding requirements, it appears that Europe is holding even lower operating stocks than four of the last five years. Note, however, the period of 2016-2017 was a period of historically high stocks.

Even with relatively weak oil demand, this stock level seems even lower when viewed in terms of days of demand. With May’s inventories at 35.3 days, they are 2.3 days below the five-year average, one-half a day above the five-year low and 4.3 days below the five-year high. This means these stocks only reach the 10th percentile of the five-year range when viewed in relation to demand. In sum, OECD crude oil inventories are just about average and product stocks are low. As a result, inventories should not be used to justify further production restraint. These countries will have to consider other factors carefully. Weak oil demand growth and macroeconomic concerns associated with trade disputes and rising barriers to trade are the greatest threat to OPEC+ planning, but those are difficult factors to address with supply management because they are exaggerated by press reporting and trading in non-oil capital market assets. By process of elimination, this elevates the role of oil prices in shaping supply decisions. OPEC+ do not want to pick a price target, but they will likely be backed into that corner. Weak oil prices should support a cautious OPEC+ approach that is likely to be rewarded later in the year.

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