The Rebalancing Act
July 21, 2016
Written By Tim Danze
Energy prices fell significantly in early 2016 as a result of record supplies of all things energy. Prior to the recent dip, prices had generally been on the rise for most of the 2000s with the exception of the Great Recession, which began in December 2007 and stretched into 2009.
The higher prices created a lot of profitable opportunities for oil companies to look for crude oil, find it, pull it out of the ground and refine it into products. The increased exploration and refinement resulted in record stock levels of crude oil, gasoline and diesel fuel. Energy demand also took a hit after the Great Recession due to high unemployment and slower-than-expected growth in China. Consequently, the abundant supply and low demand created a recipe to drive energy prices to the lowest levels the market had seen in a decade in February 2016.
Since February, the market has seen a steady rebound off its lows, and the biggest factors helping to support prices have been the decline in capital expenditure by oil companies and a falling rig count that eventually will result in declining production.
The market continues to try to determine when the rebalancing of supply and demand will begin and at what point prices will find support and the risk of another plunge will no longer be a concern. In order for the market to rebalance itself, demand will need to pick up, production will need to drop or some combination of both will have to occur.
High Supply – Is Production Adjusting?
Stock levels for crude oil, gasoline and distillates have all set record highs in recent months. Crude stocks beat record-breaking thresholds with 538.6 million barrels on April 20, 2016. Gasoline stocks put in a record high of 258.7 million barrels during the week of February 12, 2016. The supply of distillates stocks hit record levels with 165.5 million barrels during the first week of January 2016 and have since remained flat as strong production and low demand have kept stocks relatively unchanged. Gasoline supplies have been in steady decline since peaking in February while the stockpile of crude oil has steadily grown week after week.
The market has been watching the number of rigs drilling for crude oil decline substantially over the last year and a half, yet production surprisingly held steady above 9 million barrels per day until recently. The total number of U.S. oil rigs in operation is down 500 from the prior year as of April 28, and production seems to finally be heading lower. The U.S. Energy Information Administration (EIA) is predicting U.S. production will decline by 700,000 barrels per day, a greater drop in production than previously expected. Global crude oil production levels remain in flux in the short term as countries grapple with concerns over declining profits and market share.
Gas Demand Rises, Diesel Falls
U.S. motorists took advantage of low gasoline prices to drive a record 3.1 trillion miles in 2015. As of early June, weekly demand estimates continue to show energy demand is on the rise. The EIA reported gasoline demand is up about 1 percent year over year so far in 2016, and the agency has forecasted gasoline demand to increase by 1.4 percent in 2016. Meanwhile, diesel consumption fell in 2015 by 1.5 percent, and EIA expects demand to drop an additional 1.8 percent in 2016.
Eye on the Future
As of the beginning of June, the U.S. supplies of crude oil, gasoline and diesel are above or near their respective 10-year averages. Prices have rallied from the February lows, but much of this has been driven by speculation from investors. The fundamentals do not seem to support the rally, but it’s possible February’s lows were overdone.
The market will need time to sort itself out as there are still a lot of questions that need to be answered about supply and demand. I think a correction is likely after this spring’s rally. Keep your energy budgets in mind and an eye on Fall 2016 and Spring 2017 contract prices as the next several months could offer an early buying opportunity.