Oil Glut: It's The Demand, Stupid!

Source Link

by Reverse Engineer

I ran across a chart on Bloomberg which is perhaps the best demonstration to date that the Oil Economy is in Full On Collapse mode now. The chart is of Oil Inventory in storage, and covers the last 35 years since 1982 of Oil Inventory in the FSoA, and is the first graphic below the picture.

Do you note the Hockey Stick nature of this graph? For 35 years until 2014, Oil Inventories were kept within a very narrow range. Supply & Demand were kept in balance by the folks in control of both the extraction of Oil and the production of money. A more or less steady "growth" rate of the entire system was maintained, as oil output and population increased, the money supply increased in tandem with it, a couple of percentage points ahead which provided return on investment for those in charge of creating the money in the first place. For everyone else, this appeared as Inflation as the cost of housing, food and just about everything else besides technological gizmos kept spiraling upward.

However, even through all the recessions through the 1980s to today, Oil Inventories always stayed inside this narrow range. That includes the Great Recession following the 2008 Financial Crisis. Something CHANGED in 2014 though, and my good friend Steve Ludlum of Economic Undertow pegged it to the month more than 2 years in advance with his "Triangle of Doom". What changed at this time was that the cost of extracting oil went higher than the price the customers could afford to burn it at. The price crashed, from over $100/bbl down to $40/bbl or so, and briefly lower.

Charts by Steve Ludlum of Economic Undertow

August 2012 Prediction

April 2015 Reality

At this price, virtually nobody extracting oil makes a profit. A few folks like the Saudis still have Legacy fields they can extract oil at a profit at $20/bbl, but across the whole of Saudi ARAMCO their costs are a good deal higher than that. Here in Amerika, the Frackers may have got their extraction costs down to $60/bbl in some of their better fields, but they're still not making a profit at $50/bbl. Just not bleeding money quite so fast,and if they are TBTF, then Wall Street keeps rolling over their loans to keep them floating another day. This is better in the short term than having to write down $Billions$ in losses, which then would make the bank itself insolvent.

So what has occurred here in the Oil Trading market since 2014? Well, Oil Traders keep holding back selling until they can make a profit. But in the $50 range they mostly can't, so the oil stays in a tank somewhere while they wait for the price to go back up, but it doesn't. Meanwhile, the Extractors of Oil all around the world keep extracting, because they have to do that to pay their bills. Crude keeps piling up because Konsumers refuse to burn the shit fast enough, because they can't AFFORD to burn it faster!

Until they lower the price DRASTICALLY, the glut will continue to accumulate. Eventually here, they will run OUT of tanks to store this shit in, and it does cost money every day to keep the Oil you bought at one price stored in a tank somewhere to sell on another later date at the higher price you hope for. NOBODY wants to "buy high, sell low"! That's a recipe for Bankruptcy of course. So they keep the oil in the tanks, and they keep filling up more and more.

Oil Tanker Parking Lot off Singapore

Inevitably, a LIQUIDATION SALE has to come here. There is not endless room for storage of this stuff above ground, and besides that it's expensive to store all that oil. Whoever owns it is bleeding red ink as long as they hold onto it.

Now, whenever you read any of the Oil pundits, they will tell you the reason for the glut is either OPEC members cheating on their quotas, Iranians bringing more Oil online or FSoA shale frackers drilling more wells. But is the total global production really up all that much? No, in fact it's been going down since it peaked in August of 2015. So if it's not the supply going up, why the glut?

IT'S THE DEMAND, STUPID!

Because they massage the figures everywhere else in the economy to show "growth" and nobody wants to admit being in a recession, Oil inventory keeps growing. This figure you can't massage (well not too much), because the stuff is a physical quantity that has to be stored in...something. So they have to know where they are going to put it.

Oil is a Global Commodity, in which the FSoA is among the largest consumers but it's not the only consumer. Europe as a whole consumes a lot, China consumes a lot also. All the consumption is not Happy Motoring either, a lot of it is industrial consumption. Globally in aggregate, if the economy was truly growing we would be consuming more Oil, not less.

Sometimes when I make the Demand Argument with respect to both the price and the glut, critics will tell me, "But RE, the traffic is just as bad as ever and everybody in my neighborhood is still driving gas guzzling SUVs!". Well, that may be true in your neighborhood, but in somebody's neighborhood somewhere it's definitely NOT true.

My best guess is most of the reduction in demand is coming from southern Europe, where they have been in severe recession for years now. This is probably also bleeding into the Chinese manufacturing sector with declining demand for their toys. So then they use less Oil in the manufacturing process.

With a declining amount of total production, along with a Hockey Stick graph of skyrocketing inventory, the only answer can be declining global demand for Oil. In order to get the demand up, they have to drop the price down. But they're already losing money at the current price in the $50 range. So the traders keep hanging on for the day the demand will magically rebound here and the consumers will step back up to the pump and pay the prices they need to make a profit. There is however no reason at the moment to believe that the consumers will magically get more money to pay more for the oil, they already have trouble paying for it at the price it is selling for now.

Unlike the magical world of Money where you can conjure as many digibits as you want out of thin air and which takes virtually no room to store inside a laptop, Oil is a physical commodity which must be burned to have value. If it's not burned as fast as it is pumped, then it's going to lose value. The traders don't want to recognize the loss of value though, because they will take a serious bath. A bloodbath. They don't have to take the write down though until they actually sell the stuff. So they don't sell, they keep it stored on a tanker somewhere and pay the daily storage fees out of more borrowed money, which the banks keep lending them because they will go tits up when the traders they lent money to go tits up. No matter how much money they lend to keep storing the Oil though, eventually they're going to run out of room. Then EVERYBODY will HAVE to stop pumping Oil until they work through the glut. Given there is double the normal inventory, this could take a little while. Can any Oil Producing nation go even a week without the revenue from their Oil?

This condition of extreme glut has to break, and the only way to break it is a major reduction in the price. When that comes, there will be carnage all across the energy and banking industries. I don't know how long before the last storage tank and VLCC tanker will be full up, but I can't imagine it is too far off.