By John Kemp
U.S. petroleum inventories are falling towards more normal levels as the glut earlier this year caused by volume warfare among OPEC+ members and the first wave of epidemic-driven lockdowns is gradually absorbed.
Falling inventories are likely to herald a tighter production-consumption balance and a cyclical upswing in both spot prices and calendar spreads next year, which are already being anticipated by oil traders in rising futures prices.
But a cyclical upturn in the oil market depends on OPEC+ timing production increases carefully, on the global economy avoiding a double-dip recession, and on the rapid deployment of an effective coronavirus vaccine.
There appears to be a reasonable prospect for all three conditions being met, with timing of the delivery of an effective vaccine that allows international air travel to resume the largest residual source of uncertainty.
U.S. OIL STOCKS
U.S. crude and petroleum product inventories outside the strategic petroleum reserve declined by another 11 million barrels last week, according to high-frequency data from the Energy Information Administration.
U.S. petroleum inventories have now declined in 16 out of the last 17 weeks by a total of 124 million barrels since the middle of July
The drawdown has reversed more than half of the earlier build up of 224 million barrels since the onset of the epidemic in mid-March
U.S. commercial petroleum inventories have been cut to 6% above the previous five-year seasonal average, down from a surplus of 14% in mid-July.
Commercial crude and product stocks have each been reduced to 6% above average, down from peaks of 19% and 12% respectively in the middle of the year.
Lower production by the members of OPEC+, the redirection of oil exports to Asia, especially China, and a series of hurricanes which have cut output in the Gulf of Mexico have all helped to reduce the inventory overhang.
Five hurricanes and one storm disrupted U.S. oil output in the Gulf of Mexico between August and November (“The Gulf of Mexico saw its largest decrease in crude oil production since 2008 in August”, EIA, Nov. 18).
At the same time, U.S. refiners have successfully trimmed the surplus of middle distillates such as diesel and jet fuel by maximising output of gasoline instead.
INVENTORY SWING
Those production strategies are now paying off and should return the global oil market to something like balance by the end of the first quarter of 2021.
Once product inventories have been reduced to near the five-year average, refiners will have to increase crude processing significantly to prevent any further erosion in stocks.
Within the products slate, once distillates have been reduced to near average, refiners will have to switch from max-gasoline mode to more normal operation to prevent an a further unwanted reduction in diesel and jet stocks.
The shift from destocking to normal operation will provide a significant impetus to crude consumption as well as diesel supply.
U.S. refineries processed about 16% less crude last week than the seasonal average for the last five years while total products consumption was down by just 3%.
The current gap between crude processing and products consumption is around 2 million barrels per day, which will have to close when product stocks are closer to normal.
If the global economy is recovering at the same time, and deployment of an effective vaccine allows international passenger aviation and other normal business activity to resume, the boost to oil consumption could be very large.
Crude traders have started to anticipate a tight global oil market, with Brent calendar spreads tightening to less than a 10 cents contango per month in the second half of 2021.
Such a narrow contango would not cover the cost of storing and transporting crude, implying that stocks are expected to be below the five-year average and falling rapidly at that point.
Expected distillate margins have also started to improve, with futures prices for European gasoil and crude delivered at the end of the first quarter and later rising by more than $2 per barrel from recent lows at the end of October.
These price moves have all been sparked by the announcement of successful vaccine trials since the start of the month, underscoring just how much rides on rapid deployment of an effective vaccine allowing more normal activity to resume.