The dark side of the OECD oil inventory release
By Gregor Macdonald, Contributor
The IEA in Paris announed on Thursday a release of 60 million barrels from OECD inventories. The implications of this extraordinary action are not positive. Let’s first take a look at the most recent global production data, which shows the large downward move of supply coming into March 2011, from the loss of Libyan oil. IEA is pointing to this loss of supply as the prima causa for its decision.
While some asset markets, perhaps global stock markets, may take comfort from the lower price of oil over the next 90 days, the intermediate term realities, implied by this action, are rather worrisome. I will list a few here:
*We know that Saudi Arabia did not rescue the oil market this spring, as was originally anticipated. Both the Financial Times and Gregor.us covered this issue originally in February. By April, it was clear that Saudi did not make up the Libyan loss. Thus, the IEA inventory release implies that whatever extra supply Saudi Arabia can offer, it is either too sour and heavy to bring down the price of global diesel, or Saudi can only pump extra oil for short periods of time. In my view, both of these factors are in play.
*Releases of oil from inventory are counterintuitively bullish, not bearish, for prices. While oil prices no doubt will be rocked for several months now, releases such as these only highlight the fundamental problem at hand: structurally restrained supply. For example, the OECD could have turned to non-OPEC producers within their sphere of influence and asked them to produce more. But Non-OPEC producers, accounting for 57% of total global supply, have no spare capacity. The oil market is going to figure this out more quickly than most imagine.
*By knocking the price down, the IEA is threatening the vast quantity of marginal supply that has come on stream the past two years. Much of this oil is broken free from shale, drilled at great depths in oceans, or converted from oily dirt (tar sands). To the extent that price is knocked down by such actions, this will affect the future development plans of those oil and gas producers who’ve been engaged in bringing the world its new, high-priced supply. I target the $80.00 level as the price point not where supply is taken offline, but where future marginal supply of any substantial note is at risk. Again, the oil market is going to do this math and it will not take long to run the calculations.
Thursday’s release of inventory is confirmation that the era of permanently constrained supply is now very much with us. Because industrial economies are simply machines that convert energy inputs into useful work and services, today’s action is also a reminder that the dream of higher growth in conjunction with lower oil prices is now a backward looking view, a nostaglia for a past that’s no longer possible.