Demand woes vs. production woes

May 4, 2016 08:06 AM
Daily Energy Market Analysis

All of a sudden it looks like global growth is trailing off, raising more concerns about crude oil demand. Yesterday, weak data out of China and warnings for the International Monetary fund about Asian economic growth hit oil and industrial metals.

Weak U.S. factory orders also raised worries once again that the U.S. economy may still be struggling even as the Federal Reserve Bank of Atlanta President Dennis Lockhart is suggesting that a June interest rate increase is not off of the table. He even warns that the markets are way underestimating the odds. Even though Lockhart said the Fed is very concerned about the potential fallout from UK voting to leave the Euro (Brexit), he said, "I would put more probability on it being a real option.”

Obviously, the prospect of the Fed raising rates in the midst of global economic uncertainty raises more memories of the start of the trading year when the Fed raised rates in December and China's market toil created an oil price crash. That crash is still reverberating around the energy sector as it set off a wave of bankruptcies and billions of barrels of canceled energy projects. So after oil had its best run in April in during 7 years, traders decided to be safe rather than sorry as it awaits more data on demand.

Of course, despite the turmoil, demand everywhere has exceeded pessimistic expectations. There was some concern that the recent bad weather around the U.S. might impact oil demand and cause a product and oil increase in supply. Well after the close, we saw weekly data from the American Petroleum Institute that showed crude oil inventories increased by 1.265 million barrels last week. In Cushing, Okla., the Nymex delivery point, we saw supply increase by 383,000 barrels. Yet we saw continued strong demand for gasoline distillates as the API reported that supply fell by 1.2 million barrels for gasoline and 2.6 million barrels for distillates. If the energy Information Administration confirms this, we are seeing U.S. demand still exceed expectations. 

While in the short term we are seeing potential headwinds for demand, the supply outlook is looking a lot tighter than oil market bears had thought possible. Even with an increase in oil production in Iran, Saudi Arabia and Russia, other producers will see production fall. Economic and political turmoil in Venezuela will make it very difficult if not impossible to maintain output. That same can be said for Nigeria and perhaps even Iraq. At the same time, despite warnings of crashing Asian demand, on a whole it continues to be rather robust. Even after reports that Chinese oil demand growth for March slowed, for the first quarter their imports were at a record high. There are concerns about the European and Asian economies and their demand but if you look beyond the current turmoil we are still forming a long term bottom. 

I have been advocating a long term bullish outlook for many months and I have heard from many that feared they missed the boat. So, if you are not in the market, you may want to use the short-term demand fears to position for the longer term impact of "production destruction.” Reuters News reports that the, “rout in crude prices is snowballing into one of the biggest avalanches in the history of corporate America, with 59 oil and gas companies now bankrupt.” The number of U.S. energy bankruptcies is closing in on the staggering 68 filings seen during the depths of the telecom bust of 2002 and 2003, according to Reuters data, the law firm Haynes & Boone and bankruptcydata.com. Charles Gibbs, a restructuring partner at Akin Gump in Texas, said the U.S. oil industry is not even halfway through its wave of bankruptcies.

The collapse in energy investment and exploration will create a shortage down the road. If the economic outlook fears are being overblown, then we could see a major replacing of the market as refiners start to come out of maintenance. Even U.S. Energy Secretary Ernest Moniz said he expects global oil supply and demand to rebalance in about a year’s time.

Crude oil prices may also see support from  an oil sands fire in Alberta, Canada. Mandatory evacuation orders issued for 80,000 residents in north of Alberta province Fort McMurray, with reports entire neighborhoods destroyed by wildfire.   

About the Author

Phil Flynn is a senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. Phil is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets.