Oil: Inventories Remain High but Demand Expected to Increase
Global demand for oil products is the fundamental driver of the oil industry. A relevant portion of the world economy and the growing worldwide welfare still relies on oil product consumption, both for industrial production and for transportation. Oil products derive from the refining industry, which in turn depends upon the crude oil market and, consequently, the exploration and production (E&P) industry.
West Texas Intermediate (WTI) crude oil spot price was $79 per barrel in on January 1, 2010, almost $5 more per barrel above the prior month’s average. This increase reflected improving expectations of a global economic recovery and higher oil consumption, offsetting concerns about the high current level of oil inventories. Historic WTI prices are illustrated below.
SUPPLY
Domestic inventories increased year–over–year
As of January 1, 2010, U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve, which are typically held for emergencies) were 327.3 million barrels, an increase of 1.5 million barrels as compared to a year earlier. Domestic inventories increased year–over–year primarily due to reduced demand as a result of the 2008—2009 recession.
Worldwide inventories above average and expected to remain high
The Energy Information Administration (EIA) reported non–OPEC oil production averaged 50.29 million barrels per day (bbl/d) in 2009, about 0.6 million bbl/d higher than year–earlier levels. Non–OPEC oil production increases have been largely the result of higher production from the U.S., Brazil and the former Soviet Union. Projected non–OPEC supply is to increase slightly to 50.71 million bbl/d in 2010, largely the result of lower growth in the U.S. and the former Soviet Union.
For 2009, OPEC crude oil production averaged 33.89 million bbl/d, down more than 2 million bbl/d from year–earlier levels due to coordinated production decreases. Projected OPEC crude oil production increases to an average of 34.91 million bbl/d in 2010, in response to an anticipated rebound in global oil demand.
Organization for Economic Co-Operation and Development (OECD) indicated that commercial oil inventories stood at 2.68 billion barrels at the end of the fourth quarter of 2009, 115 million barrels more than the 5-year average. Inventories are projected to be at 58 days of forward cover at the end of 2009, 5 days above the 5-year average for that time of year. The EIA expects OECD oil inventories to remain above average historical levels throughout 2010 due to lower demand resulting from reduced, albeit continuing, economic challenges.
New discoveries of oil likely to reach highest level
The oil exploration industry was very successful in 2009 thanks to a series of major discoveries that have rekindled a sense of excitement across the petroleum sector, despite falling prices and a tough economy. These discoveries, spanning five continents, are the result of hefty investments that began earlier in the decade when oil prices rose and of new technologies that allow explorers to drill at greater depths and break tougher rocks. More than 200 discoveries have been reported over the first half of 2009 in dozens of countries, including Iraq, Australia, Israel, Iran, Brazil, Norway, Ghana and Russia. In addition, there were substantial discoveries in the Gulf of Mexico. It is normal for companies to discover billions of barrels of new oil every year, but 2009’s pace was unusually brisk. New oil discoveries totaled about 10 billion barrels in the first half of 2009, according to IHS Cambridge Energy Research Associates, as compared to a yearly average of approximately 10 billion barrels between 2002 and 2008. If discoveries continued at that pace through year–end 2009, they are likely to reach the highest level since 2000.
Non–standard oil source potential exceed conventional supplies
High oil prices have opened the window to a sea of new exploration opportunities, leading independents and majors to try to develop non–conventional oil from a variety of sources. Two of the most exciting, and most heavily watched, are oil sands and oil shale. Oil sands and oil shale both contain crude oil in a semi–solid state, as opposed to conventional oil which is contained in the ground in liquid form and can be directly extracted. Oil sands and oil shale on the other hand, require various methods to extract the oil from the ground. This can require injecting steam into the sand or crushing the oil shale before the oil can be extracted.
The oil sands in Canada are particularly interesting for a number of reasons, most notably because they are estimated to hold between 1.7 and 2.5 trillion barrels of non–conventional oil (by contrast, Saudi Arabia, the world’s largest oil producer, has about 260 billion barrels of proven oil reserves). Also making this an attractive investment is their proximity to the U.S. and the stable nature of Canada’s government.
Oil shale has similar dynamics. There are an estimated 2.6 trillion barrels of recoverable oil in oil shale around the world, of which over 1 trillion are in the U.S. Essentially, oil shale is sedimentary rock which contains enough organic material to yield oil and gas upon distillation.
DEMAND
Consumption expected to increase post recession lows
As illustrated below, worldwide oil consumption increased dramatically between 1988 and 2007. But the onset of a global recession in 2008 resulted in a decline in worldwide oil consumption.
The EIA forecasts that world oil consumption will grow in 2010 by 1.1 million barrels per day (bbl/d) to 85.2 million bbl/d, similar to all time high levels. Countries outside of the OECD (i.e. OPEC countries) are likely to account for almost all of this growth. Projected OECD oil consumption grows by only 0.1 million bbl/d in 2010, despite an estimated 0.27 million bbl/d consumption increase in the U.S. after a very weak 2009.
Demand expected to recover faster than supply in 2010 and beyond, driving prices upward
The price of crude oil is expected to continue its upward trend as the world economy continues to recover and demand returns in 2010 and beyond. Although 2009 was very strong from a discoveries standpoint, the ability to continually make large discoveries year after year is unlikely. As a result, as worldwide economies emerge from the recession, the associated large increase in demand will quickly outpace new discoveries.
Crude oil is mainly traded in U.S. dollars and, in such, its price is highly dependent on movement in the U.S. dollar. When the U.S. dollar weakens, the crude oil market participants (speculators, producers, refineries, etc.) push the price of crude higher on the expectations that oil producers are entitled to at least the same prices as before in their own currencies, after exchanging U.S. dollars. Due to the effects of very high foreign debt levels, the U.S. dollar is forecast to continue to depreciate, raising the price of oil.
The further recovery of the world economy in the next couple of years is anticipated to result in the price rising back above the $100 mark sometime in 2011. The lack of investment and lower production from some facilities during late 2008 and 2009 is expected to result in demand recovering faster than supply can keep up, pushing the price even higher. As oil prices reach and then surpass the $100 per barrel mark, alternative forms of energy will become more viable options potentially resulting in decreased crude oil demand.
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