The Petroleum Economics Monthly

Transcription

1 The Petroleum Economics Monthly Philip K. Verleger, Jr. Volume XXXIII, No. 8 August 2016 The New Economics of Petroleum Billion Barrels 2.0 The Rise of Opportunistic Inventories: Global Stocks of Crude Oil Held for Arbitrage or Profit (0.5) Source: PKVerleger LLC. Publication Date: 11/4/ , PKVerleger LLC. All rights reserved. ISSN Reproduction of The Petroleum Economics Monthly in any form (photostatically, electronically, or via facsimile), including via local- and wide-area networks, is strictly forbidden without direct licensed permission from PKVerleger LLC. Contact Dr. Verleger at 540 Fox Run Dr., Carbondale, CO or phil@pkverlegerllc.com.

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3 The New Economics of Petroleum Philip K. Verleger, Jr. PKVerleger LLC Disclaimer: Although the statements of fact in this report have been obtained from and are based upon sources that PKVerleger LLC believes to be reliable, we do not guarantee their accuracy, and any such information may be incomplete or condensed. All opinions and estimates included in this report constitute the judgment of PKVerleger LLC as of the date of this report and are subject to change without notice.

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5 Table of Contents Summary... 1 The New Economics of Petroleum... 3 Twenty-First-Century Demand Models vs. Twenty-Century Models... 6 Forward Prices: The Key Destabilizing Production Cuts Making Use of Markets Substitutes and the Hotelling Theory s Death Conclusion Glossary Statistical Appendix List of Figures Figure 1. Price of No. 3 Smoked Sheet Rubber on Singapore Commodity Exchange, 1992 to Figure 2. Crude Oil Price Determination in a World with No Surplus Stocks as Managed by OPEC... 7 Figure 3. Crude Oil Price Determination in a World with Opportunistic Buyers and Inelastic Demand... 8 Figure 4. Variation in Petroleum Storage Costs as Shown in Exxon 1981 World Oil Inventories... 8 Figure 5. Commercial Crude Oil Inventories Held in the US, 2005 to Figure 6. Global and US Surplus (Opportunistic) Crude Oil Inventories, 2008 to Figure 7. Merchant Short Position in Three Primary Crude Contracts vs. Opportunistic Crude Oil Inventories, 2012 to Figure 8. Six-Month-Forward Excess Returns to Storage for WTI vs. Opportunistic Crude Oil Inventories, 2010 to Figure 9. Twenty-Four-Month-Forward WTI Price, 2015 to Figure 10. BPT Share Price, 2014 to Figure 11. Open Interest in Three Primary Crude Oil Contracts in Figure 12. US Commercial Crude Oil Inventories, Weekly Data, 2015 to Figure 13. Excess Returns to Storage for Brent and WTI, Sixth Futures Contract, 2015 to i

6 List of Tables Table 1. November 2016 Excess Returns to Storage for Brent and WTI, Adjusted for Storage Cost and Returns for WTI Purchases Financed at 2.5% or 5% Interest, from January through September Table 2. Excess Returns to Storage on October 28, 2016, for Brent and WTI Adjusted for Storage Cost and Returns for WTI Purchases Financed at 2.5% or 5% Interest ii

7 Summary Economists and analysts who follow oil markets are unanimous. The high inventories accumulated over the last two years, which now total one billion barrels, must be liquidated or worked off before markets can stabilize. OPEC Secretary General Mohammed Barkindo stated this as a fact in an October talk to the World Energy Congress: It is not an issue of price at the moment. Until we can get the market back into balance by stimulating stock drawdowns, we will not be able to achieve the fair price that is fair to producers and consumers. That equilibrium price can only be achieved if collectively we re able to stimulate this stock drawdown within the shortest possible time, to bring forward the rebalancing of the market. This is where we are focused at the moment. 1 The International Energy Agency s monthly Oil Market Report issued the same day as Barkindo s talk reflected similar thinking. According to the IEA analysts, a decision by OPEC to cut output could strengthen the market. The IEA, though, believes high stocks must be reduced before prices can rise: Even with tentative signs that bulging inventories are starting to decline, our supply-demand outlook suggests that the market if left to its own devices may remain in oversupply through the first half of next year. If OPEC sticks to its new target, the market s rebalancing could come faster. 2 The OPEC and IEA views also appear in presentations by most investment banks, consultants such as HIS CERA and PIRA, and many excellent academic economists. In all cases, this standard perspective indicates an analytic process that sees the market in terms of production and consumption. Invariably, inventories are an afterthought. Stocks accumulate when production exceeds consumption and decline when consumption exceeds production. Inventories beyond amounts needed to facilitate the industry s operation are seen as an accident that requires correction. Discussions regarding excess stocks continued through October. During the month, OPEC members and experts from oil-exporting countries met to find an output cut that would balance global oil supply and demand and reduce inventories. Apparently, OPEC still believes it can control oil markets and oil prices. This perspective has also dominated the integrated oil industry for decades. Exxon and Shell briefing papers presented thirty years ago set it out initially. 3 These were followed by a series of National Petroleum Council studies. 4 Such publications treated inventories as a nuisance or curse. Inventories were held to facilitate system operations. Every researcher as well as OPEC believed stocks would likely decline as efficiencies improved. In fact, OPEC and IEA officials, indeed all analysts, considered inventories to be undesirable, a drain on capital that could be better used in other activities such as exploration and production. 1 OPEC Not Targeting Price but Seeks a Faster Stock Drawdown: Barkindo, Platts Global Alert, October 11, IEA, Oil Market Report, October 2016, p See World Oil Inventories (New York: Public Affairs Department, Exxon Corporation, 1981) [ and Changes in the Oil Supply System, Shell Briefing Service No. 1, See National Petroleum Council, US Petroleum Supply Inventory Dynamics, December 1998 [ This study updates earlier NPC studies. 1

8 This rationale characterizes an economic approach to inventory management and operational decisions that became obsolete in other economic sectors by 1980 if not before. In the current situation, inventories can be an asset rather than a curse. A firm s cost of holding stocks is essentially zero if investors finance the action through futures purchases. At times, the financial returns from keeping stocks exceeds those from risk-free assets. At such times, anyone holding stocks may have no interest in selling them. In such circumstances, efforts by oil producers to stimulate drawdowns, as suggested by Secretary General Barkindo, will fail. The economic issue confronting the market today relates to the willingness of inventory owners to sell. Oil producers may hope those holding some of the extra one billion barrels will liquidate them and help stabilize prices. To accomplish this, the producers would have to bring global supply to levels lower than global consumption. The rub with this strategy is that those owning stocks may keep them if the return from doing so is greater than the return from selling. Vitol, for example, may have hedged ten million barrels to mid-2017, potentially earning an excess return of thirty percent. If Vitol concludes it can profit more from holding inventories until hedges expire, any production cut will boost cash prices rather than induce a stock sell-off. The bad news for Secretary General Barkindo and IEA s executive director Fatih Birol is OPEC no longer controls prices if it ever did. Those with inventories are independent economic agents. They will sell their holdings or add to them as they choose. Oil has become a store of value. This is one of several characteristics of the petroleum market s new economics. A second is the reversal of the Hotelling principle. In the past, the perceived limit on total resources affected market behavior. The expectation of resource exhaustion caused producers to restrict current production at times in the hope of higher prices down the road. Today, the situation is reversed. No resource constraint exists. Indeed, the likely peak coming for fossil-fuel consumption seems to encourage producers to maximize current output. Oil left in the ground now may stay there forever. A further change in the market is the development of serious alternatives to oil. Oil producers like to think petroleum is the only transportation fuel. However, electricity and biofuel are beginning to gain market share. In ten or even five years, alternative fuels may have captured a surprisingly large portion of the transportation market. This report focuses on petroleum s new economics. We suggest the effort of producers to control markets by forcing stock draws will fail. We also show that oil-exporting nations can produce more oil, sell more oil at higher prices, and even achieve higher incomes if they embrace the new market instead of rejecting it. 2