The Crude Oil Market Could Be Full of Surprises

Eric Fry By Eric Fry
Macro Strategist, The Oxford Club

Oil & Gas

“A stealth bull market in crude is underway… and it probably has a lot more to go.”

This is the exact prediction I made in a recent issue of our monthly newsletter, Oxford Resource Explorer… and I’m sticking with it.

Admittedly, that’s a “crazy” forecast. Most analysts in the energy sector are expecting the oil price to tread water at best. But I think these analysts may be underestimating the strength of the global demand for crude oil.

Around the world, demand for oil during the last 12 months has been surprisingly strong. Not only has it outstripped supply by an average of 700,000 barrels per day (bpd), but in February, the number swelled to more than 2 million bpd!

During that month, global demand for crude oil and other liquid fuels totaled nearly 101 million bpd, whereas supply fell short of 99 million bpd.

Here in the U.S., an identical trend is unfolding. Demand is so strong that crude oil inventories have been falling sharply for months. According to data from the Department of Energy, the nation’s crude inventory has dropped 20% year over year…

The trend is very clear. And yet most experts distrust the strength of this trend. So they continually underestimate demand and overestimate supply.

The chart below tells the tale. During the last 12 months, the global production of crude oil has consistently fallen short of the Department of Energy’s forecasts. On the other side of the ledger, global demand for crude has consistently exceeded those forecasts…

This robust demand is unlikely to slacken anytime soon. Global economic growth is humming along nicely… as is U.S. economic growth. And the pooh-bahs at the Federal Reserve expect the good times to continue.

According to comments released last week, the Fed governors believe the “tax changes enacted late last year and the recent federal budget agreement, taken together, [will] provide a significant boost to output over the next few years.”

Therefore, assuming global economic conditions remain buoyant, crude oil demand should continue to rise. But the supply side of the oil market is what seems to concern most analysts.

As a group, they remain of the belief that the “world is awash in crude oil.”

Maybe. But most major oil companies have been underinvesting for the last several years. So they may not be able to ramp up oil production as quickly as they could in times past.

The chart below shows that the combined capital spending of Exxon Mobil (NYSE: XOM) and Chevron (NYSE: CVX), along with Norway’s Statoil (NYSE: STO), France’s Total (NYSE: TOT) and Holland’s Royal Dutch Shell (NYSE: RDS.A), has tumbled from $160 billion per year in 2014 to less than half that amount last year…

This very low level of investment in future oil production is an industrywide phenomenon. It suggests that future oil supplies may not be as readily available as many folks believe they will be.

The electric vehicle revolution is another variable that some analysts believe will boost supplies of crude oil.

After all, more than half of every barrel of oil becomes fuel for internal combustion engine vehicles. So it makes sense that EVs would reduce net demand for crude. But that’s not a 2018 story… or even a 2019 or 2020 story.

Demand for oil from the auto sector will rise much higher first, before sliding lower eventually. And that’s another big reason why the price of oil will likely rise much higher, before drifting lower at some distant point in the future.

Lastly, let’s keep in mind that “supply shocks” are also possible. Venezuela’s economic crisis is causing the near-collapse of its oil industry – putting more than 1 million bpd at risk.

Then there are the kerfuffles with Russia and Iran. Our government just slapped sanctions on Russia and ordered U.S. divestment from various Russian companies, including Gazprom – one of Russia’s largest oil companies.

Could these sanctions lead to a reduced flow of oil from Russia? Perhaps.

We could see a similar outcome in Iran if President Trump follows through on his threats to reintroduce sanctions on the nation’s oil production.

The head of oil market research at Société Générale believes the reintroduction of sanctions against Iran would curb the country’s oil exports by about half a million bpd.

A half-million barrels here, a half-million barrels there… and pretty soon you’ve got a full-blown supply shock. I am not predicting these shocks will occur; I’m merely pointing out the possibility that they might.

The oil market possesses plenty of potential to deliver upside surprises. So don’t be surprised if the price tag on oil hits triple digits during the year ahead.

Good investing,

Eric