Post by
JohnJBond on Feb 10, 2023 2:05pm
Oil Price
I've been thinking about how oil may behave when demand exceeds supply.
In the last decade WTI got to $143 in 2008 (followed by $32, 6 months later) and $123 in 2022 (followed by the low $70's 9 months later).
Why did the price spike?
It wasn't because demand exceeded supply.
It was because of a fear that demand might exceed supply sometime soon.
Why did the price fall thereafter?
Because the fear that demand might exceed supply, disappeared.
Demand never did exceed supply.
In otherwords, the market cried Wolf twice. Everyone came running, but there was no Wolf, so they went home.
What happens if next time, there is a Wolf?
Set aside for now, the muddying fact that annual oil supply is seasonal - ie global supply tends to be reasonably unseasonal, whereas global demand is seasonal. So far this demand seasonality has tended to be insulated from price by inventory held in storage.
At some point demand exceeds supply all year round.
I'm thinking about this now, because we are getting close to that time. More so now that the US Fed is close to reaching its interest rate top, and looks like its avoided a nasty interest rate caused recession.
If the China reopening adds 3-4 million boe/day to global demand, then a real Wolf has arrived. Global demand will exceed global supply all year.
That is not a very big IF. Opening China is not just about China - its all of Asia if not all of BRICS - not just SE Asia - its China, India, Indonesia, Russia, Iran, Brazil, South Africa etc.
The increase in Jet Fuel consumption alone could easily be 1.5 million boe/day. It doesn't take much to add in another 1.5 boe/day. All of a sudden you have a 3 million boe/day increase. That feels like the low end of the range. Thus the 3-4 million boe possible impact of China reopening.
In 2022 it can be argued that oil demand exceeded supply, which is why the US SPR declined an average of about 550,000 per day over all of 2022.
We don't know the exact global production and supply numbers. We can only tell if demand has exceeded supply by looking backwards at what has happenned to global inventories. IF they declined, it follows that more was withdrawn than added. ie, demand exceeded supply.
Looking back at 2022 we know there was always enough oil. Anyone who wanted a tanker full, got one. Prices varied, but everyone got what they wanted
Combine that with the decline in global inventories observed in 2022, and it means that demand and supply were very close during 2022. Overall the may of been balanced or negative - with seasonal swings on each side of balance.
If that is our baseline, then adding 3-4 million boe/day means demand will exceed supply.
This time everyone who wants a tanker full of oil, won't get one.
It will be similar to what happenned to LNG tankers last summer. Europe paid more until tankers turned around, and went West. These were the spot tankers - ie the marginal last price. That price got to the mid $350/boe range (today its in the $80's because Europe didn't run out of gas - it turns out they were crying Wolf).
Until recently, I'd expected something similar to happen to oil after China reopened. ie, oil would rise in price to some high number - something like $150-200 boe, then fall back a few months later, to something in the $80-100 zone.
Those thoughts were driven by prior price observation.
But in those prior cases, there was no Wolf. The price run up was caused by fear, not fact.
It seems to me that the next time it will be real
The Wolf is coming but its not being taken serouisly, because the last two times (three if you count LNG), it was a false alarm.
So what happens to the price of Oil when 3-4 millon boe/day of extra demand shows up?
The price goes up!
Thats easy. But why?
A large oil tanker holds about 500,000 boe. A very large tanker holds about 2 million boe. An ultra large tanker holds about 3 million boe.
If the World is short 3-4 million boe/day, that means that on any given day, multiple buyers are completing for a tanker load. The high bidder gets it, and everyone else gets none.
How much does the highest bidder pay before the second highest bidder gives up?
Last summer with LNG, it got to the mid 300's/boe (and that was based on fear, not reality).
When an actual Wolf shows up, you get fear AND realtiy.
I don't know the answer, but here is where my mind is going.
If demand exceeds supply we know the fear alone can take the price of oil to the $150 range.
If its real (ie demand is exceeding supply), then $150 oil will get higher not lower.
How much will it take to outbid everyone else who wants that tanker load? Will $180 do it? Maybe at first, if the underbidder thinks there will be another one later in the day to buy.
Or will it take $200/b or $250/b or $300/b or $350/b?
How far will bidders go when fear sets in?
Now we are in the realm of speculation. The only guide we have is how much was being paid for the marginal tanker of LNG last summer. I think that was in the $360 range.
When would it stop?
When oil consumption is reduced by 3-4 million barrels/day, demand and supply are back in balance. What ever price that takes, is the new equilibrium price.
Of course, markets don't just slide back to an equilbrium price, they over shoot. Like the ripples in a pond after its hit by a rock.
3-4 million barrel decline in oil consumption means global economic disruption. Economies adjust. International tourism declines, long range shipment of bulky goods decline etc. Major structural changes occur - apples no longer come from thousands of miles away. You can still buy fresh stawberries in the winter - but they are only for the rich. Maybe the Amazon model based on low cost delivery no longer works etc.
The point is these things all take a while to happen, which means that when oil spikes, it may not drop back quickly like it did before.
What else does this mean?
It probably spells Black Swan event. AKA stock market crash.
Will such a stock market crash affect OBE et al. Yes, babies tend to get tossed out with the bath water. The relative impact may be less.
Otherwise, high oil prices should mean high stock prices for OBE et al.
Except for those with big hedges.
Its hard to know what a $350 spot WTI price would mean for the 6 - 9 month contracts - but I suspect they would be up there.
Take a company like BTE or BNE that may have 40-50% of its oil hedged for Dec 2023 at US$70 ish.
Would the mark to market calls on their hedges be enough to force bankruptcy? Or would the cash flow from their unhedged portion keep them upright? I don't know. A year of margin calls vs a day of high sales price.............which is bigger? I don't want to find out, which is why I don't hold shares in those firms.
There is a real chance that by autumn global oil demand will be 3-4 boe/day more than supply. The timing may be off, but the outcome seems inevitable.
Will the next oil price spike be caused by fear or fact? ie, will there by one more round of fear based volitility before the Wolf arrives...............I don't know. In Aesop's fable the boy cried wolf twice. The third time no one came. This fable is thought to be about 2600 years old - ie I suspect 2 false alarms is the limit for human behavior. If it were more, the fable would have been modified over those 2600 years.
I'm going to stop here.