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Do Current Oil Prices Reflect the Fundamentals?

Crude oil fundamentals are the underlying factors affecting crude oil’s supply and demand dynamics. These fundamentals are crucial in determining the price and market trends of crude oil. After temporarily peaking in September 2023, oil prices dropped $20 per barrel, as management money traders reduced their positions in futures and options as the price drop accelerated. The question is whether a price in the $70s reflects the current fundamentals of crude oil. By looking at inventory levels and the future of supply and demand, you can determine if the current oil prices reflect the fundamentals.

What is the Supply of Oil?

The global production of crude oil is influenced by factors such as geopolitical events, OPEC (Organization of the Petroleum Exporting Countries) decisions, and the production capabilities of major oil-producing countries. Global oil production is estimated at 94 million barrels per day as of 2022. The all-time high of global oil production is approximately 95 million barrels per day. Saudi Arabia, the United States, and Russia are among the largest oil producers in the world.

What is the Demand for Oil?

The global consumption of crude oil is driven by various sectors such as transportation, industrial, and residential. Economic growth, changes in consumer behavior, and technological advancements can all impact crude oil demand. Recall very few industries consume crude oil. The refining industry is one example.

An oil refiner, also known as a petroleum refiner, is a company or facility that processes crude oil into various petroleum products such as gasoline, diesel, jet fuel, heating oil, and other refined products. The refining process involves multiple steps, including distillation, cracking, desulfurization, and blending, to separate and transform the different components of crude oil into usable products. Refineries play a crucial role in meeting the global demand for petroleum products and ensuring their quality and compliance with regulatory standards.

What is Refining Capacity?

The ability to process crude oil into refined petroleum products. The availability and efficiency of refineries can affect the demand for crude oil and the price differentials between various types of crude oils. Refining capacity refers to the maximum amount of crude oil a refinery can process or convert into different petroleum products, such as gasoline, diesel, jet fuel, etc. It measures a refinery’s capability to refine crude oil into finished products. Refining capacity is usually expressed in barrels per day (bpd) or million metric tons per year (MMTPA). The refining capacity of a country or region plays a significant role in meeting the demand for petroleum products and contributes to the overall energy supply.

What are Oil Inventories?

The levels of crude oil stored in tanks and facilities around the world. Inventories can act as an indicator of oversupply or tightness in the market. Significant changes in inventories can influence crude oil prices. Oil inventories refer to the amount of crude oil and petroleum products held in storage facilities, such as tanks and pipelines, by countries, companies, or organizations within the oil industry. These inventories serve as a buffer to help meet fluctuations in demand, transportation logistics, and supply disruptions. Oil inventories are essential indicators for assessing the oil market’s balance between supply and demand. They can also impact oil prices, as shifts in inventory levels can signal changes in market dynamics. Monitoring oil inventories helps in understanding the overall state of the oil industry and its future outlook.

Oil inventories are held by various entities involved in the oil industry. These can include national governments, oil companies, refineries, trading firms, and strategic petroleum reserve programs maintained by certain countries. Governments and state-owned entities often hold strategic petroleum reserves to ensure energy security in case of emergencies or disruptions in supply. Major oil-producing and consuming countries may also have oil inventories to stabilize markets and manage price fluctuations. Commercial entities such as oil companies and trading firms also maintain inventories for operational and trading purposes. The specific entities holding oil inventories can vary depending on the region and the oil industry structure in each country.

The Strategic Petroleum Reserve (SPR) is a stockpile of crude oil maintained by the United States government. It serves as an emergency backup in case of disruptions in oil supplies, such as natural disasters or geopolitical events. The SPR was established in 1975 after the Arab oil embargo to ensure energy security. It consists of caverns along the Gulf Coast states of Texas and Louisiana that can hold around 727 million barrels of oil. The SPR is managed by the Department of Energy and is intended to provide a cushion in case of major oil supply disruptions.

What Macrofactors Impact Oil?

Economic indicators such as GDP growth, inflation, and interest rates can influence crude oil fundamentals. Changes in these factors can impact global oil demand, production investments, and overall market sentiment.

Geopolitical Factors that Impact Oil Prices

Several geopolitical factors can impact the price of oil. Geopolitical factors play a significant role in affecting the oil industry.

Conflicts, wars, or political instability in major oil-producing regions can disrupt production and supply, leading to price fluctuations. For example, turmoil in the Middle East, such as the War between Israel and Hamas, or civil unrest in oil-rich countries, such as the War between Russia and Ukraine, can impact oil availability.

The concentration of oil reserves in specific regions can create vulnerabilities. Disruptions caused by natural disasters, such as hurricanes, earthquakes, or geopolitical tensions in these concentrated areas, can significantly impact global oil supply and prices.

Diplomatic relationships between countries and the imposition of economic sanctions can affect oil production and trade. Sanctions can limit access to markets or restrict the production capabilities of oil-producing nations, influencing global supply.

OPEC can alter the value of oil prices. This intergovernmental organization represents major oil-producing countries and is crucial in oil market dynamics. Decisions made by OPEC regarding production quotas or pricing policies can significantly influence oil prices and market stability.

The global move towards renewable energy sources and efforts to reduce carbon emissions can impact oil’s long-term demand and pricing. Technological advancements in alternative energy sources, such as electric vehicles or renewable power generation, can shape the future oil demand.

Futures Production, Consumption and Inventories

While oil production could be complex to gauge given the war in the Middle East and Russia/Ukraine, the United States is pumping oil in all cylinders, with production reaching 13.2 million barrels a day, up from 12.1 million barrels a year ago. The U.S. Energy Information Administration expects oil production to increase by 1 million barrels daily in 2024. The International Energy Agency sees consumption rising by 2.4 million barrels daily in 2024. Inventories are also relatively low, especially in the United States Strategic Petroleum Reserve. As of September 2023, the SPR was 350 million barrels of crude oil, the lowest level since 1983. There could be a temporary floor as the Biden Administration previously announced that they would repurchase oil for the SPR in the $67-72 range.

light crude oil futures

light crude oil futures predictions

According to the Energy Information Administration, crude oil inventories in the United States are approximately 2% below the 5-year average range for this time of year. The price of WTI crude oil, which is the U.S. Benchmark, is about 11% above the 5-year average price of crude oil (see chart of crude oil versus 60-month moving average). If the flash crash of the pandemic is removed from the calculation, the average price over the past 5-years is very close to current levels.

How Will EV Sales Impact Oil?

Another issue that impacts future demand is EV sales. There is a general expectation that the rise in electric vehicle (EV) sales could lead to a decline in oil demand. Electric vehicles predominantly use electricity as their primary energy source, reducing the need for gasoline or diesel derived from fossil fuels like oil. As more people switch to electric vehicles, particularly in countries with ambitious goals for reducing carbon emissions, the gasoline demand could decline. However, the impact on oil demand will depend on various factors, including the rate of EV adoption, government policies, and advancements in battery technology. While future EV sales could impact oil prices, getting people to transition is becoming more challenging. About 9% of the cars sold in the United States are EVs, and the slowdown in China is hampering the production of the crucial metals needed to produce EVs.

The Bottom Line

The upshot is that oil prices reflect the current fundamentals, but very few geopolitical risks seem to be incorporated into the price. Production levels around the globe are mixed. OPEC has reduced levels while the United States is pumping on all cylinders. Demand seems steady despite the global drive to increase the electric vehicle fleet. Inventories are just below the 5-year average range, and the price is close to the 5-year average range, making oil prices fundamentally reflect the current levels of oil prices.

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Malik is a skilled writer with a passion for news and current events. With their keen eye for detail, they provide insightful perspectives on the latest happenings. Stay informed and engaged!