This website uses cookies to collect usage information in order to offer a better browsing experience. By browsing this site or by clicking on the "ACCEPT COOKIES" button you accept our Cookie Policy.

Oil Supply Outlook: Is Your Barrel Half Full or Half Empty?

PIMCO

Contributor:
PIMCO
Visit: PIMCO

By:

Portfolio Manager, Managing Director - Newport Beach Office

Sentiment in the oil market can at best be described as depressed. Implied demand at the end of 2018 through mid-2019 suffered, as the effects of trade tensions and the manufacturing slowdown sapped demand for refined petroleum products. Most macro outlooks are calling for oil surpluses in 2020 due to growing U.S. production, and prospects for a global energy transition are raising concerns about long-term demand. But we believe a market transition into surplus balances may not be inevitable.

Backwardation continues and supply is tight

Despite the negative sentiment, the oil market remains solidly backwardated, meaning spot and nearer-term futures prices exceed those for contracts further out – a situation that typically occurs only when supply is in deficit and inventories are being drawn to meet demand. Backwardation may also support returns by creating “roll yield” as investors long higher-priced short-term contracts roll out their exposure to lower-priced longer-term contracts.

We think the primary drivers are twofold:

  • Despite all the focus on expected growth in U.S. production as new pipelines come online in the second half of 2019, U.S. production has been flat to date this year and has lagged expectations.
  • OPEC production has declined sharply, both voluntarily and involuntarily.

Just how tight is the crude market? Current Organisation for Economic Co-operation and Development (OECD) crude inventories are nearly 60 million barrels below the five-year trailing average, adjusting for infrastructure fill associated with new pipelines and terminals that is effectively not commercially available – one of the tightest levels in the past decade (see Figure 1).

It is also worth noting disparities in the oil supply data between crude oil, refined petroleum products, and liquefied petroleum gas (LPG), the latter of which is suffering from slowing petrochemical activity globally and growing natural gas production. Simply put, when excluding LPG, which is only partially sourced from refining crude oil, the oil market is actually quite tight. This is something the bearish narrative is missing.

Outlooks for 2020: overly pessimistic?

While there are many moving parts and the slowing global economy poses downside risks, we believe current prices underappreciate the potential for positive catalysts. We agree that output will likely increase in the second half of 2019, but see reasons why some analysts’ baseline supply estimates may be excessive. For one, most bearish outlooks for 2020 assume a big ramp-up in U.S. output in the second half of 2019 and into 2020, yet the number of active rigs and completion crews is hitting two-year lows, and exploration and production (E&P) companies have tightened the reins on investment. In addition, the global transition to lower-sulfur shipping fuels later this year and into 2020 following the implementation of new regulations will drive demand for lower-sulfur crude oils and will benefit key refined products, helping to offset some of the broader weakening in demand. And while we aren’t optimistic that LPG balances will improve significantly, we believe the crude oil market is in much better shape than the major agencies’ anticipated balances, which include all hydrocarbons, would imply.

Investor takeaways

In sum, we do not view a market transition into surplus balances as inevitable – indeed, we believe continued tight crude balances could be the bigger surprise to the market. Such a scenario would likely be good for commodity investors, as continued backwardation in the markets has contributed positive carry, supporting returns even if prices fail to appreciate meaningfully.

Originally Posted on Septemebr 10, 2019 – Oil Supply Outlook: Is Your Barrel Half Full or Half Empty?

All investments contain risk and may lose value. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Investors should consult their investment professional prior to making an investment decision.

Disclosure: PIMCO

This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. © 2019 PIMCO PIMCO Investments LLC, distributor, 1633 Broadway, New York, NY 10019, is a company of PIMCO.

Disclosure: Interactive Brokers

Information posted on IBKR Traders’ Insight that is provided by third-parties and not by Interactive Brokers does NOT constitute a recommendation by Interactive Brokers that you should contract for the services of that third party. Third-party participants who contribute to IBKR Traders’ Insight are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.

This material is from PIMCO and is being posted with permission from PIMCO. The views expressed in this material are solely those of the author and/or PIMCO and IBKR is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation to buy, sell or hold such security. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Futures Trading

Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at ibkr.com.

trading top