Verlerger on Oil Glut: "There has never been anything like it"

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While oil is a finite resource, focusing on the long term can blind one to near-term dynamics. There has been surprisingly little mention in the mainstream media of how large the current oil surplus is. The collective view seems to be that this will take care of itself in short order. But that may be longer in coming than most believe.

Some veteran oil analysts, in particular Philip Verlerger, beg to differ. From the Los Angeles Times (hat tip reader Michael):

Downward pressure on oil prices is so great that crude could trade for as little as $20 a barrel by the end of the year — less than a third of what it traded for this week and an 86% drop from its peak last year, analysts said…

The reasons are simple, said Philip K. Verleger Jr., an expert on energy markets at the University of Calgary in Canada: The still-sputtering economy has lessened demand at a time when there is already a big surplus of oil.

For eight straight months, oil supplies have been running about 2 million barrels a day higher than the global demand of 83 million barrels a day, Verleger said. Eventually, he and others predicted, suppliers will tire of paying to store all of the surplus oil and flood the market.

“That is the largest and longest continuous glut of supply that I have seen in 30 years of following energy prices,” Verleger said. “It’s a huge surplus. There has never been anything like it.”

The market will eventually correct itself, pushing prices down, Fadel Gheit, senior energy analyst for Oppenheimer & Co., wrote in a note to investors. “Excessive speculation and a weak dollar have lifted oil prices to levels not sustainable by market fundamentals,” Gheit wrote.

Crude has traded in the range of about $70 a barrel for much of the last month, closing Thursday at $66.73. The markets were closed Friday.

With so much oil available and so little need for that amount, investors, oil companies and even some banks have bought and stored surplus oil everywhere they can. By one estimate, before oil surged to its high this year of $73.38 a barrel in June, as many as 67 supertankers — each capable of carrying 2 million barrels of oil — were being used as floating storage.

Verleger said it represented a largely risk-free investment for those who could sell that oil for huge profits on the futures markets.

But the glut has gone on for so long, he said, that the cost of all of that storage is bound to rise. When it rises enough, some suppliers will refuse to pay and a lot of that oil will be dumped onto the market.

“Oil will drop to $20 a ba

rrel by the end of the year because this situation just cannot be sustained,” Verleger said.

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18 comments

  1. Hugh

    Yes, this is what I have been saying for a while. Given the size of the glut and the weakness of economy, oil futures should be trading near their low of around $34/bbl. That they aren't is pure speculation by non-commercial players. I would like to know who is funding the money through them. Hedge funds? Sovereign wealth funds? Banks? The short answer is the market remains opaque.

    This week's figures aren't due until Wednesday but last week June 26 the year over year increase in oil inventories is 50.4 million barrels, a huge number.

    The Cushing futures price dropped after last Thursday's awful jobs report. It is now in the $64-$65 zone but if the price were going to collapse now it should do so faster than it is. So there still looks to be some speculative play left.

    Verleger may be right about the end of the year price down to $20. But the thing you have to take into account is that the current pricing reflects an irrationally irrational valuation. That is to say that in some sense oil prices are always manipulated but what we have here is an extra and very heavy overlay of speculation that has completely distorted the market even in the face of huge countervailing factors (the economy and supply). So oil will probably not fall substantially in price until the (government supplied) money which is fueling both the suckers market and the spike in oil runs out. At that point, you should expect a fall off in oil prices as precipitous as what happened in the collapse in oil prices last year.

  2. Andrew Bissell

    Jun 2010 $40 crude oil puts are trading for between $1.00-$2.00. Get 'em while they're cheap, folks.

  3. attempter

    Hmm, this is the first time I've looked at it this way, but it stands to reason that as existing storage capacity is completely filled (like at Cushing, or on supertankers, the orders for new construction of which have been contracting), the price of that storage must go up, lessening any margin the speculator was looking for.

    Of course this prospect of a storage levee breaking and all this surplus flooding the market, exacerbating already high price volatility, is yet more evidence that we need to purge the commodities markets of speculators and restrict those markets to buyers who will actually receive delivery.

  4. Alan

    Downward pressure on oil prices is so great that crude could trade for as little as $20 a barrel by the end of the year

    If this is anywhere close to accurate there will be another large wave of financial chaos and political instability.

    I'd pinpoint Russia as the likely point of origin. The real local inflation rate in rubles is already at or over 20%. Banks are street advertising CD rates of 11% up to 18%. Unemployment is officially pegged at 11% and rising.

    "Stagflation" is clearly already in place here.

    Also in progress is a local "new car boom" that has featured 0 down / 0% consumer financing.

    Do the echoes sound familiar?

    When oil prices crashed starting last year Russia entered a rapid Forex cash burn of its own that was only stemmed by price recovery. If/when there's a repeat episode there will be three results.

    1. Russia will cease to be a buyer of US and European government bonds. And it will probably become a net seller. This overhanging supply can be added to any new supply of bonds being created by the US Treasury and European governments to fuel "stimulus".

    2. The ruble will of course decline drastically vis a vis the USD and euro. How much forex the Russian Central bank expends before ceasing to try to stabilize exchange rates is a second question.

    3. The demand for imported new cars and SUVs will dry up. These vehicles are produced by the usual names. I'd expect most of the consumer loans and any overlying securitizations can also be added to the vintage Security Wallpaper collections.

  5. gullchasedship

    You folks keep talking about the glut of oil.

    Don't forget that 67 tankers with 2 million barrels each is less than two days worth of oil.

    And OPEC purposely props up the price of oil by producing less. If oil goes back to $35, I can't see it staying there long.

  6. claudior

    I wonder what would happen if the oil states stop buying US treasuries, lest the price of oil drops significantly.

  7. Sivaram Velauthapillai

    Claudior: "I wonder what would happen if the oil states stop buying US treasuries, lest the price of oil drops significantly."

    Why does any of that matter? Purchase of US$-denominated assets will automatically decline as the US current account deficit, a lot of it petroleum-related, shrinks. This isn't a bad thing per se.

    If you think USA is going to have trouble issuing debt, think again. Even if US debt was downgraded tomorrow, it would have a higher credit rating than 75% of the countries out there. It will also be safer than the debt of most of the corporations out there (after all, as Warren Buffett has said, the US govt owns class A shares on all American corporations i.e. govt gets its share of profits before common shareholders do).

    Furthermore, US citizens will ramp up their purchase of US government debt. Already we are seeing the savings rate skyrocket and where do you think that money is flowing? Not into stocks or commodities or real estate. But most likely bonds.

  8. Sivaram Velauthapillai

    GULFCHASEDSHIP: "Don't forget that 67 tankers with 2 million barrels each is less than two days worth of oil."

    That's huge. Two million is just a bit less than the entire production from Canada.

    "And OPEC purposely props up the price of oil by producing less. If oil goes back to $35, I can't see it staying there long."

    There will be a limit to that. OPEC has already cut production quite a bit in the last year. I think there will be a limit to how much they can cut. The vast majority of income for many OPEC nations come from oil & gas so they can't keep cutting. They'll basically go bankrupt (especially if non-OPEC keeps stealing market share, which has been happening lately).

    As far as I'm concerned, the only way I see oil staying at current levels or going higher, is if the world economy posts strong growth. Since I do not expect strong growth, I am bearish and think something like $30 seems more reasonable.

  9. gullchasedship

    Hi Sivaram,

    2 million is pocket change, considering the world uses 80 – 90 million barrels per *day*.

    I think a correction to $45 – $55 per barrel for the rest of the year is likely. With global demand increasing thanks to the modernization of China and India, but $30/barrel?

    That's very unlikely.

  10. Hugh

    "Don't forget that 67 tankers with 2 million barrels each is less than two days worth of oil."

    OK. let me take this apart for you. First, current US oil stocks are as of last week 350 million barrels.

    http://tonto.eia.doe.gov/oog/ftparea/wogirs/xls/psw03.xls#'Data 1'!A1

    This is actually down from the 375 million level of May 1. To find a comparable period when we had these kinds of stocks for this long you would have to go back to 1993. So yes this is unusual.

    Oil is not a spigot that you can turn off for a few days and clear what you have in storage. There are millions of barrels that are always in the pipeline. So what we are looking at is a huge amount of oil over and above what is being used. Oil stocks for this year are running 50 million barrels ahead of last year. With supply in the pipeline exceeding demand, how exactly is the excess oil held in storage going to be cleared? Answer: Not easily.

  11. mxq

    just to interject

    gullschasedship: "2 million is pocket change, considering the world uses 80 – 90 million barrels per *day*."

    markets just don't work that way…especially markets as inelastic as oil…the marginal bbl of oil added or subtracted from total supply +/- paper supply is where prices are set.

    In addition to Hugh's point, the bigger US supply picture shows 1.1bn total petroleum products on hand (1.8bn if you count SPR stocks)…an all-time record. Total OECD days supply on hand is in the low to mid-60's, depending upon how much is floating around off the grid, also an all-time high. Not to mention China knocked everyone out of their seats last week when they reported having 3x more oil stockpiled than originally thought.

  12. gullchasedship

    mxq, my point was that calling for $30/barrel is overdoing it. I'm not suggesting oil is going to continue to go up.

    And the article from the Post that you presented to us make the same point. Just because the economy doesn't have the juice to support $80 doesn't mean it's going back to $30.

  13. Anon1

    Siviram: The "skyrocketing" savings level is NOT people pouring money into bonds, CDs, etc. It is a LOT of people paying down debts.

    Totally useless to the economy and US government, though good for the people themselves. The so-called "savings increase" is bullcrap. Paying off one's credit cards and loans is NOT saving. It is spending down debt.

  14. mxq

    gullchasedship: "my point was that calling for $30barrel is overdoing it…And the article from the Post that you presented to us make the same point."

    Actually, the point of the article was: "Amidst a world-wide recession, oil prices have been heading higher this year — clearly not driven by demand, which is low, but by speculators."

    I was merely showing how speculation plays a role in setting prices.

    I'm not exactly sure how you pulled "$30 was overdoing it" from that piece.

    Anon1, you're arguing over semantics.

    I'll just cite wikipedia:

    "income that is not consumed by immediately buying goods and services is saved…the part of a person's income that is spent on mortgage loan repayments is not spent on present consumption and is therefore saving by…definition, even though people do not always think of repaying a loan as saving. However, in the U.S. measurement of the numbers behind its gross national product (i.e., the National Income and Product Accounts), personal interest payments are not treated as "saving" unless the institutions and people who receive them save them."

  15. juan

    so, i'll only note that, from 1947 to 2007, the average world price in 2007 dollars was 27.00 while the median for that same period was 19.04/bbl. [WTRG]

    reversion is never a given but to believe that long only index funds and the various [other] specs can hold price above 30 in the midst of global depression and evident overproduction seems, imo, a bit mystical.

    a drop into the teens and below would not surprise.

  16. moslof

    I agree with Juan. I am looking for 10$ a barrel oil during ther next deflationary downdraft coming soon to all asset markets.

  17. Helix

    Ummmm… correct me if I'm wrong, but given worldwide demand of 83 million bbl/day, the 50.4 million bbl YOY inventory increase represents about 17 hours of world consumption, and the 68 ships holding 2 million bbl each represents about 36 hours worth of demand. I'm a bit hesitant to consider this "huge". A damaging hurricane in the Gulf of Mexico can easily take 1 million bbl/day offline, while increased pipeline vandalism in Nigeria could potentially annihilate the excess.

    Much more likely is a reduction in supply by oil producers. A price anything like $20 or even $34/bbl would squeeze marginal operations, encouraging producers to idle them, thus removing the excess supply. I therefore think it is highly unlikely that we will visit these prices except as a brief episode. The steady decline of the USD against other currencies make this an even more unlikely event.

  18. Helix

    Attempter said "Of course this prospect of a storage levee breaking and all this surplus flooding the market, exacerbating already high price volatility, is yet more evidence that we need to purge the commodities markets of speculators and restrict those markets to buyers who will actually receive delivery."

    IMO, it is not speculation per se that causes excessive volatility in this market but rather the usual suspect — excess leveraging. I believe this contributed to the huge run-up in prices last summer, and may even have contributed to the strong price advances of the last few months. A capital ratio requirement is in order.

Comments are closed.