Thursday, May 28, 2009

Floating Storage Barrel Count

As expected today, OPEC members decided not to change output and crude oil (NYMEX WTI) hit a new high for the year of $65.44.

Some have said that equity market sentiment, dollar weakness or speculation have caused the recent run up in oil prices.

The relationship between equity markets and oil markets is mostly coincidental rather than there being a causal relationship (wealth effect of equity price movements may have a little causal effect). Equity market sentiment is driven by consumer and other demand-side activities which also impact oil demand.

Dollar weakness is a legitimate factor that can move oil prices in dollar terms. However this effect has been given too much credit for recent oil price moves (more on oil and dollar movement in a coming post).

Blaming speculators for oil price movements has become the most common face saving way of saying "I don't know." Speculation has been proven to have minimal impact on oil prices but is essential in generating liquidity and reducing transaction costs (bid/offer spreads) which reduces prices for consumers.

The main reason for the rally in oil prices has been quite simple. Oil is driven by fundamental physical supply and demand. Currently physical demand is greater than physical supply globally. Above ground oil inventories are no longer increasing and are beginning to fall. Now that we are coming close to the end of the weakest seasonal period for oil demand (second quarter of each year) we should see this oil inventory destocking pace rapidly increase.

Following is a chart of oil stored on floating tankers around the world. Floating storage is a leading indicator in the oil world as it is the most expensive place to store oil and the first to react to changes in fundamentals.

Floating storage beginning to empty is evidence that OPEC members' actions are having their desired effect. Storing oil on floating tankers is described in both the storage chapter and the transporting oil chapter of Oil 101.

[ Update June 7, 2009: A week after my analysis above showing crude floating storage declining a number of articles (DJN and Bloomberg for example) appeared confirming the analysis. ]

Follow @CommodityMD