Morgan Stanley strategists have thrown a wrench into the conventional wisdom regarding oil prices. Specifically, energy strategist Adam Longson believes the U.S. dollar, and not a glut of supply, is the main driver of the currently weak commodity price.
Mr. Longson concedes that global oil markets are oversupplied and his price forecast for crude is lower for the first half of 2016. He argues, however, that the glut is significantly overstated by recent headlines and indicators. Developed-world inventory levels, notably in the United States, are high by historical standards, but this represents only half of the world's reserves. In China, for instance, oil inventory levels are declining in year-over-year terms.
He also writes that the widely publicized increase in oil stored at sea in tankers has been incorrectly measured: "These are not crude oil stocks, but rather the sum of crude, [natural gas liquids] feedstocks and products, and thus overstating true crude inventories."
All of these factors combine to overstate the amount of excess crude in global markets. "We see an average crude oil oversupply of only 0.7-1.0 mmb/d [million barrels a day] for 2015, not the 1.5-2.5 mmb/d figures often cited," he writes.
More important, the strategist notes that inventory levels have not been the primary driver of oil prices in the past. "Inventories tend to rise over time anyway, yet prices climb. The long-run trend in OECD inventories has been higher, but that has not restrained prices, because demand is growing."
The two charts included here support Mr. Longson's contention that the dollar, and not excess oil inventories, has been the strongest driver of the West Texas intermediate crude price in the past three years.
The first chart shows that indeed there is a significant relationship between U.S. oil in storage and the commodity price (note that inventory levels are plotted inversely to better show the trend). This represents the conventional wisdom and the immutable laws of supply and demand – greater available supply of any product creates downward pressure on prices.
But the second chart shows that the connection between the U.S. trade-weighted currency and the WTI price is even stronger (this is verified by correlation calculations).
It's true that correlation is not causation but the two charts, combined with Mr. Longson's in-depth analysis, present a persuasive argument that the current glut in North American oil is both smaller and less important for investors in the energy sector than was previously believed.
This is only one strategist's view, but Canadians concerned about national economic growth will cheer the optimistic implications for energy markets. It suggests that current oversupply conditions will be corrected more quickly, and that investors should also pay close attention to the path of the U.S. dollar, and oil demand from China and elsewhere in the developing world, in addition to U.S. inventory levels.
Follow Scott Barlow on Twitter @SBarlow_ROB.