When oil was wallowing below $35 (U.S.) a barrel a year ago, one of the big complaints from many market followers was that the price didn't reflect the fundamentals of the oil market. Things may have been bad in terms of the market for trading oil futures, but the actual supply/demand dynamics didn't warrant such a low – or so the argument went.
Over the past year, the global economy turned a corner, financial and credit markets stabilized, and oil has rebounded to roughly double its price of a year ago.
But, ironically, the argument about the fundamentals not being reflected by the price has become even more compelling today – only in reverse.
‘A MASSIVE GLUT'
Toronto-Dominion Bank economist Dina Cover wrote in a report this week that despite the improved global economic picture, “[the] blow to the crude oil market is going to continue to be felt for some time, as the fundamental picture remains quite weak.”
She noted that while demand from the developing world had returned to healthy growth by the fourth quarter, oil consumption among OECD countries – which still dominate world oil consumption – remains below levels from a year ago.
Over all, global demand at the end of 2009 was up a thin 0.3 per cent from the end of 2008 – but still down 2 per cent from pre-recession levels at the end of 2007.
Meanwhile, supplies have been growing faster than demand. In the fourth quarter, global production was up 1.6 million barrels a day over a year earlier, as Canada, the United States, Brazil and the former Soviet Union all stepped up their oil output.
The result, she said, is that the world oil market is “still facing a massive glut.”
Global supplies ended 2009 running 1.3 million barrels a day above demand. Official global oil inventories sat at about 95 days worth of supplies – slightly higher than where they sat a year ago, and about 10 per cent above their five-year average.
THE PRICE IS THE ENEMY
The price recovery has been a major factor in exacerbating the glut. Even though the rebound had more to do with the normalization of markets, the U.S.-dollar downturn and growing economic optimism than it did any actual demand recovery, oil at $70 was ample incentive for producers to open up their taps.
In addition to the production increases among some prominent non-OPEC producers, OPEC countries have been increasingly cheating on quotas. They have also substantially increased their production capacity.
“Even once the rebound in crude oil demand is in full swing, the supply overhang, combined with growing excess capacity, will limit the upward pressure on prices,” wrote Ms. Cover, predicting that this situation should keep oil in the $80-to-$85 range for the next two years.
