Inventory levels are a poor guide for production policy.
By
Julian Lee
Photographer: Dimas Ardian/Bloomberg We've learned two things on the oil policy of OPEC and friends from meetings in Muscat, Oman and Davos. They don't know the destination, but they know they haven't got there.
Since the group started their output cuts in January last year, it gradually emerged that they had a goal of returning inventories to a five-year average level. But this benchmark has never been precisely defined. What inventories? Where? Measured in what units? Against which five-year baseline? None of these questions has yet been addressed.
Saudi oil minister Khalid Al-Falih admitted as much during the press conference after the Joint Ministerial Monitoring Committee meeting in Muscat last weekend, when he suggested that a technical discussion was required on what the oil market needs in terms of inventory. But inventory levels themselves are not a particularly good metric on which to base output policy.
Using them as a goal may dampen some of the political heat that accompanies a price target, but the disadvantage is that they're a backward-looking measure. We don't have an accurate picture of what stockpiles are at any given time until several months later. The latest data for OECD inventories, published by the IEA on Jan. 19, are for the end of November, while figures for both September and October were revised by as much as 12 million barrels.
That said, OPEC has become averse to setting a price target, perhaps in part because it wants to avoid accusations of manipulating the oil market. So an inventory target it is. But that raises the question of what inventory target.
It has become common to see the target as returning OECD commercial stockpiles to their rolling five-year average level -- but that is largely because OECD stockpiles are the only ones that are widely and consistently reported in an accessible form. As an actual measure of how much oil the world needs to hold in reserve they are pretty useless.
Two-Speed World
Oil demand in developing countries has grown five times as much as consumption in the OECD
Limiting the focus to the OECD ignores more than half of the world's oil consumption and not just any old half, but the most dynamic one. Over the past five years, non-OECD oil demand has increased almost five times as fast as consumption among the developed nations, adding 6.4 million barrels a day between 2012 and 2017, compared with just 1.3 million in the OECD countries, according to the International Energy Agency.
The second problem is that measuring inventories in simple volume terms takes no account of the function those inventories perform. Aside from providing opportunities to profit from movements in oil prices, inventories play an important role in matching a seasonally variable oil demand to a much less seasonal profile of supply. They also act as a buffer to provide protection from supply disruptions or spikes in demand. This suggests that stockpiles should be measured in terms of the number of days for which they can perform this role, rather than simply in barrels.
With oil demand increasing on average by close to 1.7 million barrels a day in each of the past three years, the world needs more oil in storage to provide the same buffer. Accounting for stockpiles in days of demand cover, or perhaps days of import cover, which is how the IEA's emergency stockpile obligations are defined, would be a big improvement over a simple volume accounting.
And then, no matter whether you measure in barrels or days, there is the problem of the target OPEC and friends are trying to reach. Why the five-year average level of inventories? Why not four, or six? And, as Al-Falih noted in Muscat last weekend, there is the problem that the five-year average is itself influenced by the very excess stockpile that the group is trying to drain.
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By Tom Kool - Jan 19, 2018, 2:00 PM CST Higher oil prices may lead to huge growth in U.S. shale production, according to revised predictions from both OPEC and the IEA. Friday, January 19, 2018 Oil prices fell back a bit at the end of this week. EIA data shows a rise in U.S. production, but also another strong decline in inventories. Brent is struggling to hold above $70, and benchmark prices await some direction. IEA: Explosive growth in U.S. shale will test oil prices. The IEA’s latest Oil Market Report paints a mixed picture for prices. Clearly, the market is tightening, the IEA says, but it also says that shale growth will be “explosive” this year. The agency revised up its forecasts growth for U.S production from 870,000 bpd to 1.1 mb/d in 2018. That, combined with gains from other non-OPEC countries, could end the price rally, although the IEA says a lot of uncertainty remains. Venezuelan oil production plunges by over 200,000 bpd . Venezuela’s Decemb
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