Oil demand collapse versus a collapse in financial demand for oil
Recent oil price weakness is stoking fears that the underlying cause stems from oil demand collapsing. We see things differently. A case worth revisiting occurred in 2011. During that year, oil prices fell $39 per barrel amid fears Spain would default on its debt, resulting in a global economic collapse resembling the 2008-2009 credit crisis. It never materialized, but that is not the point. The point is almost all pundits blamed the oil price rout on a collapse in demand that was not the case.
In fact, global demand during 2011 was growing at a rate of over a million barrels per day. How, then, could oil prices experience a 35 percent fall?
The answer relates to the enormity of the “paper market” for oil.
Conventional wisdom suggests the daily trading volume for a mature commodity futures market tops out at three to five times the size of that commodity’s global demand. An analysis we first generated 14 years ago showed the average daily volume of key energy futures contracts totaled almost 14 times the size of global demand.
While the 2021-to-date trading multiple of these same futures contracts is almost 30 times the size of the current-year demand forecast, the actual multiple is closer to 50 when also accounting for options on futures, other energy futures contracts and the large, unregulated over-the-counter market (yes, more than 5 billion “paper barrels” of oil trade each day compared with actual oil demand of less than 0.1 billion barrels per day).
As such, we see the recent sell-off in crude prices representing another example of a collapse in the “financial demand” for oil, particularly given our separate analysis indicating global oil demand is running ahead of forecast.
The conversation seems timely given the planned Sept. 1 OPEC+ meeting, which is set to review the global oil balance and evaluate quota compliance.
Evident angst about demand growth has, unsurprisingly, stirred up conversation about delaying planned quota unwinds, which total about 260,000 barrels per day per month for OPEC and about 140,000 barrels per day per month for participating non-OPEC countries. We have not yet heard concrete indications that a delay in unwinding quotas will be agreed to, but the sense is Saudi Arabia remains adamant about not having the group “push” extra crude into the oil market before it can absorb incremental supply — the goal, instead, is to have any extra barrels “pulled” into the market from consumption pressures.
Working down global oil inventories stands at the forefront of OPEC+’s thinking which, put another way, means not having oil inventories build. The group’s efforts have been successful overall. Global petroleum inventories since July last year have fallen by almost 360 million barrels, the largest reduction on record.
In fact, we have alerted our clients that oil prices are currently sitting well below “fair value.” There is a strong, inverse correlation between oil inventory levels and oil prices. The relationship reflects the fact that all supply and demand factors intersect at storage. If the oil market is over-supplied and inventories are rising, the correct price signal would be a weakening oil price (and vice versa). That noted, our proprietary econometric models with high explanatory power built around this relationship place the current “fair value” of Brent crude close to $80 per barrel. This is 23 percent higher than last week’s closing price.