Head Fake

Jim Brown
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Crude prices rallied +4% on Wednesday after the EIA inventory report showed a decline of -5.9 million barrels. That was the biggest decline in months but it does not represent reality.

Inventories did decline. However, there is a valid reason and the decline is only temporary. Refiners have to pay taxes on oil in inventory on December 31st. For that reason they let inventories decline late in December and then continue rebuilding them in early January.

In the EIA chart below the gray area is the five-year average for inventories by month. Note that the gray area declines in December and then rockets higher starting in January. Refiners build inventories in Jan-May to cover demand for the summer driving season. Oil is normally cheaper in the first quarter because demand is low and there is always a surplus in the market. This is why refiners stock up.

Note also that inventories soared last January far in excess of normal as the oil glut increased and prices declined. That spike in the blue line in early 2015 is what created the peak in the five-year average range on the far right of the chart.

If the inventory build starting in January 2016 is even a fraction of the build from early 2015 we will be in record territory again. That high in May 2015 was right at an 80-year high.

Imports declined -986,000 bpd or nearly 7 million barrels for the week. This is the primary reason inventories declined. Tankers are waiting offshore for the calendar to turn to 2016 and then they will flood the refiners with oil. Postponing multiple deliveries of oil for a couple weeks can save refiners millions of dollars in taxes.

To summarize, oil inventories declined because they normally decline for tax reasons in late December. Refinery utilization actually declined for the third consecutive week to 91.3%, down from 94.5% for the week ended on Nov 27th. If the amount of oil they are refining is declining then the drop in inventories is not related to refining activity.

When inventories begin to build in January a new problem will arise. Goldman Sachs warned last week that global storage facilities are shrinking and a continued glut could force another leg down in prices because of the lack of storage. "Risks of a sharp leg lower remain elevated" according to Goldman. They said there is a growing shortage of tankers for floating storage with more than 100 million barrels currently stored on tankers. Some 39 tankers are lined up outside Galveston waiting to unload. Iran has 30 million barrels in floating storage in the Persian Gulf.

Iraq is increasing production at a rapid rate. They are also discounting their oil in order to gain market share. Iraq is currently selling "Basra heavy" crude for as little as $30 in the global market. Saudi Arabia is shipping oil to Poland and Sweden for the first time ever after undercutting the price for Russian oil.

Energy stocks spiked significantly on Wednesday after the sharp drop in inventories. However, it was not because investors suddenly thought the energy crisis was over. This was major short covering. For instance Devon Energy (DVN) spiked +11% and Devon produces very little oil. They are a natural gas company. Their shares and the shares of almost everyone in the energy sector rose because they were heavily shorted. With Goldman warning of the potential for $20 oil and natural gas prices at 16-year lows the entire energy sector was the most crowded short play in the market. Any spike in the underlying commodity and a major short squeeze began.

When crude prices roll over again in two weeks as inventories begin to move higher we will see energy equities decline once again. Energy investors should be patient. Oil prices still have further to fall.

Active Rigs

Active drilling rigs were flat at 709 for the week ended on Friday 12/11 and that is a 10 year low. Oil rigs rose +17 for the week to 541. Active gas rigs fell -17 to 168. Active rigs have now declined -1,222 since the high of 1,931 in September 2014. Active offshore rigs were up +1 to 24.

Oil Inventories Week Ended 12/11/15

Crude inventories rose -4.8 million barrels to 490.7 million.

Refinery utilization declined from 93.1% to 91.9%. That is up from the low of 86.0% on October 9th.

U.S. production rose +12,000 from 9.164 to 9.176 mbpd.

Cushing inventories rose from 59.0 million to 59.4 million and nearing a record high.

Gasoline inventories rose +1.7 million barrels to 219.4 million as refiners accelerated production of winter blended fuels.

Distillate inventories rose 2.6 million barrels to 152.0 million and a 12 week high.

Details in the graphic are for the prior week. All numbers are not available until the Friday of the following week.

In the graphic below green represents a recent high and yellow a recent low. The blue-green represents a record high.

Jim Brown

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