Crude oil: OPEC cutbacks and rising inventories – a paradox?

There may well be a number of market players rubbing their eyes in some dismay at the crude oil announcements passing on the news ticker these days. The crude oil inventories in the USA on which investors are currently focusing their attention have risen since the beginning of the year – i.e. since the start of the often discussed OPEC/NOPEC production cutback deal – in six (in each case positive) weekly steps of 40 million barrels (+8%). An altogether similar situation can also be seen in the western European „ARA“ storage region (Amsterdam-Rotterdam-Antwerp) where crude oil inventories have risen in the same period by 8 million barrels (+14%). But why have they risen? Hadn’t the ten „reduction-committed“ OPEC and the eleven „reduction-willing“ NOPEC countries promised an accumulated production cutback of a total 1.8 million barrels per day (OPEC-10: 1.2 mbd and NOPEC-11: 0.6 mbd) for the period 1 January – 30 June in order to bring the global crude oil inventories, that have been literally welling up since 3Q2014, back to the normal level of the 5 year average? And hadn’t virtually every business newspaper reported that in particular OPEC, with a surprisingly high level of discipline by historical standards, had fulfilled its reduction pledge in January by ~90% which corresponds to an effectively reduced output volume of around 1.0 mbd? If one assumes that the previous compliance of the OPEC 10 continues in February, a theory unlikely to prove inappropriately bold given the corresponding assertions made by various cartel grandees, and if account is also taken of the fact that the NOPEC 11 have also fulfilled their cutback pledges of 0.6 mbd by at least a quota of 50%, the 21 OPEC/NOPEC deal countries can be expected to have reduced their output in the first 53 days of the new year by nearly 70 million barrels. Even if allowance is made for the compensating production increases in the USA as well as in Iran, Libya and Nigeria, the accumulated cutback volume should still amount this year to around 40-50 million barrels. Yet if this – admittedly somewhat simplified – calculation were to prove halfway correct, why are the crude oil inventories rising in this supposed environment of cutbacks instead of at least gradually falling? And why is the crude oil price rising to USD 57 given this paradoxical inventory situation?

This apparent contradiction of simultaneously rising inventories and falling production (in net terms) can be explained, however, if account is also taken of the transport routes of crude oil. By sea, it can take between 30 and 60 days for crude oil to travel from the land of its production to the land of consumption. If account is taken of this „logistic time lag“, one of the reasons why inventories are currently rising is the time it takes for crude oil produced in November/December to reach its destination ports. Yet these were the very same months in which various „OPEC/NOPEC deal countries“ – i.e. immediately before the start of the agreed deal cutback period (January-June 2017) – had hiked their production again to „all-in“. Given this logistic background, the crude oil inventories in the global context – including those in the USA and in the ARA region – can be expected to start falling again in the weeks ahead. But whether this will be enough to nudge the crude oil price, that is currently being driven by extreme investor optimism, even closer to the USD 60 mark will depend not least on US President Donald Trump and his tax and Iran plans. We confirm our assessment that the time for crude oil prices above USD 60 will only come in 2018.

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