What Killed The Oil Price Rally?


Oil prices fell to a one-month low on Wednesday, pushed down by a rather bearish report from the EIA that showed a large increase in crude inventories.

Brent briefly dipped below $80 per barrel and WTI was back below $70 per barrel as of Wednesday afternoon.

The EIA said that crude oil inventories rose by 6.5 million barrels in the week ending on October 12. Crude stocks have actually been rising since mid-September, and are now back up to 416.4 million barrels. The four consecutive weeks of inventory gains is the longest streak since early 2017. “That’s a negative for oil prices right now, the larger-than-expected build in inventories this week,” Rob Thummel, managing director at Tortoise, told Bloomberg.

Despite the bottlenecks plaguing the shale sector, U.S. oil production continues to trend up. The EIA expects the Permian basin to add 53,000 bpd in November, compared to October levels. The Eagle Ford and the Bakken will add 15,000 bpd and 13,000 bpd, respectively. All told, the U.S. is set to see oil production rise by as much as 98,000 bpd between October and November, a stronger increase than in recent months.

However, the report is not as devastating to the bullish narrative as it might suggest. For one, they might be a little skewed because of recent storms. “The figures will be distorted considerably by Hurricane Michael and should therefore not be overinterpreted,” Commerzbank said in a note. “Roughly 40% of U.S. oil production in the Gulf of Mexico had been shut down for three days, resulting in a good 2 million barrels less crude oil being produced.”

In theory, that would mean that inventories should have climbed by even more. But the Louisiana Offshore Oil Port (LOOP) was temporarily closed during the hurricane, and exports may have been impacted a bit. That would have trapped a little more oil inside the country than might have otherwise been the case.

Moreover, the steep decline in refinery utilizations also helps explain the easing of downward pressure on crude stocks. Refinery rates have plunged from 17.094 million barrels per day (mb/d) in late September (a four-week average) down to 16.415 mb/d as of October 12. Refineries tend to undertake maintenance at this time of the year, but lower production rates means that there is less of a draw on crude stocks.

More importantly, there are several land mines that could yet push the market back up into dangerously high territory, and they are the same ones that we have known about for a while. Venezuela lost 42,000 bpd in September, and Iran lost at least 150,000 bpd in production. Iran’s export figures actually look worse than its production levels, since some of its production is being stored on ships in the Persian Gulf. So far, Iran’s oil exports are around 1.5 mb/d in October, down 900,000 bpd from April levels. Analysts expect steeper losses over the next month, volumes that will more than outweigh any gains from the United States.

The declines from Iran and Venezuela are going to be hard to cover for, without dipping too far into OPEC’s spare capacity. Standard Chartered estimates that Iran will lose another 600,000 bpd by the end of the year. Inventories are large enough to ensure there won’t be a physical shortage in the market, but the road might get rocky once again. Any unexpected supply outage, such as from Libya or Nigeria, will have an outsized impact on prices.

Oil prices are actually down a bit over the past week, but some of the losses can be chalked up to the pessimistic sentiment from broader equity markets. “Oil prices are currently being driven by a disparate mix of factors. The overall macroeconomic context remains central, in particular market concerns about trade,” Standard Charted wrote in a note. “As was seen last week, oil prices rarely weather any abrupt changes in investor risk preferences.”

The investment bank argues that the recent pullback in prices may also be a function of investors having over-estimated how tight the oil market would become in the fourth quarter. A revision of expectations, in other words, led to liquidation of bullish bets and a drop in prices. “[W]e think that one of the major factors that is leading to a scaling back of long positions is a reappraisal of short-term fundamentals by investors. We think a significant degree of money entered the market on the view that the Q4 global supply-demand balance was likely to be tight enough as to be the single dominant driver of prices.”

The hyper-bullish narrative that began to take hold in September may now look a bit overdone. Still, that doesn’t mean that the market is flush with supply once again. All it takes is another unexpected supply disruption to send prices back up again.


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