Why Ballooning Oil Stockpiles Aren’t Driving Down Prices

Inventories of crude oil and refined petroleum products are brimming, but they seem to have had little effect on oil prices.

The stored oil is measured by the number of days inventories could be met by the supply. OECD commercial inventories stood at 67 days worth at the end of March 2016. This is a marked increase from 57 days of stored supply at the end of 2013 and a five-day increase in volume from oil stores during the worst of the oil crisis, when global demand was at its lowest. Commercial inventories being overly full is normally associated with falling oil prices in light of a production glut, since there’s too much oil for existing demand. The drop in crude prices by 76 percent in the wake of a global glut is by now well-known.

But the recent surge in oil prices has not yet slowed. Prices have jumped more than 75 percent since the middle of January, but the amount of oil in commercial inventories had not dropped in response. In recent weeks, it’s been quite the opposite, according to Bloomberg.

“Companies hold inventories for a variety of reasons, which can be broadly defined as logistical, speculative and security. Oil is needed to fill pipelines, refineries and the supply chain; that’s the logistical inventory. Varying volumes may be held to profit from expected future movements in prices; the speculative inventory. Oil is also held to provide a cushion against both anticipated and unexpected fluctuations in supply and demand, this is the security inventory. All of these factors have contributed to the growth in the oil stockpile since the end of 2013.”

Oil inventories near record highs mean buyers are in no hurry to lock down new crude supply: https://t.co/RoQrw1hgfs pic.twitter.com/fNYxG9O6zR

— Reuters Business (@ReutersBiz) May 19, 2016

In other words, the normal relationship between inventories and prices has changed over the past two decades because higher stores are needed to meet sudden rises in demand or disruptions in supply, such as the recent Canadian wildfires, or recent attacks in Nigeria, which removed 2 million barrels a day from the world supply. OPEC’s production has also increased in order to facilitate these larger stockpiles, even though OPEC spent decades trying to convince producers that such extensive stores of oil were unnecessary, which has been met with criticism by oil analysts.

It may seem counter-intuitive that the world may not be ready for disruptions in supply when the world is awash with supplies of crude. However, as a separate report by Bloomberg Gadfly notes, the question is not as straightforward as you might think.

“Global spare capacity — defined by the IEA as the volume of oil that can be brought into production within 90 days and sustained for an extended period — stands at 3.44 million barrels per day, according to data compiled by Bloomberg. But much of that may not be available as quickly as you’d hope. Libya’s 500,000 barrels of spare daily capacity, for example, can be used only if the political situation improves enough to allow unrestricted exports and secure access to fields and pipelines.”

Most of the world’s usable spare capacity is held by the Kingdom of Saudi Arabia, and Deputy Crown Prince Mohammed bin Salman has stated that while the country could immediately raise output to 11.5 million barrels a day, raising it to 12.5 million would take six to nine months. In the event of a sudden and prolonged crisis of supply, the world market could count on a further 100,000 barrels a day each from Abu Dhabi, Kuwait, Iran and Iraq.

OECD commercial oil inventories have risen from 57 days at the end of 2013 to 67 days at the end of March this year pic.twitter.com/f0O3eWERW3

— Mark Constantine (@vexmark) May 22, 2016

This amounts to 1.7 million barrels per day in immediately available emergency capacity. On a global scale, that figure is insignificant, as Gadfly notes.

“This is dwarfed by some of the losses we’ve experienced. The biggest was the loss of 5.6 million barrels per day for six months during the Iranian revolution. Even more disruptive was Iraq’s 1990 invasion of Kuwait, depriving the world of more than 4 million barrels of daily supply overnight. It took more than three years to restore Kuwait’s pre-invasion output. Iraq’s didn’t recover fully for almost 20 years.”

In the current economic environment, every oil-exporting country is producing as much crude as they can, leaving little left for emergency boosting outside of Saudi Arabia. Int he absence of such spare production capacity, the oil industry needs their stores full so they can dip into them in case of demands spikes or a global crisis of supply instead of relying on OPEC countries to boost their production.

While the market may balance itself and go back to the old ways in the future, for now, full inventories need not mean driving prices down.

[Photo by Joe Raedle/Getty Images]