How Big An Oil Glut Is There Really?

Revisiting Crude Oil

Beginning in late August we have frequently discussed the possibility that a significant low in crude oil prices could be imminent in spite of the “obvious” lousy fundamentals. As blind luck would have it, the first of these articles (entitled “Is Crude Oil Close to a Low?”) was posted exactly one trading day before the low to date was actually put in. Well, you know what they say about blind chickens :).

Image credit: freshidea – Fotolia

Note here that we are not saying it was the low, although this cannot be ruled out either. It seems very likely though that it was at least a low of medium term significance.

From a technical perspective, the action in crude oil since late August is so far consistent with a medium term low. The recent advance looks actually somewhat healthier than the previous one, due to the lengthy consolidation after the initial strong rally leg – click to enlarge.

To summarize our train of thought on the topic: We noted for one thing that commodities always bottom out at a point in time when their fundamentals still look atrocious. This is simply due to the fact that prices will at some point have declined sufficiently to discount all the (by then widely known) negative factors.

For another thing, we have pointed out that the prices of commodities are ultimately not only determined by their specific supply-demand characteristics, but also by the money relation. For instance, no-one would seriously expect crude oil prices to revert back to their level of 1933 ($ 0.67 annual average), no matter how bad crude oil’s supply-demand fundamentals become. After all, since May of 1933, the Fed has managed to devalue the US dollar by nearly 95% (based on the government’s own dubious CPI statistics).

Neither should one expect nominal crude oil prices to revert to the level of 1998. The true broad US money supply (the domestic money supply alone – a lot of it has also moved into accounts held abroad and is not part of this statistic) has increased more than four-fold since 1998 (it stood at approx. $2.5 trn. in early 1998 and stands at $11.18 trn. as of August this year).

Based on this fact in combination with the long term technical picture, we have argued that the $35-$40/ bbl. price range of today is the functional equivalent of the $10/ bbl. price level in 1998 (since this particular argument about price ranges is based on empirical data, it is of course open to debate).

Subsequently we have updated this first article on the topic by looking at various other factors, resp. developments, such as e.g. the idea that the term structure of the oil futures market suggested that the supply glut was quite possibly much smaller than was widely believed at the time. As we found out, this opinion was shared by Andy Hall of Astenbeck Capital Management, who is known for being a relatively lone bull on oil.

For readers who have missed them or wish to refresh their memory, these updates and further deliberations on the subject of crude oil can be found in the following posts (in chronological order): More on Crude Oil and Industrial Commodities, A Word on Crude Oil, and Crude Oil – a “Ray of Hope”.