Production Gains Change Oil Supply/Demand Dynamic

Peak oil was a main factor cited in offering support to oil prices in 2007 and 2008 as WTI went from a low of $50/bbl in January '07 to a high of $147/bbl in July '08. Growth in Chinese demand had outstripped most of the excess supply and OPEC's spare capacity began to dwindle as producers ramped up output to meet demand. The financial crisis in 2008 and the losses in oil demand that it caused forced prices from $147/bbl to $32/bbl in the second half of 2008, but oil has never recovered more than the $115/bbl price level in the four years since. Part of the reason is that the economy is still struggling to regain pre-2008 strength, but it is also explained by growth in supply and OPEC spare capacity.

The growth rate of Chinese imports soared in the early-2000's and was still a relatively high 10.6% y/y in 2007 & 2008. The inability of supply to keep up with the new demand growth was a feature of the price surge in 2008, and essentially created an element of "growing pains" in the market at that time. Producers just couldn't keep up with the extra demand, and prices had to rise. That doesn't seem to be the case as much now, as the rate of Chinese import growth has slowed to 6.8%. Despite the slowdown in the growth rate since 2007 & 2008, the overall level of imports is much higher and yet global oil supplies are more plentiful. China's level of imports has increased to 5.26 mb/d in 2011 & 2012 compared to 3.43 mb/d in 2007 & 2008. Despite higher demand, suppliers are better able to cope with it and stocks are building globally. Oil stocks that are able to be measured such as OECD stocks fell to 53.2 days of demand cover in 2007. The level of cover increased sharply in 2008 and has averaged a steady 59.0 days in the last four years. Oil stocks in the U.S. are the highest above their five-year average since April '09 and are close to moving to the highest since at least 1990.

In addition to elevated inventories and high demand cover, the supply/demand balance and OPEC spare capacity also show the market loosening. The first chart below shows that prior to early-2008, the EIA's supply/demand balance ranged from -2.7 mb/d to +1.2 mb/d with an average 1.1 mb/d deficit. Between 2008 & 2011, the average was a 0.55 mb/d deficit largely because of Libya's civil war in 2011. In 2012, however, the balance averaged a surplus of 0.2 mb/d. The second chart below shows another comparison to the 2007-2008 period, where OPEC spare capacity has grown to 6.0 mb/d in late-2012 from a low of 2.2 mb/d seen in mid-2008 at the peak in prices. From 2007 to 2012, global demand has increased 4.3 mb/d while non-OPEC output has gained 3.2 mb/d and OPEC 2.9 mb/d for 6.1 mb/d combined. The EIA's forecast for 2013 demand growth is 0.96 mb/d while supply is expected to grow 0.85 mb/d. OPEC will play a deciding role in balancing the market again, but may have to cut production sometime in 2013. The bottom line is that supply growth has outpaced demand growth since 2007, which should add pressure to prices.

The increase in non-OPEC production of 3.2 mb/d since 2007 has seen 1.5 mb/d come from the U.S. Rig counts in North Dakota's Bakken shale formation have surged from 33 in May 2009 to over 200 in 2012 (chart 1). As a result, production from the region has increased from 100 kb/d at the start of 2009 to nearly 700 kb/d in 2012 (chart 2). Imports from Canada are still averaging around 2.4 mb/d. However, the increase in domestic output may call into question the need for the Keystone XL pipeline given environmentalists opposition to the rerouting of the pipeline over the Ogallala Aquifer in Nebraska. A decision on the pipeline is expected sometime in early-2013 and meanwhile, the rail trade from North Dakota continues to grow. Increasing discussion regarding oil exports may help to get oil out of the landlocked Midwest, but won't help the pipeline's cause.

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