By: George Trager, Financial Markets Enthusiast, Editor of investbrain.net
Oil prices have cratered over the last two years and become a source of commotion, stress and volatility in the financial markets. There’s no question that there’s a long list of factors contributing to the price pressure – the increase in shale oil production, OPEC actions (or inaction), new supply (Iran), potentially lower demand as a result of global economic weakness – but they all combine to the most basic economic concept: supply and demand. When supply exceeds demand for extended periods, prices have to come down. The four charts explain what’s been going on.
The above chart shows the estimate global oil supply and demand on a quarterly basis since 2011. As one can see, while there have been momentary periods in the past where oil supply has exceeded demand, the extent of the exceedance and the length of time has been relatively small. All of this changed in 2014.
The above chart shows the global over and under supply of oil using the estimates from the above chart. It’s an easier way to view the excess supply situation that we’ve had in the market for over eight quarters now and counting – looking at the chart notice two periods, the first part of 2012 (call it the first and second quarters) which is where we last had excess supply at elevated levels and also the first part of 2014, which was the beginning of the current excess supply.
The above chart assumes that we had zero million barrels of Oil per day in stock at the end of 2012, and then adds in the over or under supply in a given quarter to estimate what the relative inventory is under that scenario. Again, as one can see, the inventory levels have increased every quarter for the last eight quarters.
The last chart brings it all together. The two periods I asked you to notice earlier and circled in red. While the market was oversupplied periodically in 2012, it quickly came back into balance after a few quarters and so we saw a drop in the price of Oil, followed by recovery shortly thereafter. However, the second red circle shows that 2014 was a different story. The Oil price started to drop around the middle of 2014 – after two quarters of rising inventory levels that was only going to get worse, and never looked back. Supply needs to decline and the current inventory level needs to normalize before any recovery will occur in Oil prices.
Source: IEA, Bloomberg
