The Oil Supply Constriction Is Fast Approaching

by | published July 18th, 2011

Shortly I'll be off to Victoria Station, the train to Gatwick, and a welcome flight home to Pittsburgh. However, there is an accelerating development I need to tell you about before getting on the plane.

As you know, last month, the Paris-based International Energy Agency (IEA) and the U.S. government announced they were releasing 60 million barrels of crude oil into the international market, 30 million of which coming from the U.S. Strategic Petroleum Reserve (SPR).

I said at the time that this would only make matters worse (“Releasing the Strategic Petroleum Reserve Will Make Volatility Surge,” June 24, 2011). The market has already confirmed my conclusion.

The move hit an unprepared market while I was in Athens on the first leg of this five-week trip. And from the outset, neither the rationale provided by Paris nor Washington rang true.

Less Than A Day's Worth of Oil

To begin with, this was never a significant move.

The volume they released represents only about 16 hours worth of global demand.

And when all was said and done, neither the IEA in Paris or the Obama administration in D.C. could find actual customers for the full complement.

Traders have easily incorporated the additional volume into their calculations. The West Texas Intermediate (WTI) price in New York is again approaching $100 a barrel, while Brent here in London is now testing $120 a barrel.

In short, any assertion that such a supply-side move was meant to assuage prices is unwarranted.

Plus, the IEA and Washington are now in the position of having to release continuous volume from strategic reserves, merely in reaction to what will be increasing prices, anyway. If this additional volume is not continuously injected into the market, the volatility will be even greater moving forward.

In other words, the price spike may be more intense because of the distortion caused by temporary reserve releases – worse than it they were not attempted at all.

It's much like painting oneself into a policy corner… without a way out.

I also noted in the June 24 Oil & Energy Investor that demand is increasing quicker than anticipated.

That means the market will completely absorb both the 500,000 barrels per day unilaterally added by the Saudis after the last OPEC meeting, and the 60 million added by the IEA/SPR move, before the end of this year.

It is important to point out that the primary demand increases worldwide are not coming from North America or western Europe – not, in other words, from the developed countries – but from regions where the IEA/SPR volume injection has limited initial short-term impact.

So if the intent was to arrest a price increase resulting from supply-demand considerations, this was not a particularly effective way to do it.

It over-saturates regions that don't need the volume and distorts the aggregate crude balance when considering those parts of the world where the demand is increasing. Several months are actually required to redress this cross-regional balance consideration.

Yet a significant dimension has emerged.

It surfaced almost immediately in target=”_blank” href=””>my Athens conversations directly after the announcement, became part of the market analysis I was doing in Mexico City for PEMEX, and was even introduced in what were essentially evaluations of shale gas potential during my stay in Morocco. And in my London meetings, the matter has taken a central position.

It comes down to this…

The IEA/SPR release was timed to address an issue before it occurs.

In response to a tirade of criticism, the IEA last Wednesday released a tersely worded defense of its action. It said it was not attempting to react to the current pricing environment, but to provide a response to market conditions.

The same justification is now moving through policy circles in Washington.

All of which translates into this…

A “Production Deficit Bubble”

I have been seeing indications of a constriction in oil supply forming as early as the end of this quarter (3Q/2011). It results from several factors colliding at the same time.

As demand increases quicker than expected, the market is still facing the results of a prolonged decline in forward drilling.

You see, for each month the price of crude oil declined from August 2008 through the first three quarters of 2009, followed by a sluggish level into 2010, we lost about two and a half months of forward drilling volume.

That translates into us being more than two years behind when the demand (and the pricing) began accelerating. That “production deficit bubble” moving through the system has now intensified the impact of that added demand.

Also, delays in major projects like the Kashagan Field off Kazakhstan (the largest find in the last 40 years) have reduced short-term supply projections.

We are hardly running out of oil…

But getting it to market for the remainder of the year may be a bit of an adventure.

The assumption that increasing volume from Iraqi fields could make up the difference is being reevaluated. The crude is certainly there, and the expected increases in production will be significant as a group of international majors ramp up extraction at already huge fields.

Unfortunately, the condition of infrastructure – processing and gathering facilities, pipelines, oil field services, water and associated gas injection systems, and the like – will limit the ability to bring significant new volume to market anytime soon.

The only way the combined IEA/SPR moves make any sense is as an attempt to deal with a market strain in advance of its onset. (The Washington decision also has a political element; but that it not a relevant matter in the case of the IEA.)

For us, this is a very useful “heads up.”

The investing environment for the next several months will be different from what we're used to.

Normally, the slowdown in car-driving at the end of the summer brings expectations of declining prices in North America. Not so this time around.

The market will be severely tested to provide sufficient supply, with spot shortages possible.

And that means additional opportunities to make some profits.



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  1. Gene Herring
    July 18th, 2011 at 11:47 | #1

    Is all the new production from shale areas foing to find a way to market this fall. CLR, SD, DVN and a lot of other oil producers are really getting into serious drilling in th Bakken, Eagle Ford, Permian and Williston Basin. When will this crude find it’s way to market?

  2. Advill
    July 18th, 2011 at 12:04 | #2

    The IEA decision is not related to consume, as you say is just a few hours of global consumption BUT…BUT has a big impact in the financial side, in the speculation and the traders living of perpetual instability in the market, all this is around of making a true fact that IEA can coordinate an action against them and create hugh losses in that speculative market if things runs out of control…as they always try to do.

    Is an advice to for producers the message is “it could be better if you decide to produce and ship your own product instead of being in speculative markets with it”

  3. jack gordon
    July 18th, 2011 at 12:25 | #3

    if high-octane gasoline is the need, syncrude from high-volatile illinois, west kentucky bituminous coal is the way to satisfy it.
    we knew that in 1985.
    but it takes 10 years to get an industry started.
    better start now, we have already wasted too much time.
    > jack

  4. Dale Kent
    July 18th, 2011 at 13:38 | #4

    Gene Herring :Is all the new production from shale areas foing to find a way to market this fall. CLR, SD, DVN and a lot of other oil producers are really getting into serious drilling in th Bakken, Eagle Ford, Permian and Williston Basin. When will this crude find it’s way to market?

  5. Jon Imler
    July 19th, 2011 at 16:37 | #5


    In the above article you make the statement: “Also, delays in major projects like the Kashagan Field off Kazakhstan (the largest find in the last 40 years). . .”. I thought the largest find during that period was the discovery Chariot Oil & Gas off the coast of Namibia. Am I wrong about that, and have you reviewed the Chariot discovery at all?

  6. Chuck S
    July 19th, 2011 at 22:29 | #6

    The release may have worked if oil prices were at the top of a speculator-assisted bubble, like in 2008. It could have dropped the price enough to get speculators to sell their futures contracts, which could have triggered more selling. If it had been done at the top of the recent prices, it may have worked. However, prices were already dropped. It would have been hard to time perfectly to zap the speculators. Much better to do what Bush did in 2008, end the executive dept ban on offshore drilling. Adding 1 or 2 million barrels/day permanently would have been much better. Of course, the congressional ban was still on, so the speculators didn’t have to worry.

    The amount of oil could have added1 million barrels/day for maybe 20 days, which seem like it could have reduced prices maybe $0.50 per gallon. Maybe the reduction we had was in anticipation of the release?

  7. crystal
    July 20th, 2011 at 17:40 | #7

    @Sue Martinez
    Some people mean just what they say…there are meanings hidden within…like a riddle….it is no coincedence that his name is ‘Advill’ as in headache medication…so…Riddle me this…

  8. crystal
    July 20th, 2011 at 17:50 | #8

    Sir, you have just coined a phrase! “production deficit bubble”…You are the first to see this and I feel priveleged to see it here first. Thank you for your insight. For me, this situation translates into choosing between buying food OR fuel…not both. Needless to say, I will be enlarging my garden, investing in a green house, hatching more chicks for fall and winter consumption and advising my neighbors to do the same. This will also translate into fewer trips to retail outlets, restaraunts and far less money spent on entertainment/recreation. We will be eating at home and watching videos/youtube, and patching our clothes as we watch one business both macro and micro, shut thier doors due to lack of revenue. Thank you again sir, as my family and I will now know the wolf is at the door but we will also be comfortable knowing that not only is our home build of brick but that it is also built upon THE ROCK. My hope is that others will hear the wisdom in your words.

  9. Mark H. Bongo
    July 23rd, 2011 at 02:51 | #9

    Could there be another options for consumption to be adhered by the terms of probable cost to the consumers in the rising faster Oil Prices?I guess it’s just an impact of the war and manipulation process to be a reason of Gas and Oil prices to rise….

  10. BlackSwan
    July 25th, 2011 at 22:54 | #10

    Everyone is assuming none of the Euro countries will default and the Euro won’t collapse. But if it does happen, people will flock to the U.S.$ which will send it higher, thereby lowering the price of oil. But Europeans will be paying much more for oil because of the falling Euro and they will likely cutback on energy consumption. If one European country defaults, it may cause others to do the same. Greece will default, it has to. The question is when.

  11. Bill
    August 1st, 2011 at 13:26 | #11

    Look for GREAT earnings out of XTXI this week. Also rummers of a MOBIL buy out.

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