Off On A Tangent

This past week’s oil inventory report was quite strange. It reported an 8.8 million barrel decline in commercial crude oil inventories. That’s a huge drop, especially at this time of year. Inventories of both crude and gasoline are at or near the bottom of the 5-year average range. Just a month-and-a-half ago, gasoline supplies were far above the top of the average range. That’s what happens when the price of gas is so cheap compared to the price of a barrel of oil that refineries don’t work too hard to produce extra gas - there’s no profit in doing so.

But what made the report especially strange is that it included an “explanation” for the 8.8 mb drop in supply: that ships were delayed in offloading supplies in the gulf [of Mexico] ports. All the analysts are citing fog as the reason for the delays. However, there has been no fog in the region in the past week, so it’s a bit of a head-scratcher. On top of that, after the report came out, oil first shot up $3, but ended the day down over $4. I can’t quite figure that, but I suspect a lot of traders are trading on hope - hope that there really was plenty of oil imported and that it was just delayed and hope that therefore next week’s inventory report will show a monster build to make up for it. A build of over 10 million barrels or something like that. Trading on hope - not a good idea.

But more troubling:

Here are the last four weeks of crude oil imports into the Gulf Coast:

6.683 mbpd
6.130
5.173
4.996

(link)

The problem being Mexico and Venezuela primarily, but Nigeria also. This is the net exports problem, explained in the Export Land Model. Mexico’s production is falling off a cliff - 24% in the past year. Exacerbating the problem is that every country that produces oil also consumes oil. And each year most countries consume more than they did the previous year. So, a country like Mexico, where oil production is falling and internal consumption is rising, the remainder left over for oil exports (called “net exports”) becomes less and less at an accelerating rate. Mexico looks to cease being an oil exporter in the 2012-2014 time frame. Canada, often cited as a place where oil production is growing (and it is), is also experiencing declining net exports. Saudi Arabia, often cited as the one place left in the world with excess capacity, is also experiencing declining net exports. Saudi’s oil production ticked up slightly in Jan and Feb this year, but their exports have fallen year-over-year. The problem of declining exports began in 2004, but it may now be poised for a big jump in effect. At some point, it’s likely that exports will “fall off a cliff”, as they say. That point may be right now.

Certainly the problems in Nigeria aren’t helping matters with nearly the entire country’s production shut in by violence for a couple weeks, and even now they are still down a few hundred thousand barrels per day. But Mexico and Venezuela are the real problems right now:

The 2007 Annual Net Export Decline Rates for Mexico & Venezuela (EIA) are as follows, and the recent monthly data don’t look any better.

Mexico: -16%/year
Venezuela: -7.6%/year

(link)

To make matters worse, gasoline hasn’t gone high enough in price yet. Wholesale gas is at $3.40, which translates to about $4.05 in retail gas once it works its way through the system. But, at $3.40, refiners aren’t making much money with oil trading above $120. Therefore, their utilization rates have been very low this year, and in about 45 days, we’ve gone from very high gasoline stocks, to pretty low stocks. Traditionally, refinery utilization at this time of year would be 91-92% in order to keep up with summer demand. The highest it’s been so far is 87.9%. It needs to go higher, or there will be shortages of gas. If it goes higher, it will only be because the price of gas went high enough to warrant the increased costs of overtime, maintenance, etc that such high utilization rates entail. So therefore, if oil stays high, I think we’d see gas go over $4.50 by the end of summer. Possibly $5.

But, crude stocks are also low. This was not the case last year when gas stocks went dangerously low - then, crude stocks were pretty high. If we’re having a net-exports-falling-off-a-cliff problem right now, that’s going to throw all estimates out the window. It will take many weeks to find other exporters to replace Mexico and Venezuelan oil as they are relatively nearby countries. If we have to get more oil from Saudi Arabia than we do now, it will take a while for the extra tankers to get here. And we’ll have to outbid China and India for that oil. In the meantime, we’d probably have to make withdrawals of oil from the SPR (strategic petroleum reserve) to avoid shut-downs of refineries, pipelines, and gas shortages. All this would send the price of oil and gas into a pretty severe spike - maybe up to $180 in a matter of a week or two. Gasoline to $6-7.

And, even after the immediate crisis was over, oil would probably remain above $140 due to the need to outbid others for the oil we’d no longer be getting from Mexico and Venezuela - and there’s no end to the decline in net exports. Soon, these countries stop exporting, and then, they start wanting to import oil. I say “wanting”, because I don’t think Mexico will ever be able to afford to import a drop of oil. Mexican civil war of some sort is probably happening relatively soon (ie, within 10 years).

If it happens like this, we’ll end up with gas at $5+ at the end of summer and only headed upwards from there. The crisis of peak oil could be starting - may have started with this latest odd inventory report. We’ll know within 3 weeks either way, I think. If the things I describe above haven’t started happening by then, then it’s a false alarm.

Happy Hurricane Season!