Stefan’s weekly: A Case for Crude Oil

Dear Ladies and Gentlemen

Looking at the consensus forecasts for crude oil, it seems most analysts see price levels of between USD 55 – USD 60 for the years to come. Three reasons seem to convince most analysts of expecting stable to slightly lower crude oil prices. Reason number one is an assumption of almost endless supply of shale rock oil in the U.S., reason number two seems to be the assumption that OPEC members will go back to competing for market share and start flooding markets with cheap oil and reason number three is taking the assumption that alternative energy sources will lead to a decrease in global crude oil demand.

Ladies and Gentlemen, to me all three assumptions are rather boring and known to just about everyone in the market these days and they are lacking any sort of new thinking.

Fact is the global economy is growing and we found one analyst who builds his case for “triple digit oil prices” on the scenario of macro-economic growth especially macro-economic growth of heavily populated aspiring economies. I am fond of his idea. Let me try to elaborate the “why” in a reasonably concise way.

We all know from our own experiences that the global crude oil market may be very volatile. However, the global crude oil market has one very distinct characteristic, demand is very sticky almost no matter of where the price stands. This means that even if prices half as seen two years ago, consumption doesn’t jump up. Same is true for increasing price levels, i.e. even if prices for crude oil double, consumption is not really decreasing. Let’s have a look at the demand distribution, maybe we can draw a first conclusion from there. 56% of global crude oil consumption can be attributed to transport (trucks count for 24%, cars for 20% and 12% for other means of transport like marine and aviation). On a global scale this is very inelastic and even if Tesla sells many cars these days, the impact of electric cars will only be seen in decades. Another 28% of global crude oil consumption can be attributed to industrial usage. Again, I think we can agree that, on a global scale industrial demand will be rather inelastic. The next 5% of global crude oil consumption can be attributed to electric power generation. Inelastic, maybe even increasing I would think. Leaves us with some 11% for various use, which may be somewhat more elastic but even if this part of the cake increases or decreases by 20% it will not have any major impact.

Now, interestingly the same is true for the supply side. Supply is relatively inelastic. Even if we take U.S. shale oil production and potential increases by OPEC member states into the equation, relative to global consumption, global crude oil supply is reasonably stable. It appears in 2017 demand exceeded supply by roughly 0.7 million barrels per day, leading to lower inventories. According to PIRA (energy markets database) a hefty inventory increase is wanted and can be expected in 2018 and the beginning of 2019. The supply side is expected to increase only slightly but not enough to cope with regular consumption and demand for higher inventory levels.

This, Ladies and Gentlemen, is of course a very simplified explanation and maybe even speculation but gives you a somewhat different perspective of what might happen to crude oil prices in 2018.

What is your take on this?

Please share your thoughts and ideas with me. Please feel encouraged to do so and please send your messages to:

smk@incrementum.li

Many thanks, indeed!

And now, Ladies and Gentlemen I wish you a great day and weekend!

Yours truly,

Stefan M. Kremeth