U.S. petroleum inventories are depleting to critically low levels as output fails to keep pace with the rapid rebound in consumption after the pandemic, putting intense upward pressure on oil prices.
Petroleum inventories were depleting at an unsustainable rate even before Russia’s invasion of Ukraine and the disruption of Russia’s petroleum exports in response.
U.S. inventories of crude oil and refined products outside the strategic petroleum reserve have fallen in 63 out of the last 88 weeks according to data from the Energy Information Administration (EIA).
Commercial stocks have depleted by a total of 315 million barrels since the middle of 2020, more than offsetting the 204 million barrels accumulated during the first wave of the pandemic and lockdowns.
Inventories are now 99 million barrels (8%) below the pre-pandemic five-year seasonal average for 2015-2019 and at the lowest seasonally for seven years (“Weekly petroleum status report”, EIA, March 9).
Gasoline stocks are close to normal but stocks of crude are 51 million barrels (11%) and distillate stocks are 30 million barrels (21%) below the pre-pandemic five-year seasonal average.
Distillate consumption is closely correlated with the business cycle because distillate fuel oil is used primarily as diesel in freight transportation, manufacturing, farming, mining and oil and gas extraction.
Distillate is also a near-substitute for jet fuel so the inventory situation is affected by changes in aviation especially long-haul passenger and cargo flying.
Distillate stocks have fallen to just 114 million barrels, compared with a five-year pre-pandemic average of 144 million, and the lowest for the time of year for more than 15 years.
Stocks are on course to hit an expected low of just 103 million barrels before the middle of the year, with a possible range of 92-114 million barrels ().
That would put stocks below the previous low in the first half of 2008, when a shortage of distillate contributed to the spike in Brent crude prices to a record high of $147 per barrel.
The oil market was already overheating before the conflict between Russia and Ukraine escalated and Russia’s crude and fuel exports were disrupted.
The combination of sluggish growth in production, rapid growth in consumption and now sanctions has created the classic conditions for a spike in prices.
The confluence of a medium-term structural shortage and a sudden short-term interruption of supplies is comparable to the Arab oil embargo in 1973/74 and Iranian revolution in 1979/80.
In the futures market, six-month calendar spreads for Brent and European gas oil are trading in record backwardations as traders anticipate an acute shortage of crude and distillates.
The most remarkable thing is not how high prices are at the moment but that they have not already spiked much higher.
In real terms, Brent prices are the highest since September 2014, but they are still only in the 85th percentile for all months since 1990.
Brent’s current front-month price of $116 per barrel is still well-below its inflation-adjusted peak of more than $190 in July 2008.
U.S. gasoline prices at the pump average $4.20 per gallon but that is still far below the real peak of $6.13 per gallon in 2008 once changes in the hourly wages of typical workers are taken into account.
But the market is now in the tightest condition for decades and it would take only one more supply interruption or unexpectedly strong demand to send prices surging higher.
If a severe spike in prices is to be averted, inventories in the United States and around the world will have to be rebuilt to more comfortable levels.
Production will have to grow faster, consumption must grow slower, implying a downturn in the business cycle, and a major disruption of oil supplies must be avoided.
The alternative is another oil shock like 1973/74, 1979/80 and 2007/08, when extreme high prices, demand destruction and recession forced the market back to balance.
John Kemp is a Reuters market analyst. The views expressed are his own.