Oil Supply Rising

March 16, 2010

 

As with natural gas [March Madness In Natural Gas], oil rig counts can give you some information about future supply coming online—although, as you can see above, they're not a perfect predictor of future prices. New non-OPEC rigs increased as oil prices rose in 2008, only to fall off dramatically as oil prices fell, while the number of OPEC rigs remained somewhat steadier over 2008, with 2009 witnessing decreasing rig counts.

That's what makes this latest jump in rig counts so unusual: More rigs mean more supply—but where will that supply go?

 

Where's The Demand?

Certainly not to developed markets. Even without any new policy mandates or increased alternative energy usage, demand stateside is forecasted to drop each year by 0.7 percent until 2030, according to the International Energy Agency. In European countries, demand is expected to drop 0.4 percent each year.

Instead, it's our good friend China where the IEA expects to see the most demand growth, to the tune of 3.3 percent per year.

Still, as a whole, the market seems a lot less concerned with supply right now. Compare today's futures curve with what we saw in mid-December last year:

 

WTI Curve

 

Clearly the current futures curve has flattened quite a bit, indicating that contango has eased off; the market is getting comfortable with the idea of how much future supply will be available. (Remember: Contango occurs when a futures contract is more expensive in the future than it is today.)

A flatter futures curve could have an interesting effect on supply. During steep contango, you can make money by purchasing oil now, storing it and selling your futures contracts on the oil six or eight months out, locking in guaranteed profit, provided you can recoup your storage costs (and you have a spare oil tanker moored somewhere). But when the contango lessens, the oil stored in this manner could start to flow out of storage and back into the market, as the profit margin for storing that oil narrows. The result? Even more supply on the market.

While I'm not saying oil prices are going to tank anytime in the near future, the supply/demand picture does suggest things may end up being a little less volatile for a while—as long as no one does anything rash.

 

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