Economic Research Publications
Quarterly Energy Update, Third Quarter 2010
September 28, 2010
Elevated Inventories Keep Prices in Check
The price of West Texas Intermediate oil (WTI) has fluctuated around $75 per barrel for the past five months. High inventories and expectations for slower economic growth worldwide have kept prices in check. The Energy Information Administration (EIA) recently lowered its oil price forecast for 2010 and 2011 to $77 and $82 per barrel, respectively. The EIA forecast is consistent with the futures curve, which expects prices will rise to $83 by December 2011 (Chart 1).
With oil prices relatively stable and U.S. inventories at their highest in over two decades, noncommercial traders have pared their net exposure to the lowest level in over a year, implying market participants are split evenly as to whether prices will rise or fall (Chart 2). Though the total number of long futures positions held relatively stable over the past quarter, the number of short positions increased to a record high, driving down traders’ net exposure.
Demand Remains Robust
Although the outlook for oil appears muted with long-dated futures prices fairly close to current prices, the outlook for demand is slightly more optimistic. In September, the International Energy Agency (IEA) revised upward its estimate for 2010 oil demand. Global consumption is now projected to rise 2.2 percent year-over-year. The increase is driven by non-OECD (Organization for Economic Cooperation and Development) demand, which is expected to grow by 4.4 percent, while OECD demand is only expected to increase 0.3 percent in 2010.
U.S. oil product demand is estimated to rebound after moderate declines in July and August (Chart 3). Distillate consumption is also poised to increase in September, which suggests healthy trucking activity.
Strong growth in China’s economy continues to push the country’s energy needs higher. Recent data indicate China’s oil consumption rose in August, partly driven by an uptick in industrial production (Chart 4). Year-to-date oil imports are up almost 17 percent over 2009 levels.
Supply Declines Slightly
Global oil supply fell slightly in August, primarily due to lower non-OPEC output. Over the past three months, supply has held relatively steady, increasing by about 0.5 million barrels per day since May. Most of the increase came from OPEC as compliance with quotas declined from 58 percent in May to 53 percent in August.
British Petroleum’s Macondo oil well was officially pronounced dead on Sept. 20, although the flow of oil was halted in mid-July by a containment cap. Debate continues over the drilling moratorium in the Gulf of Mexico and potential new regulations. The ultimate effect on Gulf production is uncertain, but the IEA estimates that lost production due to drilling delays will total 60,000 barrels per day in 2010 and 100,000 barrels per day in 2011.
Inventories at Elevated Levels
Both U.S. and OECD inventories are hovering at historically high levels (Chart 5). The build in U.S. inventories has been partly driven by sluggish consumption growth due to the temperate economic recovery and partly driven by the increase in oil-directed drilling activity seen recently (Chart 6). The dispersion of inventory within the U.S. merits attention as well. Petroleum Administration for Defense District (PADD) 2 inventories, where Cushing, Okla., is located, are 26 percent above the five-year average, while the next highest region, PADD 4, is only 11 percent above. The high levels at Cushing have driven down the spot price of WTI relative to other crudes.
According to the EIA, OECD industry stocks rose to 61.4 days of cover in July and are nearing the record last seen in 1998. OECD inventories, and to some extent U.S. inventories, could also have been impacted by the recent draws seen in floating storage. For instance, preliminary EIA data indicate OECD industry stocks rose 9 million barrels in August compared with a decline in floating storage of 18 million barrels. Hence, the increase in onshore industry stocks was more than offset by the decline in floating storage.
Natural Gas Prices Stay Low
Natural gas prices have been trending down since June and have hovered below $4 for most of September (Chart 7). Ample supply from shale gas and subdued industrial demand has restrained prices. Despite low prices, producers continue drilling in order to retain their leases. With the recent entry of large integrated oil firms into shale through acquisitions and joint ventures, continued drilling is likely, potentially keeping a lid on prices in the near future.
The relative strength of oil prices compared with natural gas has reduced the ratio of gas rigs to oil rigs. Today natural gas rigs make up only about 60 percent of the total rig count, down from a high of 89 percent in mid 2005.
Electricity Generation Showing Strength
Electricity generation increased sharply over the summer months as warm temperatures drove demand for air-conditioning and industrial production rose. Year-over-year generation was up over 5 percent in August (Chart 8).
—Jackson Thies and Mine Yücel
About the Authors
Thies is a senior research analyst and Yücel is a vice president and senior economist in the Research Department at the Federal Reserve Bank of Dallas.