By Russell Clark of the Capital Flows and Asset Markets substack
The advent of shale oil production has transformed the US oil market.
As production of US oil has increased the net imports of oil into the US has fallen from 10m barrels a day to something like 3m barrels a day. Covid crash in oil prices seems to have stabilized the US market at current levels of production and imports.
As the largest net importer the oil until recently (China is larger now), and after the OPEC shocks of the 1970s, the US has kept a large inventory of oil. When we include natural gas and oil products the US is a net energy exporter, so there is probably less need for the US to keep oil inventory on hand. And in 2022, we have seen a historic drop in US oil inventory.
The US needed oil inventories to guard against OPEC suddenly cutting off supply, as Russia has done with natural gas in Europe this year. Now that US net imports of oil have dwindled, it is right that inventory should fall. When we look at US inventory of oil as days of net imports, between 200 and 100 days was the norm. we are currently at 400, so inventories falling by half from here could make sense.
Almost all of the recent fall in oil inventories has come from the government controlled Strategic Petroleum Reserve. Commercial inventories are still high relative to history, but I think that has more to do with increased production. Most commercial operators would hold inventory for processing and their operations. It seems to me very unlikely that a commercial business would take the risk of holding oil for speculative purposes. That is why governments are forced to hold strategic reserves.
Most of the fall in the SPR has happened this year. On January 1 this year there was 593m barrels in the SPR. The most recent data point is 423m barrels, or a fall of 170m barrels, or 600,000 barrels a day.
Where does this extra oil go? The oil released from reserves go to US refineries to turn into oil products. If we add up oil supply (production plus imports less exports) and compare to refinery output, and then smooth over a 3 month period, we can see how the run down in oil reserves has allows US refinery output to be much greater than supply.
So running down the SPR should be allowing the refiners to produce more gasoline and distillate, and hence rebuild the inventories of these products. The only problem is that neither gasoline or distillate inventory are showing any build.
My initial reaction to the collapse in the Strategic Petroleum Reserve was that it was a sensible reaction to the disruption of the oil supply due to Russia’s invasion of Ukraine. I then thought it was a political play by the Biden administration to get oil prices down before Midterms in November. Now, I think its a reaction to reduced oil supply by US producers. The SPR is being drawn down, but end consumers are using up the refined oil stocks. The implication is that US oil producers need to increase production, and will likely need to see higher oil prices.