Oil Market Fundamentals Haven’t Been This Strong in Years
2018 has so far brought in the highest price of crude oil since late 2014 (chart 1), but we shouldn’t be surprised by the price action. Indeed, ignoring geopolitics for a moment, the fundamental picture for the crude markets haven’t been this favorable in years. As we will see, from inventory levels, to the US dollar, to economic growth, to the setup in the futures markets, most signs are pointing to higher oil prices ahead.
One of the main drivers of oil prices is the relationship between production, consumption and inventory levels. As chart 2 shows, crude production in the US has recovered to mid-2016 highs, which in and of itself would be bearish for crude prices. But, the total inventory of crude has been falling over that period and now stands at the lowest level in 2.5 years. Chart three depicts total crude inventories (ex the strategic petroleum reserve) plotted with the blue line on the left, inverted axis, overlaid on the price of oil on the right axis (red line). Furthermore, oil consumption has remained strong too. The combination of lower stocks and growing demand has caused the days supply of oil to drop from 34 a year ago to just 25 now. Chart four shows the price of crude on the left axis (blue line) overlaid on the days supply of oil on the right, inverted axis (red line). These two series are highly inversely correlated, so a contracting days supply should result in higher prices. As we will see later, a continuation of this trend is likely.