Demand is Surging, Pointing to Higher Oil Prices Ahead

As the oil markets continue to focus on the supply side and the possibility of reaching a nuclear deal in Iran grows, something else has been developing in crude.

Worldwide demand is beginning to surge.

OPEC has raised its global demand estimate again for the third time this year and the International Energy Agency (IEA) in Paris will shortly follow suit.

As expected, regions of the world other than North America or Western Europe are leading the charge.

As I’ve discussed before, more and more demand is moving to Asia.

And given the latest downturn in oil prices, demand for crude is accelerating…

Demand is Rising Faster than Expected

Now, it’s true: The demand forecasts are all over the map, and in some cases quite literally so. But the rise in demand is genuine and will continue into 2015.

Much of this surge is driven by pent-up needs from developing industrialization and economic diversification. Some is the result of changing energy trading patterns, and a fair amount is from the simple dynamic that markets use more energy as the price declines.

Either way, there’s only one conclusion. Demand is absorbing inventory much more quickly than anticipated.

This has led a few to suggest that the inventory figures regarded by most commentators as almost sacrosanct may be much softer than originally thought.

Then, with the newly announced framework, there’s the prospect of an accord with Iran, which has depressed oil prices as well.

The logic seems simple enough. If you release Iran from Western sanctions, the Iranians will flood the market with crude, driving down prices in the process.

However, as I noted two weeks ago, even a broad-based accord with Tehran won’t have much of an immediate impact on oil prices. Any rollback of the sanctions will occur in stages and will require verification at each juncture. So there will need to be a very protracted process set in motion before any sanctions are lifted and even one additional drop of Iranian oil makes it to market.

Of course, that hasn’t stopped the talking heads on TV. In fact, one of them recently claimed that the 20 million barrels of Iranian oil stored in tankers offshore “could hit the market pretty quickly.”

The reality is something very different.

The volume is stored in single-hulled Iranian vessels that are not licensed or equipped for transoceanic transport. This volume would require several things before it could be delivered, including transfer to internationally licensed tankers, end-user contracts, pre-transport hard currency finance, and insurance. None of these can take place while sanctions are still in force, and those restrictions will not be lifted up front.

Once again, like the inventory figures, much ado about nothing.

U.S. Output Drops for the First Time in Two Months

But the pundits will grasp onto anything in pursuit of the 30-second explanation for what is happening in the oil market.

Take Wednesday, for example.

U.S. crude inventory increased (again) by almost 5 million barrels for the week ending March 27, marking the 13th consecutive week that inventories hit at all-time highs.

So what did the market do?

Oil prices were up by 5%, breaking the $50 a barrel mark for West Texas Intermediate (WTI). Meanwhile, Brent – the London benchmark more widely used in global oil trade – tested $57 a barrel before settling in at $56.72, climbing 2.7% for the day.

As a result, two matters are becoming pretty clear.

First, there is a new floor for oil prices, and it is higher than it has been over the past six months or so. Second, a matter I’ve been discussing for some time is finally catching the attention of the broader markets.

Given the decline curve in the unconventional oil wells that have been developed over the past 18 months, there now is near-term factor causing downward pressure on overall U.S. production levels.

Remember, there is still plenty of readily available reserves that can be tapped to supplement the volume figures. So any decline in production won’t trigger a mad dash back to $100 a barrel.

But a leveling off of aggregate production will cause a slow rise in average oil prices.

While the amount in storage continues to go up, weekly American aggregate production actually went down for the first time this year.

Admittedly, it went down by barely 200,000 barrels week-on-week to 9.2 million. But it’s still the first drop in production for some time.

Given that we are, by my best estimates, more than three months away from when the genuine production decline will hit (July-September), this week’s modest dip may be a very early tremor or simply an outlier.

Yet the attention is finally focusing on the decline in U.S. production, no matter how small.

And with demand showing signs of another surge forward, it’s shaping up to be a very profitable spring and summer.

What goes down always comes back up, especially when it comes to energy.

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