Oil supply/demand by the numbers

The difference between a cartel and a free market is that in a free market the high cost producer modulates supply by varying his production in response to price while in a cartel all members (in theory) vary production irrespective of cost. How this worked in the case of OPEC is that the low cost producer, Saudi Arabia, alone varied its production in response to price while the high cost producers always produced at capacity. 

The oil market has now flipped from a cartel to a free market. Price will be determined by the costs of the high-cost producer; oil will be priced at the cost of the highest cost producer whose production is needed to meet demand. Lower cost producers will produce at full capacity at all times.

So now that we are in a world where the high cost, not the low cost producers will have to adjust production to bring the market into equilibrium, let's consider the numbers of the high cost producers.

• The EIA says that excess production is about 1.5 million per day. Iran will add another 500,000-1,000,000 BPD in 2016
• The high cost producer is the Canadian oil sands, producing about 2.5 mn BPD.
• The next highest cost producer is the US shale oil industry, producing about 4.0 mn BPD.
• The marginal cash cost of producing WCS (West Canadian Select) is about $27/barrel (according to Suncor). (TD Securities says all-in breakeven averages $44.) This oil sells for $15/barrel today. (Producers have hedged to some unknown degree, however.)
• Already shale oil production is declining at a monthly rate of 100,000 BPD, so the reduction in the daily rate will be at least 1.2 mn BPD by year-end due to the lack of drilling.
• I don't know how fast Canadian production is declining, but since hedged producers can cash out of their hedges at any time and shut down, it could be precipitous or gradual depending on their expectations of future oil prices. (They move slowly because it is difficult and expensive to stop and restart production.)
• Demand ought to rise by 1.5 mn BPD by year end.
• Given the Canadian cost structure, I am guessing the equilibrium price is somewhere around $50/barrel.
• Conclusion: Assuming Saudi Arabia, Iran, Russia, et al continue producing as much as the can, the production trends are already in place that will bring the market back to equilibrium, perhaps by the end of this year. In the meantime, the price will be volatile.

Another comment on Iran and oil supply/demand

World oil consumption is 95 million barrels/day.

According to Vessels Value of the UK, Iran has 25 VLCCs with 56 million barrels. (This is at the high end of various estimates.) This is under one day's world consumption. It is important on the margin, but not decisive. 

 The important thing is how fast will the high cost producers (Canadian oil sands and US shale oil, which together produce about 6.5 million barrels/day) reduce their production. Canada is losing $15/barrel in marginal cash cost at $30/barrel WTI. (WCS, the Canadian benchmark, gets a $15 discount to WTI and costs just under $30/barrel to produce.) If these prices persist their 2.5 mn BPD will go quickly.

 

Iran's floating oil reservoir: Less than one day of world demand

World oil demand is about 95 million barrels of oil/day.  According to Vessels Value of the UK, Iran has a floating inventory of less than one day's consumption.  It is significant on the margin, but it is not overwhelming.

The myth of declining oil demand

You all understand well, perhaps better than I, the oil supply/demand issue, but since there has been some loose talk among the attractive people with nice voices on Bloomberg and Fox Business about "collapsing" oil demand, I could not resist the urge to comment.

As the chart below shows, world demand each quarter has consistently exceeded demand in the same quarter of the previous year. Demand continues to grow along its accustomed trajectory. It's almost like a law of nature. The problem, then, is supply.

And we are not talking about a lot of excess supply. What we have is a small amount of excess supply persisting consistently over time. If, for example, one left the faucet dripping and the sink were plugged, then the drips would, in time, flood the house. So the oil market is being flooded in a sort of Chinese water torture.

In this case, however, supply will have to keep increasing to maintain an oversupply, because demand keeps growing. In the second chart below, you can see the biggest oversupply was in the second quarter of 2015. Nonetheless, demand in that quarter was still greater than supply in the corresponding quarter of the previous year.

This is an interesting and important time. For the first time since OPEC was formed in the 1960s were are seeing a free market in oil. In a free market, the high cost producers drop out as the price drops and equilibrium is maintained. In the cartel world, this was upside down. The low cost producer used to drop its production to maintain the production of higher cost producers. It will take some time to find the equilibrium price because the low cost producer is now going all out many high cost producers still have a low marginal cost, but equilibrium will eventually appear. In the meantime, the price can go anywhere.

Sanders' Medical plan would extend Medicare to cover everyone

Bernie Sanders has issued a brief "white paper" giving his plan for national medical insurance.  He would simply extend Medicare to everyone and add coverage for vision, dental, and nursing home care.  (You may click on Bernie's picture to access the white paper.)

Medical insurance costs for the average family would drop 90% to a maximum of $466/family. 

The simplicity of the program should result in some cost savings.  (He estimates $600 billion a year in savings out of the  $3000 billion currently spent annually.)  Half of the cost of the program would be paid by taxes on workers and their employers and half by soaking the rich through higher income taxes, estate taxes and taxes on investment.

We may argue about how to pay for the plan, but it has the benefits of simplicity and extending coverage to nursing homes.  This would, on the surface, appear good for seniors.  Let's hope some of the mainstream candidates picks up on the best of these ideas while eliminating the eccentricities.

Dollar bubble: Trade-weighted US dollar will peak as China devalues

When the dollar eventually turns down, capital will exit the currency.  The trigger will likely be either 1. Indication by the Fed that further tightening is unlikely; or, 2. Significant drop of the Renminbi.

US mortgage applications are up 25% year-over-year

This week one of my daughters and her husband are taking out a 30-year mortgage. I guess they are not alone:

This ought to have a positive effect on consumer spending, all other things being equal.