Given the extremely rapid movements in the price of oil (NYSEARCA:USO), and the confusing and contradictory commentary surrounding the issue, I felt it best to resort to my own analysis. Using publicly available data, I created a simple chart, which I would like to share with readers.
Days Supply Outstanding
The US Energy Information Administration, or EIA, is a good source of information. Using quarterly data from Q1 2000 to Q3 2014, I compared World Consumption to World Production, and accumulated the difference in a variable labeled barrels outstanding. From there, dividing by the daily consumption rate, I arrived at Days Supply Outstanding. It was necessary to seed the data with a starting supply in barrels. I used 12 billion, for the fact that as an initial value it gave the best correlation between Days Supply Outstanding and the 90 days subsequent spot price of WTI over the 14 years of data under consideration. The correlation was -87.27%.
The correlation was not very sensitive to this assumption: 7 billion yielded a -86.27% correlation, while 20 billion was -86.28%.
WTI Spot Price adjusted for Inflation
I got the data on WTI from the EIA and on inflation from the St. Louis Fed website, which has a graphing facility and permits users to download the data. Combining the two sets, I developed an inflation adjusted price history.
Developing a Formula
The resulting data were then charted as shown, and the software produced a formula for the linear regression. R2 at 85% is impressive. I held out three outliers: the 2nd and 3rd quarters of 2008, and the current price. If these points had been left in, R2 would still be very acceptable at 83%.
Eyeballing the chart, the current price is just as much an outlier as what prevailed back in 2008, but in the other direction. The point is, the price is not behaving as it usually does. It normally varies in a fairly predictable manner, driven by Days Supply Outstanding. Based on past history, it should self-correct within 90 to 180 days.
The Magic Number
The EIA projects World Production and Consumption out through the end of 2015. While one or the other may lead for a quarter or two, over any substantial period of time they are in sync. Here’s a chart:
The linear regressions run exactly parallel, although there are substantial short-term discrepancies. No such imbalance is visible at the present time.
Getting back to the first chart, if the linear regression formula is applied to EIA projections for the 1st quarter of 2015, the indicated average spot price of WTI is $101.93, round it down to $100.
As a retail investor, I don’t give advice. I enjoy posting my opinions, and participating in the comment stream. From time to time, I like to take some fairly simple data and push it to its limits, particularly when the results run contrary to popular opinion and the wisdom of industry pundits.
I’m long Exxon (NYSE:XOM), Occidental (NYSE:OXY) and Carbo Ceramics (NYSE:CRR). I regard the current price of oil as driven by speculation, and will not reduce my positions until the evidence shows otherwise.
Loose Ends – Futures, Options and SPRs
While the descriptive power of the data as treated is excellent, the estimate of barrels outstanding, meaning produced but not yet consumed, finished the period at around 12.6 billion, only slightly above the initial value. That’s substantially greater than the amount of reported commercial storage, which is approximately 3.7 billion. Global SPRs (Strategic Petroleum Reserves) total an estimated 4.1 billion barrels, according to the EIA. While we may assume that there is more in transit, or sitting unconsumed in the form of final products such as gasoline or heating oil, there is still a substantial gap.
Futures may provide a partial answer. The oil they reference is “notional,” and has no necessary logical connection to the amount of physical oil in existence. But the market behaves as if it were real.
I was able to locate an EIA document that addresses open interest on exchanges, with the cautionary comment that the bulk of such positions are traded OTC. Here’s a chart:
With approximately 1,600 thousand contracts outstanding on exchanges at the moment, at 1,000 barrels each, they equate to 1.6 billion barrels, or perhaps twice that, since every position has a long and a short side, both of whom have a stake in some of this notional oil.
Adding in OTC contracts and options, the gap can be closed further. While futures and options open the door for manipulation, it would appear from this analysis that they smooth out price fluctuations, since the market acts as if there were more Days Supply Outstanding than can be explained by the existence of physical oil.
It’s tempting to try and work this notional or phantom oil into my equation. On the other hand, the equation accurately describes past price behavior without further modification. No doubt George Soros could do something with his theory of reflexivity. As for me, I’ll wait patiently for $100 oil.
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