The amount of oil in storage is concerning and may lead to sharp decline in oil prices

Combined with oversupply, the situation is risky

IEA and other estimates put the amount of oil in storage worldwide at about 5 billion barrels. With world consumption of ~100 million barrels a day, oil in storage comprises about a fifty day supply. In an article published in 2020, the New York Times reported that the world was running out of places to store its oil.

A lot of money is tied up in the oil held in storage - at US$70 per barrel, about US$3.5 trillion.

World oil demand is growing but capacity to produce oil is growing even faster. IEA expects demand to grow over 1 million barrels a day for the next few years which oil bulls hope will bring the market into balance without the need for “shut in” production. That seems wishful.

OPEC and others are keeping about 5 million barrels of oil a day “shut in” to support oil prices. That spare capacity seems likely to rise as non-OPEC producers like Guyana, Canada and Brazil expand their output and total world production capacity grows faster than demand.

At some point, artificial attempts to maintain price through agreements by the OPEC cartel and its aligned supporters (who make up OPEC +) may fall apart. Suppliers like Iran, Venezuela and Brazil may prefer to keep increasing output to support their fragile economies and a “market share” war emerge. Donald Trump, the front runner for the November 2024 election, promises policies he calls “drill, baby drill” to promote domestic U.S. production and lower oil prices to quell inflation. The U.S. can add production quite quickly if unshackled from Democrat “anti-oil” policies. The result could see over supply occur quite quickly following November.

The last time OPEC saw a risk that U.S. production could take market share from the cartel in parallel with Russia refusing to curb output, Saudi Arabia led an effort to ship more oil and drive down prices “to teach Russia a lesson” and oil prices dropped dramatically. Brent crude fell to US$20 and WTI prices even went negative in the middle of 2020 when the fight for share was exacerbated by lockdowns during the pandemic.

I don’t see the same confluence of factors resulting in such a dramatic fall in world oil prices at this point, but I do see a risk that oversupply might prompt those with billions tied up in oil in storage to decide to sell down their inventory to prevent massive losses. The table is set for a much lower oil price environment in 2025 in my opinion.

Offsetting the dilemma described above, lower oil prices will ease inflation and stimulate more economic activity while oil companies will cut capital spending as they pull oil out of storage. Energy costs rose to a record 13.5% of global GDP in 2022, more than double 2021, making energy the major contributor to inflation worldwide. A drop in oil prices will likewise lower inflation, which will see central banks reduce policy rates and stimulate economies globally. Renewed growth will manifest itself in higher energy demand.

Over time, the market will re-balance itself. But in the interim, many leveraged oil companies will suffer investor malaise and stock prices can fall significantly.

This is a time for caution in the energy sector. A sell-off in oil company shares will present opportunity for rationale investors who have kept a cash balance and avoided buying on margin.