Supply: Part I
The quantities of goods or services that sellers are willing and able to produce to provide value to the public is known as supply. As discussed in a recent post, demand seems to be waning. To find evidence of this, seeking out data that could reflect this reality would be the next step. Thinking logically, the inputs that determine how goods and services ultimately reach a demand destination would be a good place to start. Looking at the current market dynamics of a base item like crude oil would be ideal.
Disregarding crude oil’s cartel nexus, the price is a function of market demand versus market supply. That is, if producers are producing a certain number of barrels and the market is comfortable with that number, then there will exist a form of economic equilibrium in the market with those present conditions. That price equilibrium is dependent on the elasticity of supply. Elasticity determines how sensitive market prices are to sudden supply imbalances. This is relevant to a market such as crude at its very core for several reasons.
Crude oil is a pervasive commodity, as it and its derivatives permeate life every day in every way. Crude is used from the extraction of itself to the production of petroleum jelly (think Vaseline). It is used in the production of all chemicals, plastics and varied synthetic materials. Transportation that uses petroleum-based engines require petroleum derived fuels, such as JP-4 and gasoline.
In 2022, the USA used 3.2 billion barrels, or 135 billion gallons, of gasoline for wheeled transport. To put things in a different context, that is 8.8 million barrels of gasoline per day that were used in 2022, or 370 million gallons. What about aviation? That segment accounted for a total of 4,419,000 barrels, or 185 million gallons, consumed in 2022. From a daily consumption perspective, that is 12,106 barrels or 508,000 gallons a day.
Up to now, we have an idea of what demand was for one year. However, what about the supplied product to the market that was not sold? It is hard to get a gauge of that without collecting data and doing the analysis. When trying to comprehend the present market stance, gaining a hold of the past is key to market tone clarity. Therefore, it follows that a look at the gallon volume of purchases and the number of people flying is warranted to get a more comprehensive view of the supply versus demand picture, and this also normalizes the visible currency impact in headline data.
Given that commodity prices are sensitive to material and timely occurrences, analyzing market price dynamics over time is another way to gauge historical precedent in demand-supply imbalances. However, the goal is to get a comprehensive view to get a clear picture of what the producer side of the market is supplying versus what the demand side of the market is consuming, and how those metrics coalesce with market prices. The idea is to look at what the market is doing from as many facets as possible and connect those dots to make sense of present prices. Data always tells the story and how we analyze data leads to perspective. We will proceed to look at several data points from a high-level perspective to paint a picture.
Figure 1 shows a radial chart of the weekly U.S. ending stocks for crude oil, excluding the special petroleum reserve (SPR). The weekly crude stocks are the available market supply, and the SPR barrels are not for sale in the open market. This radial chart shows the last 10 years of data, and I would like to draw your attention to the recent increase in crude oil stocks, beginning in March 2022. While we are not close to the caliber of a non-functioning economy like that of 2020, the increase in stocks could potentially highlight a lack in relative demand. Per present monetary policy, we are supposed to be under some type of growth regime.
From August 2020 to March 2022, the demand for crude was strong and it shows in the data. Supply stocks went from 1.46 billion barrels available for sale, down to 1.14 billion barrels for sale. At the peak of supply stock levels in August 2020, crude oil prices were recovering from the volatile price action of earlier in the year and the price per barrel was near $24. At the trough of supply stock levels in March 2022, the price per barrel was near $109. On the way to the top of $109, the market comprehended that supplies were being depleted on top of the SPR narrative. I have written about that recently as well.
The idea is to capture the overall supply side trend to ascertain whether we have a build-up or draw-down. Therefore, the WRCB metric provides analytical value that the noise of daily data cannot for this analysis. As such, we can see the decline in supply and turnaround into a steep rise in the WRCB coincides with the start of, and eventual perpetual, build up in the supply stocks to date. Important to note that while the rates of change in the stocks of supply vary over time, the overall trend has been in one direction since the beginning of 2022.
Figure 3 provides the market price perspective to supply stocks. We are working with a price range peak of $120 with a trough area of $70. Leaning on the WRCB, we note that the market was about a month ahead of the peak in the WRCB in terms of direction. This goes into the notion of the market’s perception of what was happening with supply versus demand before and up to that point in time. Noting the orange line, WRoC, we can eyeball more orange above the respective zero-line than below it, from the price peak on forward. Therefore, it is fair to conjecture that the market dynamics were such that prices were at a disequilibrium with prices.
So far, we have somewhat of a clear view of the supply side of the crude oil price-equation with a week lag, but with some critical context. Comprehending how a market got to where it currently is, is just as important as determining impending direction. This is one way of the many on how to gauge a market’s price dynamics with respect to demand and supply. In the next post, we will dig further into the available data to get a coherent picture but from the demand side as detailed at the beginning. Thanks for reading.