The COVID-19 Shock and the Curious Case of Missing Barrels
In almost every oil cycle, the market is confronted with the problem of ‘missing barrels’, the gap between the change in inventory implied by global supply-demand balances on the one hand and the observed change in inventory levels by commercial and government entities (adjusted for floating storage and oil in transit) on the other hand. Based on IEA global oil balances, the surplus in the first half of 2020 reaching a record level of 7.6 mb/d. Out of the total stockbuild in the first half of the year, total OECD stocks accounted for 344.3 mbbls or 25% of the total increase, floating storage and oil in transit accounted for 105.3 mbbls or 8% of the total increase and the remaining 940.4 mbbls or 68% of the total increase to balance is essentially unaccounted for including changes in non-reported stocks in OECD and non-OECD areas. The volume of missing barrels in H1 2020, is the largest ever recorded gap between observed and implied stocks since at least 1990, being three times larger than previous historical downcycles such as in H1 1998 and more recently the H2 2018 downturn and nearly 10 times larger than the imbalance of H2 2008 in the aftermath of the global financial crisis.
The issue of missing barrels is not incidental. Given the severity of the oil shock in 2020, the focus has been on supply-demand balances. But once the dust settles, the focus will shift to the size of available stocks and OPEC+ efforts in drawing down these stocks to ‘reasonable’ levels. If the missing barrels are ‘artificial’, the result of imprecise measuring of supply and demand, then the buffers in the system are thinner than currently estimated and OPEC+ task in reducing stocks is less of a challenge. If the missing barrels are ‘real’, then most of these barrels are to be found in non-OECD particularly in China given its large storage capacity. This may reveal the fact that while Chinese demand has been strong, the country’s high level of imports reflects mainly stockpiling and stocks are already at an elevated level and thus crude import flows may ease representing a bearish factor. We argue that large accumulation of barrels has occurred in China which suggests that ‘artificial’ or ‘imaginary’ barrels, as a result of imprecise measurement of global oil supply-demand balances, are not the only explanation to the missing barrels question. Indeed, even though China’s crude balances are riddled with inconsistencies, the country has amassed large volumes of crude this year which have contributed both to the country’s strategic reserves and commercial forward cover. At the same time, Chinese demand may well be underestimated given refiners’ tax avoidance practices.
The complexities of global crude balances highlight the ongoing challenges facing OPEC+ in estimating how long it will take to rebalance the market. Going forward, can OPEC+ afford ignoring non-OECD stocks? But if these stocks are being stored for strategic purposes and the bulk of these stocks will not be released back into the market, does targeting non-OECD stocks really matter for oil policy purposes? Should we exclude years of elevated stocks from the averages or have these become main features of the new cycles and the adjustment process? As we go into 2021, these questions will become more pressing.