The Strange Case of the Missing Barrels

At the time of writing, oil prices are testing lows last seen (in nominal terms) in 1973, with the severity of the 1998 oil price crisis now greater than that of 1986. The speed of adjustment in oil markets, and the sharp price changes occasioned by each new piece of information that hits the news screens, gives the impression of highly tuned markets that make minute adjustments as their certainties on the fundamentals of supply and demand change. That is however a misleading impression, and the complexity and technology of modern markets masks a far less precise reality.

The truth is that we observe the fundamentals of the oil market with very little precision. The market may react strongly to news of minor quantity changes, but its ignorance on much more important quantities is profound. Demand is observed imprecisely and with huge lags, for example at the end of 1998 the International Energy Agency (IEA) is still making revisions to its demand estimates for 1996. Supply is also observed imprecisely, particularly from OPEC members. Information on OPEC supply comes from the assessments of journalists, and the basis for those assessments is tainted by the highly political nature of supply. At times in recent years the journalists have been overestimating OPEC supply by as much as 1 mb/d (million barrels per day). The error is not their fault, because in good faith they are reporting the information they have been given informally by the industry, but all too often that information has been deliberately designed to mislead. In sum, at any one point of time there is a huge margin for uncertainty on both the supply side and the demand side. Given that we have no precise idea of where the fundamentals are at any present, it is not surprising that predicting the future becomes akin to necromancy.

Such is the margin of error involved that the divergence between current estimates of supply and demand can be huge. Such has been the case in 1998. For example, for the first quarter of 1998 the latest (December 1998) estimates from the IEA’s Monthly Oil Market Report show supply exceeding demand by 1.6 mb/d. Reported inventories in OECD countries actually fell slightly over the quarter, leaving 1.7 million missing barrels per day. Part of this, (0.2 mb/d), is put down to an increase in oil in transit, cutting the unexplained element to the still massive level of 1.5 mb/d. Part of this may be stock changes in non-OECD areas, although the fluctuations here tend not be large, and it is unlikely that there would be a significant rise outside the OECD at the same time as a fall in the OECD. In fact, early in the year Asian oil companies were selling inventories to raise cash, so we can probably ascribe none of the missing barrels to a non-OECD stockbuild. Those missing barrels are almost certainly comprised of firstly an underestimation of world oil demand, and secondly an overestimation of OPEC supply. Nearly nine months after the first quarter finished, those barrels are still unaccounted for, adding up over the quarter to a total of some 135 million barrels. To add to the missing barrels there are still, some eighteen months later, a total of 110 million barrels unexplained from the second quarter of 1997, and 100 million barrels from the second quarter of 1998. In just the first half of 1998 we then have 235 million barrels unexplained, a dramatic sign of the fog in which the oil markets actually operate.

The missing barrels on which the market has focussed are of another variety. The concentration has been on those barrels of Asian demand that were predicted, but that failed to materialise in the depths of economic chaos. The contention has been that the problems of the Asian tigers have been the primary cause of the 1998 oil price crisis. Well, yes and no. Of course the market would have been healthier had Asia continued to grow. However, there has still been demand growth in non-OECD Asia including China. While (according to the December 1998 IEA numbers) it has only been 0.1 mb/d, we would suspect that some of the year’s missing barrels have been due to some under-reporting of Asian demand. This demand growth as reported, falls short of what were the expectations at the end of 1997 by about 0.7 mb/d. However, (also compared with the IEA projections at the end of 1997), non-OPEC supply has only increased by 0.2 mb/d in 1998, falling short of expectations by 0.6 mb/d. So the barrels of unexpectedly lost Asian tiger demand are almost exactly matched by non-OPEC supply that was predicted but failed to materialise.

This is not a demand side crisis. The fall against projections of non-OECD Asian tiger demand, even when augmented by the falls in demand in the OECD members Japan and Korea, are dwarfed by the increase in supply from Iraq alone, even before the increase from other OPEC members is added. As noted above, non-OECD Asian tiger demand has risen slightly this year. A rise in demand does not cause a fall in prices. Prices have been driven down by rising supply, and hence 1998 is as much of an OPEC determined crisis as 1986 was. The missing barrels of Asian demand are a useful scapegoat and easy explanation, but they are not the primary driver of this story.

By: Paul Horsnell