Crude Oil Market Disconnect: A Problem Emerging

Last week crude oil prices bounced back above $70 a barrel before closing at $67.51, down $3.01 on Friday. As the chart of oil prices for the past six months shows, there has been a strong recovery this year, especially following the correction in July. Last week, oil prices closed above $70 on three of the five days, and on Friday the week before, they nearly reached $73 a barrel. This price action came in the face of continued government reports of crude oil inventories building and Frontline (FRO-NYSE), a large oil tanker operator, saying that the volume of crude oil in ships being used as storage had increased from 80 million to 100 million barrels.

During the week, the International Energy Agency (IEA) released its monthly oil report in which it boosted its forecast for oil demand by 150,000 barrels per day (b/d) for 2009 and 90,000 b/d for 2010. The IEA is now projecting global oil demand this year should average 83.94 million b/d. That estimate is close to the one recently issued by the U.S. Energy Information Administration (EIA) of 83.76 million b/d. The EIA’s recent estimate was reduced from its prior projection that was even closer to the latest IEA.

U.S. oil demand is estimated at about 18.7 million b/d currently, or more than 22% of total world consumption. Despite near record oil storage volumes, a sharp economic recovery boosting oil consumption or a faster decline in U.S. oil production could put further upward pressure on oil prices. Estimates are that U.S. oil production is declining at about 4% a year, despite the recent rise in oil drilling. That decline rate is below the IEA’s recent study of global oil fields showing the world’s annual oil production decline is 6.7% a year, up from its prior estimate of about 3.7%.

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