My article Surprising Facts About Oil Prices (And The Questions They Raise) was published last week. In it, I mentioned that “the price of oil has experienced at least five major crashes over the past four decades despite demand for the commodity being higher than supply in every year.” When Vision Capital’s Eugene Ng – who’s a friend of both Jeremy and myself – read it, he was intrigued by what I discovered about oil prices and wanted to find out more.
Eugene noticed that the U.S. Energy Information Administration (EIA) maintained its own database for long-term global oil consumption and production. After plotting a chart of EIA’s data, he obtained similar results to what I got from BP (NYSE: BP) (the BP data was shown in my aforementioned article). Eugene and I talked about this and he decided to ask the EIA how it is possible for oil consumption to outweigh production for decades.
The EIA kindly responded to Eugene, who shared the answers with me. It turns out that there could be errors within EIA’s data. The possible sources of errors come from incomplete accounting of Transfers and Backflows in oil balances:
- Transfers include the direct and indirect conversion of coal and natural gas to petroleum.
- Backflows refer to double-counting of oil-streams in consumption. Backflows can happen if the data collection process does not properly account for recycled streams.
The EIA also gave an example of how a Backflow could happen with the fuel additive, MTBE or methyl tert-butyl ether (quote is lightly edited for clarity):
“The fuel additive MTBE is an useful example of both, as its most common feedstocks are methanol (usually from a non-petroleum fossil source) and Iso-Butylene whose feedstock likely comes from feed that has already been accounted for as butane (or iso-butane) consumption. MTBE adds a further complexity in that it is often exported as a chemical and thus not tracked in the petroleum trade balance.”
Thanks to the EIA, I now appreciate that the BP data I cited in Surprising Facts About Oil Prices (And The Questions They Raise) might contain errors, and how those errors could have appeared. This answers the third question I had in the article, but the first two questions remain unanswered. Even after knowing that there could be years between 1980 and 2021 where production came in higher than consumption, I can’t tell what the actual demand-and-supply dynamics of oil were during the five major crashes in oil prices that happened in that period.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently do not have a vested interest in any companies mentioned. Holdings are subject to change at any time. Holdings are subject to change at any time.
This series is interesting!
I have some thoughts about your first 2 questions:
– You looked at oil price quoted in USD, hence the USD relative value to commodity prices and other fiat currencies should also play a part. There’s possibility that if you plot oil price by gold price (ie. hypothetically we still use the gold standard), you may see a different picture. The timings and magnitudes of the crashes may be different.
– Price of oil and gas should also depend on the cost of carrying (eg. transport cost, port storage cost). When EU stops importing directly from Russia, they turn to importing more from other sources (Middle East, Turkey, etc.) which come with higher carrying cost. It’s possible that those countries actually import oil from Russia to sell to EU, so end of day it’s just intermediary cost.
Thanks for the great comments, Xuan!
1) On oil price vs gold price. I’m not as interested to look at oil price in relation to gold price because I looked at the history of oil prices primarily for my research into oil & gas companies. These companies earn their keep and pay their expenses in US dollars, so that was my focus.
2) Great point about the cost of transporting the commodity. I was looking mainly at demand vs supply because the key bullish thesis for oil prices today is the demand vs supply dynamic, that demand would overwhelm supply (there’s simply no growth in supply right now, and even if companies started building supply, the supply would not come so soon). So I wanted to understand how the interplay of demand and supply affected oil prices in the past.
– Ser Jing
Hey Ser Jing, following up on your reply:
1) While oil price is pegged to USD, expenses are driven by local operational costs. Russian and Middle East O&G companies do not pay expenses in USD. Which brings me to the second point, US does not dominate the global O&G industry. If you look at US O&G companies only, you are probably not seeing the full picture.
2) Demand – Supply dynamic undoubtedly drives price, but it isn’t the only factor. Thus, sharing additional viewpoints for your consideration. You can choose to expand your research to answer your primary question (oil price), or you can stick to your thesis 🙂
All the best!