One of my favorite companies to follow for a macro view of the energy market is Enterprise Products Partners (EPD +0.45%). The company pipes, processes, and stores a large portion of America's oil and gas, so it has its finger on the pulse of the domestic energy industry. It shares some of its insights on the broad picture of the energy industry at some investor conferences. Here's what Enterprise thinks about the current turmoil in the oil market.
Bird's-eye view of the oil market
Enterprise Products Partners prepared the following slide featuring observations on oil prices.
Source: Enterprise Products Partners Investor Presentation.
As that slide highlights, the current predicament in the oil market is largely due to strong supplies from OPEC, Russia, and North America. OPEC, which typically trims supplies when oil prices weaken, decided against doing so at its latest meeting because it is threatened by growing supplies from the U.S. and Russia. This means it would take some time for global supply growth to slow, as Russia and the U.S. can't reduce output quite as easily as OPEC can. This is because Russia, for instance, simply can't shut down oil wells in Siberia during the winter. Meanwhile, the U.S. oil industry is made up of hundreds of independent oil companies, which don't answer to anyone but their own shareholders.
That being said, U.S. producers are slashing spending, which eventually will slow production growth in America. Likewise, production growth in Russia should slow as Western sanctions and falling oil prices reduce the amount of money pouring into the country's energy sector. But it will take time for supply growth to weaken, as U.S. crude oil supplies are sure to increase this year due to all the wells coming online over the next few months. As we see on the next slide, production growth is expected to slow, but output should increase through the end of the decade as long as the price of West Texas Intermediate crude averages $65 per barrel.
Source: Enterprise Products Partners Investor Presentation.
How demand might improve
These growing supplies will be a problem until demand picks up. The good news here is that lower oil prices almost always are the cure for weak oil demand. As the first slide illustrated, low oil prices create incremental demand, including an incentive for Asian nations to fill up their strategic petroleum reserves. In fact, China in November provided updates on the second phase and third phase of its emergency oil stockpile. The second phase, which is expected to be complete by the end of the decade, will hold 170 million barrels at peak capacity. That phase is estimated to be partially filled already, and falling oil prices will encourage China to top off the available capacity of its strategic reserve.
Economists estimate that every 10% drop in the price of oil creates 300,000 barrels of demand per day. With oil prices now down about 50%, that's roughly 1.5 million barrel per day of incremental global demand, which incidentally is the current level of market oversupply. However, there is a time lag between the price drop and the increase in demand. So it will take time before this incremental demand shows up in the market and begins to ease the glut of oil.
Investor takeaway
Enterprise Products Partners always offers great insights into the global energy market. Right now it sees no real slowing in supply growth because it will take time for oil production in the U.S. and Russia to drop. It will also take time before new demand emerges due to the lag between a drop in oil prices and an increase in demand. This suggests investors need to dig in for a while as oil prices are likely to be stuck while the market slowly works its way through its current imbalance.
