Plunge in oil prices is a transitory phase
In 2011, crude oil prices fell by $39 a barrel because of a prevalent market fear that Spain was going to default on its sovereign debt. Such an event was generating angst that this would result in a replay of the 2008/2009 global credit crisis. The default never materialized, but that is not the point. The point is most all pundits blamed the oil price rout on a collapse in oil demand which was simply not the case — global oil consumption was, in fact, growing at a pace that was more than a million barrels per day on a year-over-year basis. How, then, can such fears cause a 35 percent drop in crude prices? The answer relates to a term we call financialization and the size of oil’s “paper market.”
Conventional wisdom used to be that the daily trading volume of a mature commodity futures market would max out at three to five times the size of that commodity’s daily global consumption. An analysis we first generated in 2007 examined the average daily trading volume of key energy futures contracts. The daily rate then was running at about 14 times the size of global oil demand. The 2021-to-date daily volume of trading for the six main energy contracts in the US and Europe is a hefty 30-times the size of the current year’s global oil demand.
The multiple of trading to global oil demand is actually closer to 50 if one accounts for the daily trading activity of options on futures, other listed energy futures contracts and the large, unregulated over-the-counter market. By our reckoning, there are currently more than 5 billion “paper barrels” of oil that trade each day as compared with a world demand figure of less than 0.1 billion bpd.
The recent sell-off in the oil market looks, to us, like another case of a collapse in the “financial demand” for oil. Recent separate analyses that we have published for our client base suggest that global oil demand is running close to forecast.
Global air traffic accounts for about 7 percent of the world’s oil demand. In March of 2020, when isolating and containment measures related to COVID-19 were first being imposed, we saw flying activity plummet by 70 percent over the course of six weeks. It took several months to climb out of that proverbial hole, but it was not until after the vaccination program began to roll out worldwide that global flying activity moved up toward 2019 levels (i.e. pre-pandemic activity). The overall growth in air traffic has mirrored the overall recovery in global oil demand.
It seems notable that the most recent week’s air traffic activity showed total flights to have run higher than their respective 2019 rate — a first since mid-March 2020. This and a very recent proprietary analysis of key inventory data suggests global oil demand is not falling back (actually that it is still in a recovery mode).
These suggest to us that the recent price plunge in the crude oil markets related to fears about the omicron variant will prove to be a period of transitory price weakness. It seems instructive to recall periods of oil price weakness tied to the delta variant (first identified in December 2020) proved transitory with global oil demand recovering materially over the course of the ensuing 12 months.