Fundamental Analysis – Are Falling Crude Oil Prices All About Supply?

Falling crude oil prices are all the talk these days, in part because of the reversal of long-term trends in proven U.S. oil reserves. Proven U.S. oil reserves are at their highest levels since 1975. The rise in recoverable reserves can be traced to increased production since 2009 due to the implementation of fracking technology in the Bakken shale formation in North Dakota, and to subsequent expansion in this industry.  The table below shows the dramatic increase around 2010 in U.S. oil field production versus net oil imports and petroleum products supplied.  It is interesting to note that total domestic petroleum products supplied remained flat during the same time.  Does flat domestic petroleum supply imply the recession reduced demand, or is something else going on? 

Total demand for petroleum products can be partially measured by total vehicle miles traveled and job growth. From the FRED chart below we can see that the moving 12-month total vehicle miles traveled fell 3.2% from its peak of ~3,038,000 million miles traveled in November 2007 to ~2,942,000 in November 2011.  On a percentage basis, the drop is relatively small, but you have to go back to the 1979 Arab oil embargo to find a similar multi-year decline in vehicle miles traveled.  Since 1981, total vehicle miles traveled increased every year until November 2007, when miles traveled flat-lined. When job growth is added to the chart, we see a strong directional relationship between the two data sets.  There appears to be a secular relationship between miles traveled and job growth.  Thus we could hypothesize that after four years of continued job growth and eight months of 200,000 plus job gains there would be an uptick in vehicle miles traveled and demand for oil, but to date that has not happened.
Indeed, the housing and financial recession was deep and protracted, which leads us to believe the economic recovery will be long and protracted, too.  Maybe the relationship between vehicle miles traveled, job growth and oil prices will return at some point.  Or perhaps changes in technology like those responsible for the incredible rise in U.S. oil reserves will create new patterns and relationships that are just beginning to mature.  For example, cheap rooftop solar cells connected to battery storage capacity has the potential to upend the municipal electric utility sector.  To paraphrase a Bloomberg News article titled, “Musk Battery Works Fill U.S. Utilities Promise seen as Doom,” electric utilities may be disrupted by unregulated products available at Home Depot, which could leave the old business models no place to hide.  There may be other emerging risks and trends similar to those affecting electric utilities that impact our credit holdings.  By performing fundamental credit analysis, we can mitigate emerging risks and capitalize on new trends by selecting credits with strong balance sheets and/or excellent leadership, capable of managing their way through a changing environment.

Sources: FRED, U.S. Energy Information Administration, Bloomberg News, Financial Times