Oil inventories provide insight into the balance between supply and demand in the oil market and, of course, influence oil prices. The relationship between supply and demand is one of the fundamental concepts of economics, and it is no clearer than comparing how the ebb and flow of crude oil inventories affect the commodity market.
Key points to remember
- Like most commodities, the greater the supply, the lower its market price for the same level of demand.
- Excess oil supply is held in inventories, some of which are held by governments to be kept as reserves.
- When these amounts increase, prices tend to fall, and vice versa.
Oil stocks and prices
Crude oil prices are dynamic. Although prices for some commodities may take time to equilibrate as the market reacts to changes in supply and demand, in the case of oil, price adjustments can be instantaneous. When oil inventories rise, traders can question oil demand at the current price and immediately sell their postsleading to lower prices.
When oil inventories are falling, traders can take this as a signal that demand is increasing, and they can buy back into the oil market, pushing prices up.
The US Energy Information Administration (EIA) provides a weekly national inventory update. The Weekly Inventory Report shows how U.S. petroleum inventories, other than those in the Strategic Petroleum Reserve, have changed over the previous week. This is a major piece of data in the market. Ahead of stock report, analysts release inventory adjustment projections. If the EIA reading differs from analysts’ estimates, oil prices may react dramatically. The EIA weekly inventory report also updates total inventory levels which can be compared to average inventory readings from previous years.
Another crucial piece of EIA inventory data is the number of oil inventories at the Cushing, Oklahoma delivery hub.Oil is delivered from producing areas across the United States, stored in Cushing, and then transported to completion refining markets. Inventory levels at Cushing reflect the rate at which U.S. oil supply moves from domestic producing areas to end refining markets. A build up of inventories indicates that more oil is being supplied than can be transported for refining. West Texas Intermediate (WTI) crude oil prices, the main North American benchmark, are set at Cushing.
Effect of supply on the economy
It is unlikely that the oil market will ever balance. Oil is a traded commodity, not just a good purchased for end use. Instead of reaching equilibrium, oil supply and demand move rapidly in unison with prices. An increase in supply suggests that sellers are willing to produce more oil at the current price than buyers demand. In theory, to encourage demand, suppliers should lower the price and see if more buyers come to market at the lower price. When the supply decreases, it means that buyers are very interested in that price. In this situation, sellers may have the opportunity to raise prices.
Oil inventories provide a crucial observation on one of the fundamentals of the global market: the level of supply. Simply put, the level of supply influences prices. Oil prices may react immediately after the EIA’s weekly inventory report if they deviate significantly from analysts’ expectations. Total inventory levels are also crucial because weekly inventory adjustments are made in the context of the overall inventory level. If inventory is low and there is a huge weekly drawdown on inventory, prices could see a big spike. If total inventories indicate a well-supplied market and weekly inventories continue to rise, oil prices could come under downward pressure.