Oil prices rose last week after the International Energy Agency (IEA) predicted China’s oil demand would increase sharply in 2023, following the lifting of COVID restrictions, while Russia’s oil supply would decline under the weight of Western sanctions.
The IEA’s bullish forecast marked a change in mood from the previous few months when mildly bearish sentiment hung over the market, and exerted downward pressure on prices.
A sustained rally, however, will require definitive proof that the oil market is tightening.
To understand oil market conditions, the best indicator is inventories, which move up and down depending on the supply-demand balance.
If supply is less than demand, inventories decrease, which justifies higher prices, and vice versa.
Ursa Space’s Oil Inventory Index, based on our satellite imagery-derived measurements of thousands of storage tanks, provides a daily view of this key statistic.
The scale is calibrated such that a score of 100 means inventories are exactly at the “normal” level for the same time of year. Greater than 100 means “above normal” and less than 100 signifies “below normal.”
Inventories vs Prices
A quick glance at the Index since 2018 demonstrates the impact of two major events on the oil market.
The Index peaked at 106 during the height of COVID lockdowns and sank as low as 88 after Russia’s invasion of Ukraine.
The graph below plots the Index against Brent crude, the global oil price benchmark, demonstrating the strongly inverse relationship between inventories and oil prices.
Since its history began in early 2018, the Index’s correlation with Brent crude is equal to negative 0.86, according to our calculations.
The Index can therefore provide traders and analysts with fundamental data that signals future price direction, which is particularly valuable when the market dynamics are unclear.
That would certainly apply to today’s environment considering the two biggest stories – China (on the demand side) and Russia (on the supply side) – are evolving rapidly and very opaque.
In January 2023, the Global Index was around 95 (i.e., inventories are still low by historical standards), though up from 90 a year earlier.
What do the trends look like if we dig a little deeper?
We can break the Global Index into two parts depending on whether inventories are located in countries that are member-states of the Organization for Economic Cooperation and Development (OECD).
The OECD Oil Inventory Index increased significantly over the last four months of 2022, as a result of mild weather in Europe.
The 2023 outlook hinges on whether OECD economies enter a recession, and if so, for how long and how bad?
What would help offset the weakness in industrialized economies is a resurgent China.
China expected to lift demand
“The preeminent driver of 2023 GDP and oil demand growth will be the timing and pace of China’s post-lockdown recovery,” the IEA said.
Some signs suggest China’s lifting of COVID restrictions on December 7 had an immediate impact.
China’s oil inventories stopped building, and even declined slightly, around that time, a trend visible in the Non-OECD Oil Inventory Index shown below.
As the IEA acknowledges, China’s economy and Russia’s oil exports are two wildcards. Both will play a big role in the oil market this year, but It’s anyone’s guess how things will unfold.
The net impact will be seen in the amount of oil held in storage, which is captured in the Oil Inventory Index.
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