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Many crude oil market observers point to current global inventory levels to explain today’s low prices.  The recent price decline is also attributed to concern about possible future decline in Chinese demand growth.

The problem with both of these explanations is that no one can describe with sufficient certainty the causal relationship between current crude oil inventories or future Chinese consumption and the future price of crude oil.  To paraphrase economist Mohamed El-Erian  the crude oil market may simply be “repricing to a new volatility paradigm.”

Relationship of Crude Oil Inventory and Future Prices; Theory of Storage Need Not Apply

As Reuters market Analyst John Kemp has written, in a perfect market with perfect information, there should be a relationship between changes in  crude and products stocks and changes in prices, but no such relationship has been found in past market data.

According to the late Stanford professor Holbrook Working’s Theory of Storage, the level of commodity inventories should shape the forward price curve. When inventories are low, the market creates backwardation. When inventories are high, the market creates contango.

Historically the crude oil futures market has not seen significant correlation between inventory levels and its forward price curve.

More fundamentally, the market moves on survey and estimated inventory numbers that are subject to significant subsequent revisions.  As David Pursell with Tudor, Pickering, & Holt has observed, “the observed OECD inventory builds in late 2014 and early 2015 showed a market that was oversupplied (inventory builds larger than normal) but much less oversupplied than published supply-and-demand numbers would suggest...