PTQ Q3 2026 Issue

Missing inventory channel in oil market analysis

Stocks increasingly influence prices, demand signals, and refining margins via the inventory channel, affecting how supply-demand fundamentals shape market outcomes

Arif A Abdullah Iraqi Ministry of Oil

O il price behaviour has increasingly diverged from what the production-discipline side would suggest over the last several years. Upstream supply continues to anchor medium- and long-term market balance. At the same time, short-term prices, volatility, forward curves, and refining margins have become more sensitive to inventory dynamics than in earlier cycles. This is clearly reflected in the oil markets through the effects of the world’s two largest inventories. The US largely influences markets through expecta - tion-driven signals associated with its Strategic Petroleum Reserve (SPR). However, China’s impact operates primarily through realised balance effects tied to opaque, systematic stockpiling behaviour. Refining and product markets emerge as the final interface through which inventories influence crude demand. Treating inventories as active market state variables helps explain why production cuts can stabilise long-term balances while producing muted, delayed, or uneven short-term price responses. Traditional oil market frameworks Previously, oil market analysis focused on flows. Production, consumption, and trade volumes were treated as the prin- cipal drivers of price performance, while inventories were viewed largely as a residual outcome, rising when supply exceeded demand and falling when demand ran ahead of supply. Within this framework, sustained price movements were expected to follow sustained changes in upstream pro - duction discipline. This context no longer matches market behaviour, as the market is no longer driven by flows alone. Recent cycles have seen coordinated production cuts yield weaker, slower price responses than expected. At the same time, prices and volatility have shifted sharply during periods when headline supply conditions appeared relatively stable. Refinery activity, meanwhile, has often seemed misaligned with conventional demand indicators. These patterns do not imply that production discipline has lost relevance. Rather, they point to a change in how fundamentals are transmit- ted into prices. Inventories today are no longer merely a response to balance; they increasingly are the balance. Thus, strategic and commercial stocks absorb imbalances, shape expectations, and either delay or amplify market reactions.

Expanded storage capacity, deliberate strategic stockpil - ing, and the deep integration of oil markets with financial instruments have strengthened the role of inventories in conditioning price behaviour. At the same time, increasingly complex refining systems have made crude demand more sensitive to product balances and margins than to upstream supply signals in isolation. The result is a market in which stocks actively shape how fundamentals are interpreted and priced. Therefore, understanding the performance of the oil market today requires a view that recognises inventories as a central transmission channel between flows and outcomes. From residual balances to market state variables In conventional analysis, inventories are often introduced late in the assessment process, after evaluation of supply, demand, and trade flows (see Figure 1 ). In practice, however, market participants frequently respond to inventory signals first, using them as immediate indicators of tightening or loosening conditions. Inventories influence market outcomes through several interconnected mechanisms. Inventories provide the first line of defence against phys - ical imbalances. Surplus supply can be stored rather than immediately discounted, while shortfalls can be met through draws instead of abrupt price spikes. This buffers moder- ate short-term volatility but also delays price adjustment to changes in production or consumption. Stock levels exert a powerful influence on the structure of the futures curve. High inventories tend to flatten curves or push them into contango, while low inventories support backwardation and scarcity premiums. Expectations about future stock movements can reshape curves even before physical inventories change, affecting storage economics and refinery procurement decisions. Inventory draws are commonly interpreted as signals of strong demand, while builds are seen as signs of weakness. These signals often carry more weight than contemporane- ous consumption data, which may lag reality or be revised. In this sense, inventories serve as a practical proxy for demand momentum. Product inventories are a key driver of refinery behav - iour. Elevated product stocks compress crack spreads and discourage higher utilisation, while tight inventories sup- port margins and incentivise runs. Through this channel,

PTQ Q3 2026