What Is (and Isn’t) Driving Oil Prices
NYMEX crude oil began trading today (November 5) at almost $87 a barrel, the highest figure in over six months. The price has risen more than 5% in the last five sessions, rising in seven of the last 10 trading days. If we have a closing price in excess of $87 today, that will mark the first time in over two years.
Crude will face some resistance in the $86 to $88 range and then again at around $94. Once the market breaches these levels, it is well into triple-digit territory.
Recall, as I have often mentioned here, this will be a ratcheting effect – overall direction up but requiring some intermittent periods of consolidation. The dips, however, will be brief.
Consider that, in the daily trading session results since September 10, NYMEX crude has exhibited a positive figure in its rolling monthly average (adding the results of the latest daily session, eliminating the earliest) 95% of the time (38 of 40 daily sessions). This is hardly a New York-only development. The dollar-denominated Brent price (ICE London) has run positive figures in its daily session monthly averages 93% of the time since September 7 (40 of 43). Brent closed yesterday at $88, the highest figure since May.
Both NYMEX and Brent are actually giving the near-month price – that is, the price for delivery of crude in December. However, as we see the emergence of an established contango curve (with prices increasing for each successive month deliveries are moved out into the future), indications are growing that prices are going to be rising further.
So this means the race in on, right? Well, not quite yet.
The Implications of a Weakening Dollar
The current spike is largely a result of the dollar’s continuing decline against the euro, not changes in the supply/demand relationship in the market.
The weakness in the dollar has been building for some time, but it is now also augmented by the Fed’s decision to buy $600 billion in long-term (7- to 10-year maturity) U.S. debt, starting out at $75 billion a month. The quantitative easing part 2 (QE2) will keep bond interest rates low. That, in turn, will depress the value of the dollar against the euro (and, generally, other foreign currencies). The dollar was at $1.4215 per euro at yesterday’s close, falling as low as $1.4282 midsession. This is the weakest level since late January.
Here’s where the impact on oil comes in…
While there has been an ongoing debate over the likelihood that more international contracts may end up denominated in a currency other than the dollar (or traded against a basket of currencies), the actual move in that direction is cumbersome, time-consuming and, with the ongoing overhang of dollar-denominated assets held worldwide, self defeating.
On this last point, the value of those assets is dependent upon the continuing use of dollars as the primary international trading currency. Dumping the dollar in favor of, say, the euro would depress even further the value of those assets. It would also heat up the euro, with inflation being the last thing European Union planners in Brussels need at the moment.
Even with a few more contracts denominated in euros coming out in the Dubai exchange, the Russians planning to move their crude along with volume from Central Asia (Kazakhstan primarily) through the new exchange in St. Petersburg denominated initially in rubles, and Iran and Venezuela moving away from the dollar, the U.S. currency will remain the dominant oil trading vehicle.
However, its declining value means more of them are now required to buy a barrel of oil.
The overall transaction value encompassed by an oil sale becomes more closely associated with the value of the commodity not the currency. As a result, the Fed action increases the price of oil by decreasing the trading value of the dollar. Other commodities are also witnessing such a transfer.
Yesterday, The Thomson Reuters/Jefferies CRB Index of 19 commodities advanced 2.4%, to 312.30. That just happens to be the strongest level in more than two years. Seventeen of those commodities were up.
The increase, therefore, is a result of currency values, not the result of rising demand for oil. In fact, the Energy Information Administration in its weekly report on Wednesday (November 3) put crude inventories in the U.S. market at a level higher than any point since May 2009.
Most analysts are opining that the current rapid increase in prices cannot be sustained absent demand returning. I certainly agree. However, that demand return is coming… and it is coming fast.
OPEC Just Released Its Annual Estimate
Almost unnoticed in the flood of yesterday’s reports was the annual estimate from OPEC.
For the second time in less than two months, the cartel has increased its demand projection. It now tells us that global oil demand will be increasing, at a rate faster than originally predicted.
OPEC believes the rise will continue through at least 2014, with the overall daily demand coming in at 89.9 million barrels, or a hefty 5.1% above current levels. This is an 800,000-barrel increase on its earlier figure. That "earlier" figure was a 600,000-barrel per day increase from last year’s projection.
Don’t confuse the rise in demand worldwide with what is happening in the U.S. or Europe. This increase demand push is not coming from the developed Western industrial states. It is coming from Asia and Africa, where premiums to Western delivery prices are a fact of life.
So, yes the current price rise is currency not demand related. But the demand intensification is already on the way.
P.S. To find out how to profit from higher crude prices, take a look at Monday’s story. As you’ll see, oil field service (OFS) providers are incredibly attractive right now, even more so than the producers themselves.