Egypt Events Prompt A Change in the Oil Mindset

by | published February 4th, 2011

As the world awaits developments out of Tahrir Square in Cairo, Egypt – and ripples of discontent begin emerging from elsewhere in the region – European oil analysts are switching perspectives.

There is now a “risk premium” being factored into the calculation of expected Brent prices in London. Today prices are retreating to under $100 a barrel in London and less than $90 in New York.

Yet the overall dynamics continue to point toward a virtual guarantee of levels above $100 a barrel for the near term – on both sides of the pond.

The new risk element is, of course, a result of the political unrest in Egypt and calculations about what that may mean for the wider areas of the Middle East and North Africa (MENA). Yet, just as significantly, it is not a prognosis of supply problems.

What we are seeing is the first stage in a major cycle of volatility in the oil trading market. Egypt may have been the trigger, but it is the trading markets themselves that are creating the problem…

Let me be clear about this. While concerns are expressed about wider MENA impacts from the current unrest, that unrest has had no measured effect on the availability or crude oil or oil products in the global market.

This rising risk premium is all about the difficulty of the trading environment to meet uncertainty.

And we shall certainly be seeing more of this…

The Trading of Oil Itself Is Becoming A Generator of Risk

The usual suspects in determining short-term moves in oil price remain the same.

I continue to look at a number of conventional standards in estimating expected price: currency forex rates; demand; the availability and quality of supply; inventories; and mergers and acquisitions. Added to these are the occasional weather issue and/or geopolitical event.

Yet, as I have mentioned several times recently, the rising specter of instability is beginning to take over as a primary driver of prices.

(See “How the Egypt Crisis Can Impact the Oil Market,” January 31; “The Whole Truth About Rising Oil Inventories,” January 21; and “Crack Spreads, Oil Futures, and $5 Gasoline,” January 7).

This has resulted in this rising risk premium – one that is more noticeable in London trading than in New York (at least for the moment). Currently, the premium is probably adding at least $5 to $7 a barrel in London. And it will only intensify.

The risk factor is not likely to shrink, even if the political issues in Cairo are “resolved.”

The overall risk element in the trading market itself is rising without factoring in the geopolitical (e.g., Egypt), supply stricture (e.g., European port strikes), or the weather (e.g., hurricanes and heavy snowfall interrupting distribution, such as we saw recently in the U.K. or Germany).

The trading in oil itself is becoming a generator of risk. That will buttress overall pricing, with the more traditional considerations already mentioned merely spiking the price even higher.

The Widening Spread Shows the Effects

Another way to view this involves the widening spread between New York (WTI benchmark crude rates) and London (the Brent rate).

As I am writing this in the early afternoon of Friday trading, that spread is exceeding $9.50 a barrel. Brent has been trading higher than WTI for some time, with the spread between the two widening of late, as the dollar has once again accelerated its losses against the euro.

On a daily basis, Brent represents a greater amount of global trading than does WTI. However, both account for less than 15% of the trade, because they are sweet crude rates (low sulfur), whereas most oil actually traded is more sour (due to heavier sulfur content).

That means most crude traded internationally is priced at a discount to either grade. The prospects that “lower” NYMEX prices could pull down London levels is not in the cards – for one very simple and overriding reason.

This spread is not the cause of anything. It is an effect.

It reflects rising volatility, occasioned by accelerating uncertainty in the market itself. In such an environment, therefore, Brent will continue to occupy the high end of the spread (because of its more direct impact and more actual crude usage daily), and WTI will continue to feel the pressure upwards as a result.

This is because, with market factors showing a further rise and both benchmark contracts trading in dollars, it is less the overall aggregate cash value of the contracts (still favoring New York) than it is the higher impact of trading on the actual delivery of the underlying crude consignments (the “wet” barrels of actual product) that determines the effect of the crude spread.
Brent is the benchmark standard in more markets worldwide than WTI, and it has a more immediate impact.
We are, therefore, witnessing the emergence of a protracted period of volatility.

No surprise there.

This is, after all, what I counseled when I began writing Oil & Energy Investor in 2009. It will raise prices, but do so by also introducing an advancing element of uncertainty.

The emergence of risk premiums in oil pricing, while widely perceived as a result of Egypt (and probably seeing a more rapid increase because of those events), tells us more about the trading market than outside events that actually have no immediate impact on oil availability.

The premiums are telling us there is broader instability in the markets themselves than most analysts would care to admit.

Our overall approach from the beginning has expected just that.



P.S. If you missed interview Monday on Fox Business, where I discussed Egypt and oil, you can watch the video right here.

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  1. Herminio Gamponia
    February 4th, 2011 at 17:22 | #1

    Tell me which stock to buy now related to your presentation.?
    Herminio Gamponia

  2. Steven Payne
    February 4th, 2011 at 17:34 | #2

    I am a subscriber to your service. Can you tell me how to find your stock portfolio recommendations?


  3. February 4th, 2011 at 21:11 | #3

    Needs are necessary!
    This is an opportunity for humanity to advance and get rid of the chains,too.
    We, humans, like Egypt now,need a new start, a new economy model; a new source of clean energy.
    This is the hour to realise that new tecnology we all need.

  4. February 4th, 2011 at 21:14 | #4

    There is oil next to the US, Venezuela,a other countries, even in the Middle East.

  5. vijay nayyar
    February 5th, 2011 at 01:33 | #5

    kindly be dot on the point

    oil price will go up or down and why

    your messages too difficult to understand

  6. richard l chambless
    February 5th, 2011 at 08:53 | #6

    thanks. rlc

  7. Anne Philipps
    February 5th, 2011 at 09:18 | #7


  8. Edward Thomas
    February 5th, 2011 at 22:37 | #8

    what do you see ahead for TRGl and the under Paris oil reserves?

  9. February 7th, 2011 at 01:30 | #9

    (esph) please tell the 2011 price?

  10. im Madsen
    February 7th, 2011 at 13:31 | #10

    vijay nayyar :kindly be dot on the point
    oil price will go up or down and why
    your messages too difficult to understand

    I agree I signed up to get advice- not to be entertained by reading.

    February 28th, 2011 at 12:20 | #11

    I live in Bentleyville PA, a stones through from where the Dr. lives…..?

  12. tanie
    March 17th, 2011 at 14:42 | #12

    I know you’d like to defend your maple-syrup drinking breathern up North who can’t even figure out how to win in the Olympics THEY host when they spend 9 months of the year playing Winter sports, but… let’s face it, the only thing Canada can do right is health care and a balanced immigration policy. That’s it!

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