The New "Normal" for Oil Pricing

The New "Normal" for Oil Pricing

by | published July 20th, 2012

Crude oil and gasoline futures contract prices are moving down today, as the market takes a breather from an accelerated upturn.

Renewed concerns in Spain this morning will dampen European stocks and those on New York exchanges as well. It will also bring back the “doom and gloom” crew of commentators.

Sometimes you can’t tell the difference between a genuine commentary and some guy just fronting for a short play!

But the overall medium-term trajectory of oil no longer appears to be in doubt. As I have indicated on several occasions recently, the downward movement in May and June was an overreaction to softness in the sector, with the ultimate slide over twice as large as any objective reading of the fundamentals would justify.

We are now witnessing a return to a “normal” oil market. That doesn’t mean a lack of volatility or a narrow range of trading.

This normal is hardly boring.

Oil Prices are Impacted by Three Primary Factors

What it does mean is the price will be determined by three factors:

  1. Supply and demand;
  2. The spread between benchmark crude grades; and
  3. Geopolitical tensions and events. Here, we are considering matters we’ve discussed here a number of times.

Now we will continue to see, on occasion, external factors weighing in, such as what is occurring today. Renewed concerns about the debt crisis in Europe are weighing down on both the market as a whole this morning and on oil prices.

That results in something I have discussed previously – a sort of “cart leading the horse.” It produces an expectation that, if the trend continues, it will depress overall demand and thereby push prices downward. Some of this occurs all the time; it is what fuels the usual movement of oil levels.

But it does not affect actual demand levels unless the situation is protracted. That is because such concerns are not part of the oil cycle itself. For them to become so, we need at least a quarter of movement in the same direction, and we haven’t had anything close to that.

The move down over the six-week period in May and June has already been countered by a strong move upward over the past several weeks – overreaction countered by recovery.

The three factors that have a genuine consequence, however, are directing us back up.

On the supply side, we have witnessed a significant drawdown in inventories. This has been happening for several weeks now, but has had an impact only recently. That has been augmented by refinery capacity problems and interruptions of production from the North Sea (where pending labor actions are still a factor). Demand is returning in the U.S. market at levels even the pessimists are finding hard to ignore. Globally, however, the real drivers on the demand side have been moving up for some time.

Remember, this market is not determined by North American consumers or those in Western Europe, but by the developing world and emerging markets. There, oil demand is increasing and at a faster pace than anticipated.

This is not simply an estimation of energy demands in China and India. The developing world’s dictation of demand levels is now much broader than those two economies. Given the integrated nature of the oil sector, what occurs anywhere has an impact everywhere.

The Brent-WTI Spread Widens

As to the second factor, the spread between the Brent benchmark in London and West Texas Intermediate (WTI) in New York is increasing (again).

At open today, the difference in price between the two as a percentage of the WTI price (the better way of looking at this) was in excess of 18% and rising.

That of itself tends to increase overall U.S prices. But it also does something else. More than 85% of oil trades actually done worldwide each day are in consignments that have higher sulfur content than either Brent or WTI. That means these trades are discounted to the dominant two benchmarks.

Brent is used as the preferred base for pricing those traders much more often globally than is WTI. And that translates into overall prices rising internationally faster when the spread is increasing than when it is contracting.

Iran Remains a Key Factor Moving Forward

Finally, the geopolitical is becoming a major factor in the move up. Mideast tension is certainly in the forefront here. But it is the rising Iranian crisis that is the primary concern. Absent a resolution – and, for the reasons I have previously talked about in OEI, that shows no prospect of happening – this will get worse as we move into the third quarter.

This is because the European Union embargo of Iranian crude deliveries took effect only on July 1. The impact of that move affected only shipments changed after that date. We are now working through the first ripples of that effect.

And it will become worse.

That is even without trying to figure in what an increasingly desperate Tehran may end up doing. Already over the past week, the head of the Iranian military confirmed they were setting up contingency plans to block the Strait of Hormuz (an action the U.S. Fifth fleet will actively resist), and the director of Iranian ports pledged insurance coverage for tankers moving Iranian crude.

This latter development results from both EU and U.S. sanctions now extending to shipping companies, insurers, and banks providing finance for Iranian oil trade. Nobody in the business, by the way, has any idea where Iran will find the money for this underwriting program or how the country will be able to guarantee it – since the sanctions also cut the nation off from access to international banking.

These are the real factors behind how the oil market operates these days. These are hardly calm waters, and movement is not always in one direction. But the trajectory is for prices to rise.



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  1. dourdan
    July 20th, 2012 at 13:59 | #1

    thank you son

  2. Leslie Terrien
    July 20th, 2012 at 15:28 | #2

    Mr. Moors
    I have been dying to ask this question to someone who knows about oil.I am a news junky and i also watch the oil prices and i must say we are getting screwed big time. The say gas is coming down but i have to disagree. I used to follow it every day and to make this a little shorter i’ll go back to the first of the year and i was paying around 2.90 to 2.95 per gallon and oil was anywhere in the range fo the ninty to one hundred dollar range.In May of this year a barrel of oil started to cimb to a hundred and over and it went crazy,anywhere over three dollars up to 3.75 cents. Now i have seen the price go as low as $82 dollars a barrel and the price even as of to day is weel over $3 dollars. How can i be paying around $2.95 a gallon when oil was in the $90 per barrel range and now i am paying over $3 dollars when oil was in the $80 dollar range. Something just don’t add up and i call it getting Srewed? I would appreciate it very much if you could inlighten me in how the price did not return to the $2.90 range and actually should have been lower with the price in the low $80 range. Thank you Mr. Terrien

  3. Doris kelsey
    July 20th, 2012 at 16:51 | #3

    Nobody in the business, by the way, has any idea where Iran will find the money for this underwriting program or how the country will be able to guarantee it – since the sanctions also cut the nation off from access to international banking.
    The answer- China.

    July 21st, 2012 at 02:19 | #4

    Is there any forum to subscribe with Oil and Gas Call options?

  5. Dom Brunone
    July 21st, 2012 at 13:06 | #5

    How does all the new supply of tight oil coming on in the USA affect your price models? At some point, it seems to me that this supply will become cost-efficient to export and overwhelm the global supply figures. I would appreciate your comments.

  6. Robert Thompson
    July 22nd, 2012 at 10:03 | #6

    Dr Kent Moors: I’ve purchased BNO to position myself to profit from the Iranian crisis. Iran is currently storing up vase amounts of crises. If the Iranians agree to Western demands, this 90 million barrels will flood the markets and crash oil prices. I have a stop loss in place. Would you please comment on this possible scenario?


    Bob Thompson

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