Why Oil Prices Aren't Falling Off a Cliff

Why Oil Prices Aren’t Falling Off a Cliff

by | published October 10th, 2013

As the incompetence in Washington continues, crude oil prices have started to do the unexpected – at least to some folks anyway.

After falling during the initial stages of the crisis, oil prices have started to climb.

This morning WTI is up modestly, while Brent is continuing a trend of stronger prices that appears to be accelerating.

According to the “traditional wisdom,” none of this is really possible.

Given all of the financial uncertainty (and that is an understated way to describe the circus in DC), oil prices should be falling due to the associated decline in demand.

But in reality, the exact opposite has started to happen: Prices are rising, not falling off the cliff.

So what’s the reason behind this apparent disconnect in oil prices?

Here’s my take on crude, along with a developing opportunity in natural gas…

What’s Really Behind the Rise in Oil Prices

Of course, it is true that the prices for both oil benchmarks declined when the crisis first hit and have been subject to recurring waves of volatility since then.

However, the more recent indicators now tell a different story. In fact, they reflect two separate developments that are already underway.

The first has to do with gold.  As I have previously discussed, crude oil has begun to replace gold as the standard of reference in determining the overall condition of the economy.  That is, crude oil has started to become a store of value when the markets start to head south.

Here, once again, the “traditional wisdom” has come up short.

Normally, we would expect a flight to gold as a safe haven during periods of downward market moves. Well, that is certainly not happening here. After posting a rather anemic improvement, gold has been tanking.

Conversely, crude oil has been stabilizing in tandem with gold’s decline.

Second, and this is one of those odd quirks in market behavior, crude oil has served as an early indicator of impending “resolutions” to political mayhem.

In this case, it might well be telegraphing the forward investment view of a pending compromise in Washington. We’ll see.

Meanwhile, there is another consideration. The fact Brent is moving up faster than WTI reveals some renewed upward pressures on oil prices from other sources, primarily geopolitical.

This is important to keep an eye on and I’ll have much more to say about these developments from London next week.

And Then There’s the Rise in Natural Gas…

Meanwhile, when it comes to natural gas something else entirely is pushing up prices.

Of course, the recent move higher has been hardly unexpected as we move into the winter heating season. However, as I noted on Tuesday, there is acceleration in natural gas demand building from five primary sources: electricity generation; petrochemical feeder stock; industrial usage; increasing applications in transport fuel; and the advance of liquefied natural gas exports from the U.S. (and elsewhere globally).

What’s new is that there is also a regional problem that is adding to the expected jump in prices as we move into colder weather – especially in parts of the Northeast.

Due to a continuing shortfall of natural gas pipeline capacity into the region, price spikes in New England this winter could be just as bad, or worse, than last winter, according to Richard Kruse, Vice-President of Rate and Regulatory Affairs at Spectra Energy Corp. (NYSE: SE).

Earlier this week  Kruse noted, “This last winter New England paid substantially more for energy than the rest of the country, and from the price indices that are shaping up for this coming winter, we see that repeating itself, maybe even more dramatically.”

According to the Spectra VP, spot prices for natural gas at the Algonquin City Gate (a primary hub pricing location for the region) averaged $8.23 per 1,000 cubic feet or million BTUs for the first half of 2013. That marked a 146% increase compared to the same period in 2012.

On the other hand, according to Gas Business Briefing, spot prices at Henry Hub, the Louisiana location where the NYMEX daily price is fixed for the country as a whole, averaged $3.75 in the first half of 2013, up 57% from the previous year.

On a region-to-region basis, that’s quite a difference in price.  Again, part of this disparity revolves around pipeline capacity.  In short, there’s not enough.

Investing in New Pipeline Capacity

This disparity in price is why, along with other operators, Spectra has suggested that new pipeline systems into New England would pay for themselves. “New England is paying a lot of money for gas,”  Kruse notes, “We would suggest they could actually save money if additional pipeline is built. You could pay for that pipeline and still save money.”

At present, Spectra Corp. services about 50% of the gas-fired power plants in the region and acknowledges that generating facilities are not willing to pay for new pipelines, in part “because power markets don’t provide a way for generators to recover the costs of firm pipeline capacity,” Krause said.

So as power companies play the spot pricing game to maximize their profits, and the consequences to providers and transporters remains up in the air, some new pipeline completion may be in order. Yet that means the overall availability for all end users would essentially be dictated by the power plants, at least in the short-term.

As it stands, Spectra’s Algonquin Gas Transmission pipeline system is running full from west to east, yet no power plants have signed up for capacity on the company’s proposed Algonquin Incremental Market Expansion project, slated to begin service in 2016, according to Kruse.

He adds that from a gas-fired generation perspective, “we would suggest you definitely need more capacity committed to the electric generators than what currently exists for reliability.”

I don’t know what the pundits would take from all of this, but I can tell you this:  I smell some nice investment moves headed our way.

That’s going to be true even if the clowns inside The Beltway continue to hit each other with rubber chickens.

The need for energy is just far too great.

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    October 10th, 2013 at 16:06 | #1

    I cannot quite agree with your analysis that oil has replaced gold. True, the divergent move in favour of gold would tend to support your idea, but whenever this madness of money creation out of thin air comes to a stop and the Dollar crashes, what medium of exchange will we have to revert to? I cannot fathom anybody running around with a gas can full of gasoline or diesel to buy groceries, or a new fridge. But I can well see someone with a silver Dollar or gold coin do these things.
    So, your idea is a good academic exercise, but it makes no practical sense!

  2. Howard Walter
    October 10th, 2013 at 21:35 | #2

    My assessment of cost differences of natural gas throughout the
    US is not simply related to supply capabilities. The NE is going to always be colder, thus demand higher, than Louisiana. Subsequently, the natural law, supply and demand will reckon price. While better supply will help lower everybodies prices, we cannot depend on our Representatives, senators or President to solve that problem.

  3. Gary Body
    October 11th, 2013 at 02:40 | #3

    I haul natural gas in wheeling area sounds Good futures look good

  4. Robert Gordon
    October 11th, 2013 at 05:35 | #4

    You are correct RL. The oil based currency continues to be created with abandon. Therefore oil is also artificially high. Oil, $, & market go poof and value must accrue to gold.

  5. js
    October 11th, 2013 at 07:48 | #5

    I think you gentlemen are view this on a micro scale. Look at what he states about oil as golds replacement on a macro scale. It’s more plentiful than gold and I can see nations favoring it over gold bc its not as restricted as gold. Gold is for the individual finances not a nation.

  6. yngso
    October 11th, 2013 at 08:15 | #6

    Expanding the argument: I don´t know exactly where Europe, China, Japan etc will get natgas from, but more supply in the world should help prices from exploding?
    I do agree with Dr M. that that the assets with most real value are the real stores of value.

  7. Razor
    October 11th, 2013 at 10:44 | #7

    I totally disagree with your analysis. Oil is artificially high due to QE. If Monetary policy was under control, the price of Oil would be much much lower. Gold is being pushed down by the powers to be to keep the petrol US$ in place. This will last for some time until the Fed runs into a brick wall. We saw this last month that tapering will not take place. It cannot given that interest rates will move higher and the US debt would implode. Gold will always be there as it has been for thousands of years. When the Fed runs out of arrows, Gold will increase dramatically and Oil will tank.

  8. Mike
    October 11th, 2013 at 14:17 | #8

    @Howard Walter
    The problem in the NE isn’t just the lack of pipelines, it’s their incessant blind eye to adding these pipelines and even drilling for gas in New York State. The Louisiana price is substantially lower not because LA is warmer in the winter time. It reflects the price for the entire Midwest, Midsouth & South. It’s far colder in the northern states than the NE, but those states pay the same LA reasonable price. The NE, like the West Coast will always get hosed because of their liberal attitudes and actions.

  9. js
    October 11th, 2013 at 21:38 | #9

    I still think the point he was trying to make is not being understood. Gold is for the individual not the nation. Countries will not have a 100% gold standard because it will constrain their activities. Governments can control oil alot easier they can’t control gold so they won’t allow gold to be put in a powerful economic dictating position, think about it.

  10. Heatblizzard
    October 12th, 2013 at 04:06 | #10

    However what has gone up is our water bill by 125 percent because the city foolishly spent money on fixing up murals instead of roads that need bad fixing and now the city acts surprised about the bad roads forcing water bills up to pay for it.

  11. Heatblizzard
    October 12th, 2013 at 04:07 | #11


    I agree. Even just SAYING extra drilling will happen even if nothing actually gets produced will lower prices for a short while as speculators invest on it……..assuming they haven’t fled the country which according to alternate news sources they have dumped the stocks and fled overseas.

  12. Heatblizzard
    October 12th, 2013 at 04:08 | #12


    And most of the country will not have the money to buy the oil despite the low price.

  13. John Folsom
    October 24th, 2013 at 18:05 | #13

    This is the very reason I invest in kog LNG fpp MHD and a few others inc 4 mlp’s ‘s and I suggest others do as well .

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