Why Oil Prices Aren’t Falling Off a Cliff
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.