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The Two Real Reasons Oil Prices Are Currently Slipping

by | published September 25th, 2015

The Energy Information Administration just released its latest report on oil. And although I’m no conspiracy theorist, what’s going on in oil pricing has all the earmarks of a setup.

Each week, the report tells us what the crude oil and oil product markets looked like as of the previous Friday. It is usually the yardstick by which analysts appraise everything from oil supply through refinery utilization to the markets for processed products such as gasoline, diesel fuel, and low sulfur content heating oil.

This week’s report showed criteria that would normally signal upward pressure on prices: a drawdown in oil supply, tighter refinery usage, and a widening spread between crude oil and oil product prices.

Now, this last criterion may be the most important for assessing pricing across the board. It involves the relationship between crude raw material pricing and supply on the one hand and similar considerations for gasoline and heating oil on the other (heating oil serves as a surrogate for diesel in these calculations since both distillates come from the same refinery cut).

Simply put, prices should not decline when the spread is rising.

So why are oil prices heading downward?

Distortion currently occurring in the market.

Here are the culprits behind this price manipulation… as well as how we can profit from these artificial moves…

A Drawdown Should Push Prices Up

In the past few weeks, the drawdown on supply has been greater than anticipated, in some cases by a significant margin. That spread is improving, which usually contributes to an overall rise in price for the underlying raw material.

Yet the pundits continue to grasp at straws in their attempt to explain the resistance to a rise in crude oil and oil product prices.

This time around the “spin” involves claiming a decline in gasoline demand has offset the upward pressure of an expanding drawdown on the storage side. For the past two weeks this has been shaping up as a pronounced cycle.

For one thing, the overall drawdown has been multiples of what the American Petroleum Institute had recently forecast. This week, it was no less than six times the industry estimate.

For another, the drawdown at Cushing, Oklahoma, is even more important than the figure as a whole. Cushing is where the West Texas Intermediate (WTI) daily pricing peg is set for crude futures contracts trading in New York using the WTI benchmark. Consecutive weeks of reductions here have had a direct impact on the spread.

Not only are the concerns about gasoline demand missing the point, but they are themselves quite misleading when taken alone. Gasoline demand usually decreases this time of year, since refineries are already well into the cycle of switching from primary output in high-octane gasoline to heating fuel. A deeper warm trend in the fall, for example, almost always results in a spike in gas prices as usage extends longer than expected into what is supposed to be the cooler season.

Also, we have just experienced a tick up in gasoline usage in August and through Labor Day beyond what had been expected. This is at best a non-issue for this time of year.

So what gives?

Here’s Why Prices Are Depressed…

There are two matters of import at play here, both reflecting indirect paper moves having little to do with the actual underlying dynamics of the market:

  1. another round of shorts by those who know no other way to make money from commodities; and
  2. a widening usage of derivatives based on what are called “crack spreads.”

Regarding the first, the recent OPEC “opinion” that we will not see $100 a barrel oil until about 2040 has to be read with more than a grain of salt.

As we have revealed here in Oil & Energy Investor, major OPEC sovereign wealth funds have been shorting oil. It remains in their best interest to keep prices low to defend market share. In pursing this objective, they are shorting their own product. Therefore, statements about reduced prices in the future merely support another objective entirely – one that has little to do with improving their revenues for the sales of oil!

As to the second, derivatives, some explanation is necessary. Crack spreads allow an investor to play the difference between both WTI and Brent (the London-set benchmark) and the market price of gasoline and heating fuel. Of course, the investments here are very big. This is not an approach any retail investor could make.  But it is a recourse of hedge funds and their ilk that are intent on turbo-charging short plays.

The combination of the two strategies are producing the latest myopic way to generate profits… as long as its adherents can persuade investors that depressed prices are ongoing.

Now to be realistic, we have a number of factors contributing to that persuasion – from an Iranian accord, through OPEC increased production, to a constriction in the U.S. shale-tight oil patch.

And then there is the other culprit: Goldman Sachs. The investment firm is continually talking down the price of oil and now suggests that $20 a barrel is possible. This analysis is far from objective, given that Goldman is the largest shorter of oil in the market.

A decline that profits the short crack-spread players becomes an easier sale.

…And How We Can Profit

Given these dynamics that are distorting the market, we are likely to approach $70 a barrel only next year, with a further move to $80 sometime beyond that (a view, by the way, on which OPEC concurs). Even without the shorts and crack-spread derivatives we would still be coming in much lower than the triple digits of some 15 months ago.

But it is incorrect to assume that these machinations are merely reflecting, rather than dictating, what the market is telling us. There are plenty of other participants ready to continue external ways of distorting pricing.

By how much?

I have been beta testing an index of wet barrel (actual oil consignments) comparisons to paper barrels (futures contracts and derivatives) in an attempt to find out. Initial reads are telegraphing a widening effective impact. As of the end of August and the first full month of running the yardstick, it was coming in at $8 a barrel in New York and closer to $9 in London.

By the close of trade last Friday (September 18) it has both accelerated and converged, coming in at about $12 for both benchmarks.

Now, even pegging the actual price at $57, rather than $45, in New York still indicates a weak oil market. Nonetheless, as I fine-tune this tool, it will be telling us something else of greater importance to our purposes.

This approach should tell us when the curve is moving up before it appears in the market. And that will prove very useful in picking stock moves moving forward.

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  1. Paul Ellenbogen
    September 25th, 2015 at 14:36 | #1

    The market is the final arbiter. All opec producers need all the revenue they can generate. The Saudis gave 130b to the Saudi people they r afraid of Isis and internal threats even though they have 800b in reserves. If the Iran nuclear deal goes through more oil on the market. What I don’t understand if we r allies with the Saudi’s how we can let them try to destroy our shale industry. Also I don’t understand why the opposition to the keystone pipeline. There r many thousands of miles of pipeline in this country. With Goldman and citi both projecting much lower prices I am very confused and I have followed oil for over 40 years

  2. Robert in Vancouver
    September 25th, 2015 at 15:30 | #2

    You are right Paul, it’s hard to understand the opposition to keystone. Canada would love to sell all of our excess oil to our friends and relatives in the USA.

    USA would get a reliable oil supply produced and shipped according to best environmental standards, Canada would get a long term reliable customer, and all of the money would circulate within our two countries instead of filling the vaults of dictators who hate the USA.

    But thanks to left wing politics, environmental extremists, and the media, keystone won’t be built.

  3. James Parrott
    September 26th, 2015 at 10:40 | #3

    This is nothing about the market. It is all about geopolitics, and GS’s American Greed at it’s finest!

  4. james parrott
    September 26th, 2015 at 23:33 | #4

    Your next remarks on this theory could be the most important thesis on this subject anyone could ever conceive! please keep up this great work toward the truth of what is really happening! Thanks in advance!

  5. Steve Craft
    September 28th, 2015 at 08:25 | #5

    The Saudis have been covering our pricing desires single handedly since post WWII arrangements. Now, Obama sells Israel down the river, and plays nice with Iran and paralyzes the Pentagon, and does only enough for cover against Isis. The Saudis must think that if we will sell Israel down the river, we could easily do the same to them. Then, after all of the price protection they have done for us for 40+ years, we crank up the oil fraction machine, sending a signal of ‘thanks for the long help, but we will do this regardless of your opinion’. As of late, we are bad partners and thus deserve what we get. God willing, this will change soon. The keystone issue is ridiculous. No one really cares about the environment. It is a no risk irrefutable weapon of fear and votes and manipulation. Caring is a way for non caring selfish people to prove their face in the mirror to themselves as they do all the they can to dismiss God.

  6. Brian S Galpin
    September 28th, 2015 at 23:18 | #6

    Keystone will never happen due to Buffet purchasing BNSF. and taking it private. With the wells he had interest in and coal from Wyoming who is going to even try to match his wit? Unless he has a major spill that threatens the environment he is the King of the rails and petroleum processing and transportation. Now thatvisconly part of it but for one man to have that much power may hurt Americaxin the end!

  7. Naveen Sreedevan
    September 29th, 2015 at 08:49 | #7

    Kent, Want to share few points that corroborate your views. Firstly, Sadui and Abu dhai is one of the top five soveriegn wealth funds and they can out play even Goldman sachs in futures market.
    Here is some data that imply to me that oil is in bea market territory. these two I picked from US energy information administration website.
    As you can see in this lin (scroll down please) Us crude inventory is record high compared to five year average -more than 100 million barrells compared to 5 year avg.
    http://www.eia.gov/petroleum/weekly/archive/2015/150923/includes/analysis_print.cfm

    Secondly, Debt service as a percentage of operating cash flow is now more than 80% as of 2nd qtr for US onshore oil producers.

    http://www.eia.gov/todayinenergy/detail.cfm?id=22992

    Saudi Arabia is investing heavily in Solar farms. they want to export electrcity in future.

    Now oil, the Black Gold has become the Black sheep and king Coal has become Dirty Coal

  8. Naveen Sreedevan
    September 29th, 2015 at 08:51 | #8

    Another pointer to bear market for oil is currency chart of USD/CAd. It is in an uptrend indicating that Canada a commodity/oil player is in the dumps.

  9. October 4th, 2015 at 08:29 | #9

    information is very helpfull

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