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Watch this Key “Oil Spread” for Brexit’s Real Oil Impact

by | published June 30th, 2016

Crude oil prices rose again yesterday, after a nice spike on Tuesday, overcoming the initial reaction to last week’s Brexit chaos.

The immediate cause is a larger drawdown from U.S. stockpiles than initially anticipated.

Both the American Petroleum Institute (API) survey on Tuesday and the official figures from the U.S. Energy Information Administration (EIA) yesterday indicated larger declines (3.9 and 4.1 million barrels a day, respectively) than expected by analysts.

Now, neither figure tends to correspond with surveys of market players that are made before the figures are released. In fact, over the past three years, the numbers have differed from the surveys 70% of the time.

Not this week.

And that points to one key “oil spread” as the gauge for where oil prices are going next…

Oil Overreacted to Brexit

As you saw here in Oil & Energy Investor just after the Brexit vote, there’s been an overreaction to implied future (and broader) market pressures. Put simply, the crude market quickly became oversold as lemmings raced for the cliff.

What we have witnessed over the past two days is a rebound (supported by the storage data) from a correction that had little basis in fact to begin with.

Now, I’m still sticking to my forecast from April that WTI (West Texas Intermediate, the benchmark crude rate set daily in New York) would come in at $50 a barrel by the end of this month (i.e., June).

We are hovering just below that level as I write this.

True, a pending strike by oil workers in Norway has added to ongoing wildfire problems in Western Canada and civil unrest in Libya. In addition, a declining situation in the southern delta region of Nigeria combined with intensifying terrorism by Boko Haram in the country’s north have all contributed to taking almost five million barrels of supply a day off of the table globally.

That figure eclipses the daily global surplus but has not yet been matched by rising production.

Meanwhile, the penchant for OPEC members to increase available volume has also been restrained of late, a result of factors ranging from financing problems, extraction limits, and the realization among some that recent overproduction cannot be sustained.

Non-OPEC Production Isn’t Going Up Any Time Soon

Outside the cartel, all eyes remain fixed on Russia and the U.S. Current prices make a rapid (and sustainable) acceleration of production unlikely in either country. For Moscow, maturing of primary basins along with a noticeable decline in available capital investment are restraining a move up.

In the American market, another debt squeeze is fast approaching, resulting in another round of liquidations and working capital cuts among oil companies. My latest estimate from two weeks ago put the WTI price necessary to begin a serious stimulation of U.S. production at $62-$65 per barrel.

We may finally reach that level by the end of this year and into the first quarter of 2017, but we are certainly not going to be there anytime soon.

Meanwhile, any relief from fires, strikes, civil wars, or insurrections will restrain major price advances.

However, there is one more factor strongly influencing current oil prices…

This Key “Oil Spread” Shows Brexit’s Real Impact

This is, you guessed it, the UK’s decision to leave the EU (the “Brexit”) and signs that this will progressively move energy investment focus away from London to New York.

Consider this: Since August 10, 2010, Dated Brent – the global crude oil benchmark rate set in London – has traded at a premium to WTI in all but a few daily sessions. That despite the fact that WTI is a better grade of oil.

Both have a lower sulfur content than as much as 80% of the crude actually traded on any given day. But Brent has become the more widely used standards worldwide against which an average consignment is discounted, largely because of London’s importance as a global financial center.

Analysts closely follow the “spread,” that is, the difference in price between WTI and Brent. The more accurate way to express the spread is to calculate the difference as a percentage of the WTI price (since that gives us a good thumbnail expression of the discount).

This spread has been narrowing in the aftermath of Brexit and now stands at less than 1.5%, down from double digits a few months ago. We are looking at parity in the near future, as the American market stabilizes while instability remains the keyword in London, along with Brexit’s impact on the value of the British pound sterling and the euro against the dollar.

Another factor contributing to the Brent premium has been large U.S. crude surpluses, especially as seen in the gluts surrounding Cushing, OK (the primary pipeline confluence and the location where the WTI price is established each day).

New pipeline capacity and direction reversals (to move more volume to petrochemicals complexes on the Gulf Coast), combined with a continuing decline in excess supply, are changing that dynamic, as we saw in the API and EIA data released this week.

Other developments include U.S. refineries as the largest exporters of oil products worldwide and two longer-term impacts: the Congressional allowance to export all grades of crude oil, reversing an over forty-year-old policy, and a guarantee that the main center for energy finance will gravitate from London to New York (and elsewhere) as the UK settles in as a second tier economic and banking location post-Brexit.

All of these considerations benefit American-based oil production against outside competition, boosting investment in the U.S. energy sector, and will be creating some nice opportunities for U.S. investors going forward.

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  1. Domingo mejia
    June 30th, 2016 at 18:24 | #1

    Lis grandes bancos ocultan las verdaderas razones de las subidas y caídas de los precios del petróleo y de las acciones del mercado

  2. Curt Kvamme
    June 30th, 2016 at 23:04 | #2

    Hi. Is all the abuse refineries have been taking lately, is it a long term concern?

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