Oil Prices Spike as Mayhem Takes Hold
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Oil Prices Spike as Mayhem Takes Hold

by | published April 10th, 2018

As I write this, oil prices are billowing higher.

Both West Texas Intermediate (WTI) and Brent are rising sharply, each up 1.9% for the day before the market even opened.

That means WTI has jumped 4.1% in less than two trading sessions, while Brent has improved by 4.3% over the same brief period.

Now, I do expect that there will be some leveling off as the rise catches some resistance.

However, we cannot underplay what’s been happening in oil recently.

With WTI approaching $65 a barrel and Brent already surpassing $70, both have surpassed my estimate of where the prices would be at the end of June.

And this is why…

What Happened?

The one reason garnering the most press for oil’s recent volatility is China.

The oil market is seeing a relief rally after U.S. officials backpedaled on a potential trade war with the “Red Dragon” over the weekend.

Yet, that remains largely speculative, as (no pun intended) analysts attempt to read tea leaves in search of substance.

And then there is always the ever-present possibility of a tweet from the White House undoing everything.

The second reason being the markets gave back most of a huge gain late yesterday afternoon as news spread of a subpoena-fueled office and residential search of the president’s personal attorney, Michael Cohen.

Based on what is happening this morning, much of that lost advance is likely to be reclaimed today.

Third, adding to the upward trajectory is a spree of geopolitical mayhem developing across the globe.

We’ve got a deteriorating environment in the Persian Gulf, a continuing collapse in Venezuelan oil production, and persistent uncertainty in Libya and Nigeria.

And then there is the ongoing weakness in the dollar, adding to the push-up.

Notice what all of these have in common…

With the possible exception of forex considerations, and even then discounted by the mere fact that the value of the dollar has an impact on oil prices almost entirely in international sales, these elements have nothing intrinsically to do with oil itself.

The Problem With Oil…Isn’t Oil

These are all exogenous political or geopolitical elements affecting oil from the outside.

For some time, it has been a fictitious notion to believe that such forces are exceptions to the rule.

They are now deeply ingrained in how the oil market genuinely operates.

As I have noted on many occasions, these are not outliers, interruptions of what is a normal situation.

These are endemic to the situation itself.

Nonetheless, when the actual condition of oil only is considered, the prospects of a sustainable rise improves even more.

The essential reason is found in the rapidly arriving balance.

That balance is based upon the classic interchange between supply and demand.

As veteran Oil & Energy Investor readers well know, this does not mean supply merely equals demand.

There are some other dynamics afoot.

The JIT Approach

One considers the volume available in the market.

There, a “just in time” (JIT) approach – that is, managing to reduce costs from cutting stockpiling by providing material as needed – would be disastrous.

JIT might work in some distribution of finished oil-based product to final end users.

But given the process from upstream production through midstream transport to refining to wholesale, a JIT for oil would result in significant pricing volatility.

As a result, a staple balance market requires an oil surplus. It is the perceived trajectory of that surplus that results in the biggest single factor in determining pricing range.

Now that range is best viewed by focusing upon the pricing floor rather than the ceiling.

The give and take in oil is usually found at the highest end of the range, where more traditional elements of resistance mitigate further advances.

Support levels are a floor consideration.

But in oil, they act a bit differently.

In situations where demand is perceived as rising, support tends to rise as well.

Of course, that assumes outside factors are not influencing prices. And as I have already observed, that is now the normal way things operate.

However, perception is also an important factor in oil pricing.

Once again, let’s turn to an observation I have made many times before in Oil & Energy Investor.

“Paper” barrels (futures contracts on consignments of oil) drive the price of “wet” barrels (the actual oil in trade).

On any given day, there are much more paper than wet barrels in the market. As the expiration approaches on the futures contract, arbitrage takes place to square the market price for the oil itself.

And that brings us to another staple in my oil market explanation.

The perception of where prices are going remains the single-most-important drive of the market price.

Remember, traders peg contract prices to the expected cost of the next available barrel.

In periods of anticipated rising prices, that is translated into the highest expected cost of the next available barrel.

Traders do this because in rising price situations they require more insurance (hedging) on the higher side.

We are in that environment now.

Markets surge up seeking equilibrium, resulting in the end of strong pricing rises.

But they do so with a higher floor (and support).

That’s all we need to continue making money.

Sincerely,


Kent

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