Tracking the Oil Price Roller Coaster
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Tracking the Oil Price Roller Coaster

by | published February 19th, 2019

Following the intersection of several bullish elements, crude oil prices are moving up again.

Absent some extraneous moves by those desperate to “fake” a slide, thereby cashing out on another quick round of short plays, this upward trajectory is taking hold.

And even without major geopolitical crisis events jacking up the price – and traders consider global uncertainty one of the worst elements in suppressing prices – oil prices are moving up.

This trend is certainly a breath of fresh air after the last few months.

There are several reasons for this change in the market, some of which I have discussed in previous editions of Oil & Energy Investor.

However, as always, the market is complicated and multi-faceted.

In this case, there are three overarching considerations that are fundamental to the current market…

The Fundamental Market Considerations

First, the balance between global supply and demand continues to tighten.

There remain considerable excess extractable reserves that could be brought to market rapidly. But, aside from geopolitical reasons to do so, the prevailing preference among producers is to keep the excess in the ground to support price.

In fact, as we shall see, OPEC – led by Saudi Arabia – has been cutting production even more than expected.

Second, both West Texas Intermediate (WTI), the benchmark crude oil rate set daily in New York, and Brent, the more internationally used equivalent benchmark set in London, have been on a tear.

As of this morning’s open, both have risen 22.8% since the beginning of 2019, and are on pace for the strongest quarterly performance in eight years.

As a corollary to this observation, Brent continues to trade at a significant premium to WTI. The pricing differential of the spread between Brent and WTI as a percentage of WTI – the better way of calculating the market impact of the difference – has been double-digit every trading day since September 20 of last year. These 101 consecutive sessions have been the longest continuous period since I began recording the spread more than 12 years ago.

Now, as the more often used yardstick for pricing actual consignments of oil for trade, Brent is more susceptible than WTI to geopolitical events and the actual underlying dynamics in the global market.

Remember, the genuine exchange between supply and demand worldwide produces the real price of crude, not what occurs in either North America or Western Europe.

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The spread averaged 13.6% for all the sessions since September 20, and has even intensified recently; the daily average thus far in February has been 14.4%. All other matters being equal, Brent having a greater impact in setting international crude prices pulls up WTI more often than WTI pulls down Brent.

Third, as I have previously noted here in Oil & Energy Investor, is my proprietary Effective Crude Price (ECP) algorithm…

The Numbers Continue to Reveal an Oversold Market

I have designed the ECP to determine the actual market price for oil once the exogenous factors to genuine market dynamics – things like short plays, derivative manipulations, and artificial moves to suppress prices – are stripped away.

Now, I generally run the ECP number crunch every two weeks. As of Friday, February 15, the closing price for WTI was 8% and the Brent price was 12% lower than what my algorithm tells me the ECP should be.

That means we still had an oversold environment fueled by hype rather than underlying fundamentals. This is true both for oil as a commodity as well as for the revenue obtained by companies drilling, producing, transporting, or refining it.

However, the difference between market and ECP is constricting.

At close on January 18, the figures were much higher – 18% for WTI and 21% for Brent. The application of the ECP approach indicates a clear rising of the price against what the market dynamics tells us it should be.

As I have noted on several recent occasions, the present saga of crude oil pricing reflects contrary pressures…

Two Contradictory Pressures

One pressure is the overwhelming aggregate of factors pushing prices up.

The other is very limited-term orchestrations of largely overdrawn concerns.

To the extent that these latter machinations are believed, narrow windows form in which artificially-driven short plays allow manufactured declines to generate profits for those arbitraging futures contract (“paper” barrels) prices with the actual market costs of physical oil in trade (“wet” barrels).

Notice that each mention by a pundit of what factors are depressing oil prices falls into one of several categories. They posit a decline because of economic expansion concerns (Chinese industrial slowdowns being the preferred optic of late), a general foreboding angst about an impending global recession, or fears that U.S., Russia, or OPEC operating companies will produce us into a major oversupply.

Keep in mind the following:

  • Each of these elements only surfaces as an actual depressing influence in statistics that are not available even in a preliminary version until three months have passed and in a better read only after six months. They are lagging indicators.
  • None of the pundits want to consider global crude oil demand. Despite aberrations by region, overall worldwide projections continue to advance, and at a rate that is higher than expected driven by accelerating Asian requirements.
  • Major producers could flood volume on the market. But they have no reason to do so. In fact, the only recent example of excessive supply reducing prices occurred after an artificial manipulation of supply by Washington.

As I have discussed in several previous editions of Oil & Energy Investor, the new U.S. sanctions against Iran were to have taken effect in the first week of November. All indications were that the unilateral actions would cut Iranian exports significantly.

In anticipation, Saudi Arabia and other OPEC producers, Russia, and even the U.S. increased exports to make up the slack.

However, at the eleventh hour, the Trump Administration provided 180-day exemptions to the eight largest importers of Iranian crude, putting virtually all of Iranian oil exports back in the market.

The result was a huge oversupply that pushed prices down until the glut worked its way out of the trading channels at the beginning of 2019.

The action also seemed an attempt to subdue the prices for refiner products such as gasoline as the U.S. moved into a pivotal off-year election. Such political sleight of hand will not work again.

In response, OPEC and Russia have cut exports for the first quarter of 2019, with the Saudis last week even extending these cuts beyond levels initially agreed to.

Now the stage is set for the next act in the sanctions drama…

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Will The Political Manipulation Pay Off?

In the first week of May, Trump must deliver on imposing the sanctions, in which case the earlier expected decline in export volume hits and prices rise, or the U.S. loses all credibility.

Either way, OPEC has taken over control in determining its own pricing levels by lowering production beforehand.

Against this backdrop, the other global elements I have been addressing are intensifying.

Exports from Venezuela – once the second-largest producer in OPEC – continue to collapse as the country teeters on the brink of an absolute civil implosion overseen by two contesting presidents.

Rising civil war has required the declaration of force majeure on Libyan exports already contracted, while Nigerian domestic unrest taxes oil production.

Meanwhile, the failing Petrocaribe system throughout the Caribbean increases pressure on the region as Venezuela and Cuba relinquish responsibility for providing discounted oil.

In the background are added supply pressures, even in the U.S.

Prices have recovered and most companies are able to produce at a profit while keeping one eye on the cost of debt needed to continue operations.

However, the 2014-2016 period of abnormally low prices caused a lack of forward capital investment for new drilling beyond existing half-cycle fields.

Pricing Projections Are Still on Track

Such fields already have wells in production with completed infrastructure, thereby allowing for ready localized extension through so-called step out wells. But the working capital necessary to explore and develop new acreage has been late in coming.

There will be an overemphasis in lifting from existing fields, resulting in the kinds of pipeline problems witnessed in the Permian Basin, where production levels will exceed pipeline takeaway capacity in 2019.

This is likely to translate into additional supply having difficulty making it to market rapidly enough.

My earlier projections of $70-$72 a barrel for WTI and $82 for Brent by midyear seem on track, even with the myriad other factors intervening.

These include the U.S. sending troops into Venezuela, or Iran exploiting indecision in the Persian Gulf, or a UK March 29 Brexit without an agreement with the EU, or increasing Chinese moves in the South China Sea.

There will still be retreats and attempt to exploit them by those intend on making money from pushing the crude price down. But the overall trend is moving in the other direction.

Sincerely,


Kent

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