Weekly Crude and WTI Oil Market Summary: WTI reaches highest price in 9 weeks

As I mentioned in my last weekly post, oil transactions were likely to see low volume over the past week due to the Christmas holidays and thus prices were likely to change mostly on big-name events. Indeed, over the past week volumes have been down as much as 81% below the last 100-day moving averages, and we have seen big price fluctuations as market sentiment regarding the likelihood of a US fiscal agreement to avert the so-called fiscal cliff has swung from positive, to negative, and back again.

While the WTI price finally reached a 9-week high on positive fiscal-cliff related news,  a negative market reaction to the later-than-usual weekly release of inventory data, which showed an increase in gasoline stocks, was enough to prevent WTI maintaining its highest point of $91.5, and instead the grade ended the week at $90.8. Despite both grades being affected by similar economic news, the WTI-Brent spread narrowed for a second week in line with the trade recommendation put forth in my previous post “The WTI-Brent Spread: narrowing in the New Year?”.

A Daily Summary

Both WTI and Brent futures for February delivery slid on Monday 24^th, with President Obama leaving for a Christmas break amid no fiscal agreement or even consensus that one would be reached; WTI fell -0.3% to $88.6 and Crude -0.2% to $108.8. These losses were more than offset by news on the 26^th that the President had cut short his vacation to return to Washington and resume budget talks, with WTI increasing 2.1% and Crude 1.7%. Despite these rises both grades had fallen from their high points for the day, but this is likely due to a number of short-term traders taking gains as momentum slowed from the rapid price increases that had taken both grades above known technical resistance areas indicated by Bollinger bands (see chart).

Both grades traded more-or-less sideways on the 27^th as both transactions volumes and news was slow. However, with volumes still low on Friday, both grades ultimately suffered losses as remaining traders reacted strongly to negative inventory news from the weekly EIA release. The report indicated that gasoline stockpiles increased 3.78 million barrels last week, almost 3 million barrels above the 850,000 increase that had been expected by analysts in an industry survey. This negative inventory news came in conjunction with negative petroleum consumption data, showing a drop in total petroleum consumption of 5.5% to 18.9 mB/D. This news that consumption had dropped by its highest level since August 17^thand that stockpiles were already rising rapidly, in conjunction with the expectation that consumption will drop greatly if the fiscal cliff is not averted, was enough to spook WTI and Brent market participants and the former grade fell -0.8% on Friday,  while the later dropped -0.5%. Despite these drops both grades experience a weekly gain, with WTI finishing the week 2.1% up at $90.8 and Brent increasing 1.5% to $110.6.

The Week Ahead

With fiscal cliff negotiations reaching the deadline of 31^st December, it is becoming more and more likely that a deal will not be reached in time, however there still remains hope that an interim deal will be pushed through to prevent such deep fiscal cuts coming in to effect, as reported in this article from the New York Times. Any type of deal should be slightly positive for oil prices; although with the large price increases seen on the 26^th of December it is possible some of the positive macroeconomic effects of such a deal are already priced in. Nevertheless, providing an interim deal is reached tomorrow, I expect both grades to increase on the week. A higher increase in the domestically produced and consumed WTI should serve to narrow the WTI-Brent spread further by the end of the week.

Weekly Oil Market Summary: Budget news to overshadow supply fundamentals over the coming week

 17^th – 21^st December

WTI Crude (02/13 contract) finished 2.1% up on the week at $88.7, having started the week at $86.9. Brent managed only a 0.6% rise on the week, increasing from $108.3 to $109. Hence the WTI-Brent spread narrowed from $21.4 to $20.3 over the course of the week.

The main piece of economic news affecting oil prices remains the progress of US political discussions regarding the so-called fiscal cliff negotiations. While there was some optimism an agreement would be reached at the beginning of the week, seeing both grades rise on Tuesday, this was offset later in the week as the Republicans rejected the Democrat’s latest negotiation proposal. Any potential new tax and spending cut law will now be voted on after Christmas, and with the time counting down market participants will remain worried that no deal will be reached, which would be negative for demand fundamentals of both grades.

A combination of two oil inventory reports, the American Petroleum Institute release late on Tuesday and the weekly EIA release on Wednesday, both reported a decline in US crude stocks and were positive to the prices of both grades; WTI increased 1.8% and Brent 1.4% on Wednesday. Given the total crude stockpiles actually fell by less than forecast, the increase in WTI was much bigger than would be expected by just the headline number. This could be due to the more detailed numbers provided in the report -  I’ll provide a more in depth post on the importance of these details after the holidays.

While prices of both grades rose slightly on Thursday, in part due to a second release of US GDP data for Q3 coming in higher than expected, this was offset on Friday by three main factors. This included the negative sentiment reflecting budget negotiations, and for WTI only, technical indicators and news regarding the BP Whiting refinery. With the Thursday price going above WTI’s upper Bollinger band (see chart below) there were indications the commodity may have been overbought that day, prompting some traders to lock in the profit and forcing the price back down on Friday. Furthermore Bloomberg reported in this article that the Whiting refinery upgrades will be delayed, and as I mentioned in my previous post, "The WTI-Brent Spread: narrowing in the New Year?" , such upgrades are integral for the narrowing of the Brent-WTI spread. Thus this news saw such houses as Goldman Sachs downgrading their views for the WTI price over the next three months. However Goldman analysts still see the WTI-Brent spread narrowing to $14 by the end of March, from its current position of $20.3. Interestingly, the spread did not widen on Friday despite this news. Whether this is an indication that markets believed the spread was already too wide, or whether the spread could actually widen over the next few trading days, remains to be seen.

With trading limited over the next week due to the holidays, markets could lag small fundamental factors but still move to big-event news. Hence, while my previous posts have predicted WTI to increase due to more favourable supply conditions (see here), this increase may be overshadowed if negative news is released regarding US budget negotiations. This should not change the fact that WTI will continue to increase into the New Year to come closer in to line with the Brent price. Hence while we may see both grades react similarly over the next week or two, WTI should begin seeing lower losses or higher gains than Brent on a daily basis as market activity picks up again in the New Year.

Happy Holidays!

The WTI-Brent Spread: narrowing in the New Year?

UPDATE: For more on the WTI-Brent spread check this updated article "Seaway no Solution" as well as a discussion of 2013 forecasts here.

The WTI-Brent spread describes the relationship between the two most widely used benchmarks for crude oil prices. While the oil represented by each benchmark is similar, WTI has historically fetched a slightly higher price for a number of technical, economic and geographical reasons.  While being similar grades of light, sweet oil, WTI has preferable sulfur content and is better for producing gasoline than Brent. Furthermore with the USA being a large importer of oil, the total price paid to import Brent, that is the cost of the oil and the delivery costs, should roughly reflect the total price of domestically produced WTI, all other things being equal. Hence when factoring out these higher delivery costs from the North Sea region, Brent has tended to fetch a slightly lower price.

Despite these factors, Brent currently fetches a massive premium of around $22 per barrel over WTI, and as the chart below from yCharts shows, this is near a record high. So what are the reasons for this recent disparity, and what’s more where should we expect this relationship to go over the short-medium term?

Brent WTI Spread data by YCharts

Let’s begin with a bit of background information on the difference contracts: due to the physical nature of oil transactions, each contract must have a delivery point. For Brent it can be anywhere in Europe, but for WTI it must currently be Cushing, Oklahoma. This is an important factor in the pricing of WTI; as Jim Brown of Oil Slick explains,  if there are logistical problems such as excess demand for storage at Cushing, the price of WTI will decline as the cost of opportunities for traders, such as buying and storing WTI for future sale, increases.  With this increased supply glut at Cushing it is also harder for traders to take advantage of short-term opportunities as there is more competition for pipeline capacity and therefore the oil takes longer to move. These factors are all currently at play, and hence the price of WTI is being driven down.

While there are factors that are driving down the WTI price, there are also factors that are driving up the Brent price and thus causing the spread to widen. With Brent the international benchmark for much of Middle-Eastern produced oil, increased risk in these regions drives up the chance that less Brent-benchmarked oil will be available in the future and that current contracts may not be delivered. This increased risk is represented in the total Brent price as a risk premium, and the risk premium has increased greatly since early 2011 due to a number of factors such as the Arab Spring uprisings and continuing political turmoil in the Middle Eastern region. This is clear if you cross-examine this Guardian-provided timeline of these events against the spread chart from Ycharts; we see that the spread spiked as events associated with the uprisings began in January 2011 and further spikes coincided with events such as a intensifying of fighting in major oil producers such as Libya in September 2011, shortly before the death of Colonel Gaddafi in October 2011, after which the spread began to fall as sentiment improved.

In 2012 risks to the Brent supply have continued with events such as the civil war in Syria threatening oil supply routes as well as other recent events that have caused the Brent price to spike; for instance trade sanctions on Iran have reduced potential supply and there have been a much higher occurrence of unplanned oil field outages in the North Sea than normal during this time of year.

The question that is of interest to us is where the WTI-Brent spread is heading, and while it is hard to predict political events that influence the risk premium of Brent, there are at least a number of factors that should mean the price of WTI will begin to rise and converge to the Brent price minus it’s associated risk premium, therefore creating a WTI-Brent spread trading opportunity. As Sandy Fielden of RBN energy explains in this article, the major Seaway oil pipeline between Cushing and Houston, which historically has flowed toward Cushing, is being reversed and expanded to allow 400,000 barrels of oil per day (mb/d) to flow away from the supply glut and towards refiners on the Gulf Coast, with an estimated completion date begin early 2013. Furthermore from mid-2013 an upgrade at the BP Whiting refinery in Indiana should be complete and will add around 400,000 to oil demand in the area. In addition to these factors a number of rail upgrades throughout 2013 will continue to alleviate the supply glut at Cushing and therefore reduce the rate at which supply is currently outstripping demand. Many analysts thus predict a narrowing of the WTI spread.

While there are a number of reasons why we may expect the WTI-Brent to narrow in 2013, we should also be aware of the structural changes in the global economy which may mean the spread may not revert to its previous position in which WTI commanded a slight premium. As mentioned in my previous post, “The long-term relationship between the US dollar and oil prices” (LINK), the macroeconomic structure of the global economy is changing and the USA will in the future account for less of the total oil demand than it has done historically. As mentioned above, part of the reason for a WTI premium is the delivery cost of Brent to the USA. If instead Eastern economies such as India and China begin to outstrip the USA’s oil demand, then it could be that WTI will trade at a lower price due to higher delivery costs to these emerging economies. If the current political rivalry between these emerging economies and the USA continues, it is also possible that trade sanctions and the political charge for energy independence in the US will mean US exporters will not be permitted to export to these economies, and thus WTI will in effect face a different demand market than its European counterpart, with different price implications attached. 

Overall trade idea: shorting a medium-term Brent contract while going long on the associated WTI contract will give investors exposure to the factors that influence the spread while hedging against movements based on macroeconomic fundamentals. As of end of trading 19/12/2012, Brent is priced at  $110.16 while WTI is at $89.69 we'll revisit these in the new year to track the progress of a virtual trade on this spread.

The long-term relationship between the US dollar and oil prices

Bloomberg published an interesting article yesterday stating that the USD is expected to appreciate in the future given the US shale oil production boom that could make the US a net oil exporter by 2020. While higher US production will have an impact on global oil markets, how could a strong USD also impact? http://www.bloomberg.com/news/2012-12-17/fracking-boom-is-dollar-boon-in-energy-independence-currencies.html

Firstly let’s look at the current relationship between oil and the USD. At the moment the US is a net oil importer, this means that there is a USD outflow to oil producers such as the OPEC nations. These countries seek to invest this income in a portfolio of assets which are not all priced in USD and hence to make these investments USD must be exchanged for other currencies. This means that as more oil is imported, more USD flows on to currency markets and the USD will depreciate due to laws of supply and demand. With a higher domestic oil output this process should reduce or even reverse, and so the USD is expected to appreciate.

To answer how this stronger USD could impact oil markets, we can look at what the effects of a weaker USD, caused by QE during the crisis, were expected to have on the price of oil. A 2011 article by Reuters  thought that for two main reasons this would case a rise in the oil price. Firstly, oil purchases would become more attractive for holders of other currencies, which results in higher demand for purchases. Secondly, because producers of oil receive USD for their exports, a weaker USD can cause these producers to reduce supply to drive up the oil price such that in terms of their domestic currency their export income remains the same. While OPEC producers have in fact kept supply strong, this has been due to their belief that a higher price could endanger an economic recovery and therefore their future earnings.

So if a weaker USD results in a higher oil price, can we for the same reason expect a stronger USD to result in a lower oil price? Well, in terms of the action producers take, they may be keen to maintain a certain level of income, but it is unlikely they would take action to prevent a higher level of income. The exception to this rule is if they believe a high oil price for non-US countries could again endanger the global economy, however we might hope that this will not be such an issue in 5-10 years if economic growth picks up. Additionally, the changing structure of the global economy and global oil demand may mean that economic growth can support a higher oil price. For instance, if the US becomes a net exporter then the world’s largest economy will benefit from these prices, and providing this money is invested in other economies as well high global growth could persist.

While a stronger USD will make oil purchases less attractive to holders of other currencies, with Eastern economies growing in size and other currencies growing in importance, oil transactions are more and more becoming priced in other currencies. Because of this changing macroeconomic backdrop, other currencies should become less inextricably linked to the USD and the weight of USD in total FX transactions (the USD currently is on one side of xx% of FX transactions) could decrease, with the currency also potentially losing its position of strength as the world’s preferred reserve currency. This may also reduce some of the downside risks to the oil price of a stronger USD.

With a dramatically changing global macroeconomic structure, and the geographies of global oil flows changing, there are therefore plenty of reasons to question whether the current relationship between the USD and the oil price will hold in the future. While these questions may not have such an impact on the short and medium term outlook for oil markets, we should take note of them for the long term direction of where oil is heading. 

Weekly Oil Market Summary: Time for a Breakout?

Brent closed at $108.18 on Friday, an increase of $2.64 from the previous Friday’s close of $105.54. This was despite concerns over whether the US fiscal cliff will be diverted, and means Brent crude has registered a fifth weekly gain since the beginning of November.

The first two days of the week saw oil move slight upwards on Tuesday as German consumer confidence increased to its highest level in seven months. However the momentum could not continue on Wednesday, and despite prices reaching $108.99 during trading, the market closed at $106.54 as increased US inventories indicated an increase of supply and provided fuel for the bears.

Thursday saw further downward price movements as concerns built over whether US political leaders will negotiate the fiscal cliff and prevent automatic spending cuts and tax increases coming in to force in January. 

The biggest daily rise and main component of the weekly gain came on Friday with the release of US industrial output and Chinese PMI data. Industrial output in the US was seen to have increased 1.1% in November on the back of rebuilding after Hurricane Sandy, while the Chinese PMI number came in greater than expected at 50.9. While the rebound in US industrial output could be temporary, these two key indicators nevertheless gave short-term support for the oil price, and offset loses seen after the increased US inventories reported on Wednesday.

The coming week

Without an extension of the current spending and tax profile, the macroeconomic outlook for the world's largest economy, and therefore oil prices, is certainly to the downside. Market participants will therefore continue to watch US budget discussions over the coming week; news suggests that republicans are discussing a back-up plan that would at least cancel some tax rises and therefore be more supportive for oil prices than nothing at all. Because of this massive unknown hanging over the market, it is unlikely that other economic events will cause prices to break out of the recently traded range of $105-$110. In fact, as a quick glance over the chart below shows, prices have been fluctuating over a narrower range over the past week, possibly in anticipation of a market breakout. Whether this breakout will be positive or negative remains to be seen, but with the US economy rapidly heading toward the fiscal cliff, there remains significant downside risk on the horizon. With this being the last full week of trading before the holidays, we may also see a price fall toward the end of the week as traders close out positions before the holidays.

Welcome to Profit from Oil: a Guide to the Oil Market

Welcome to Profit from Oil: a Guide to the Oil Market. The aim of this blog is to provide commentary and news regarding current oil prices and the future market outlook.  I'll regularly be posting a combination of news commentary and fundamental macroeconomic analysis, as well as discussing potential technical factors influencing the oil price.

While most of the posts will relate to the more well-known types of analysis, I'll also be periodically introducing less-common technical analysis and discussing whether these tools have any relevance to current market sentiment. With this discussion I hope to further both my own and your knowledge of potential analytical tools that could be used to better our understanding of this complex market.

As well as frequent technical and fundamental analysis and commentary I will be posting more general, one-off guides to the oil market such as market overviews and guides to the supply and demand factors that generally influence the oil price. Therefore by following this blog I hope to give you the chance to not only understand the current issues at play regarding the markets, but also understand the history and background behind this important commodity.

As anyone who has an interest in markets will know, it is only by sharing and discussing ideas that our knowledge grows; hence I welcome all comments and questions and will share my own views in response.  If you agree with me that’s great, and if you disagree that’s even better! Furthermore, the topics behind my posts will be based not only on current issues but also on any feedback or questions I receive, so please ask away!

While the title of this blog is Profit from Oil: a Guide to the Oil Market, I do not pretend to be an expert in the oil market and nor am I giving investment advice.  Rather I hope that you will use this blog as a tool to find out more about oil as both a commodity and a financial instrument, as well as building your awareness of the fundamental and technical factors that influence its price. Above all, while I hope you will find my views useful and interesting, you should question them as much as you should question anyone else’s views on market issues.

Thanks for reading this introductory post, look out for the first post covering oil market commentary coming up in the next couple of days!