Speculators make the oil price belie market logic

The fickle crude oil market is yet again giving an indication about how divorced it is from macroeconomic fundamentals and why a concoction of confused geopolitics and canny speculation is behind the recent peaks and troughs. To give a bit of background – the WTI forward month futures contract surpassed the US$106 per barrel level last week; the highest it has been in 16 months. Concurrently, the spread between WTI and Brent crude narrowed to a near 33-month low of US$1.19 in intraday on July 11 [versus a high of US$29.70 in September 2011].

 

Less than a couple of weeks ago Goldman Sachs closed its trading recommendation to buy WTI and sell Brent. In a note to clients, the bank’s analysts said they expected the spread to narrow in the medium term as new pipelines help shift the Cushing, Oklahoma glut, a physical US crude oil delivery point down to the Houston trading hub, thus removing pressure from the WTI forward month futures contract to the waterborne Brent.

 

Goldman Sachs' analysts were by no means alone in their thinking. Such a viewpoint about the spread is shared by many on Wall Street, albeit in a nuanced sort of way. While Cushing's impact in narrowing the spread is a valid one, the response of the WTI to events elsewhere defies market logic.

 

Sadly Egypt is in turmoil, Syria is still burning, Libya’s problems persist and Iraq is not finding its feet as quick as outside-in observers would like it to. However, does this merit a WTI spike to record highs? The Oilholic says no! Agreed, that oil prices were also supported last week by US Federal Reserve Chairman Ben Bernanke's comments that economic stimulus measures were "still" necessary. But most of the upward price pressure is speculators' mischief - pure and simple.

 

Less than two months ago, we were being peddled with the argument that US shale was a game changer – not just by supply-side analysts, but by the IEA as well. So if that is the case, why are rational WTI traders spooked by fears of a wider conflict in the Middle East? Syria and Egypt do not even contribute meaningfully to the global oil market supply train, let alone to the North American market. Furthermore, China and India are both facing tough times if not a downturn.

 

And you know what, give this blogger a break if you really think the US demand for distillates rose so much in 10 days that it merited the WTI spiking by the amount that it has? Let's dissect the supply-side argument. Last week's EIA data showed that US oil stocks fell by about 10 million barrels for a second consecutive week. That marked a total stockpile decline of 20.2 million barrels in two weeks, the biggest since 1982.

 

However, that is still not enough to detract the value of net US inventories which are well above their five-year average. Furthermore, there is nothing to suggest thus far that the equation would alter for the remainder of 2013 with media outlets reporting the same. The latest one, from the BBC, based on IEA figures calmly declares the scare over 'peak oil' subsiding. US crude production rose 1.8% to 7.4 million barrels per day last week, the most since January 1992 and in fact on May 24, US supplies rose to 397.6 million, the highest inventory level since 1931!

 

But for all of that, somehow Bernanke's reassurances on a continuation of Federal stimulus, flare-ups in the Middle East [no longer a big deal from a US supply-side standpoint] and a temporary stockpile decline were enough for the latest spike. Why? Because it is a tried and tested way for those who trade in paper barrels to make money.

 

A very well connected analogy can be drawn between what's happening with the WTI and Brent futures' recent "past". Digging up the Brent data for the last 36 months, you will see mini pretexts akin to the ones we've seen in the last 10 days, being deployed by speculators to push to the futures contract ever higher; in some instances above $110 level by going long. They then rely on publicity hungry politicians to bemoan how consumers are feeling the pinch. Maybe an Ed Markey can come alone and raise the issue of releasing strategic petroleum reserves (SPRs) and put some downward pressure – especially now that he's in the US Senate.

 

Simultaneously, of course the high price starts hurting the economy as survey data factors in the drag of rising oil prices, usually within a three-month timeframe, and most notably on the input/output prices equation. The same speculators then go short, blaming an economic slowdown, some far-fetched reason of "uptick" in supply somewhere somehow and the Chinese not consuming as much as they should! And soon the price starts falling. This latest WTI spike is no different.

Neither the underlying macroeconomic fundamentals nor the supply-demand scenarios have altered significantly over the last two weeks. Even the pretexts used by speculators to make money haven't changed either. The Oilholic suspects a correction is round the corner and the benchmark is a short! (Click graph above to enlarge)

 

Away from crude pricing matters to some significant news for India and Indonesia. It seems both countries are reacting to curb fuel subsidies under plans revealed last month. The Indian government agreed to a new gas pricing formula which doubled domestic natural gas prices to $8.40/million British thermal units (mmbtu) from $4.20/mmbtu.

Meanwhile, the Indonesian government is working on plans to increase the price of petrol by 44% to Rupiah 6,500 ($2.50) per gallon and diesel by 22% to Rupiah 5,500. With the hand of both governments being forced by budgetary constraints, that's good economics but bad politics. In Asia, it's often the other way around, especially with general elections on the horizon - as is the case with both countries.

 

Elsewhere, yours truly recently had the chance to read a Moody's report on the outlook for the global integrated oil and gas industry. According to the ratings agency, the outlook will remain stable over the next 12 to 18 months, reflecting the likelihood of subdued earnings growth during this period.

Analyst Francois Lauras, who authored the report, said, "We expect the net income of the global oil and gas sector to fall within the stable range of minus 10% to 10% well into 2014 as robust oil prices and a slight pick-up in US natural gas prices help offset ongoing fragility in the refining segment." 

 

"Although oil prices may moderate, we expect demand growth in Asia and persistent geopolitical risk to keep prices at elevated levels," he added.

 

The agency anticipates that integrated oil companies will concentrate on reinvesting cash flows into their upstream activities, driven by "robust" oil prices, favourable long-term trends in energy consumption and the prospects of higher returns.

 

However, major projects are exerting pressure on operating and capital efficiency measures as they are often complex, highly capital intensive and have long lead times. In the near term, Moody's expects that industry players will continue to dispose of non-core, peripheral assets to complement operating cash flows and fund large capex programmes, as well as make dividend payouts without impairing their balance sheets.

 

Finally, the agency said it could change its outlook to negative if a substantial drop in oil prices were triggered by a further deterioration in the world economy. It would also consider changing its outlook to positive if its forecast for the sector's net income increased by more than 10% over the next 12-18 months.

Moody's has maintained the stable outlook since September 2011. In the meantime, whatever the macroeconomic climate might be, it hardly ever rains on the speculators' parade. That's all for the moment folks! Keep reading, keep it 'crude'!

 

To follow The Oilholic on Twitter click here.

 

To email: gaurav.sharma@oilholicssynonymous.com
 

© Gaurav Sharma 2013. Photo: Pump Jacks, Perryton, Texas, USA © Joel Sartore / National Geographic. Graph: WTI Crude Futures US$/barrel © BBC / DigitalLook.com

Crude bits of the ‘Lough Erne Declaration'

As predicted, Russia and the West's differing positions for and against supporting the Assad regime in Syria threatened to overshadow everything else at the G8 Summit here in Lough Erne Resort, Enniskillen, Northern Ireland but mercifully didn’t.

The leaders of the group of eight leading industrialised nations, meant to promote trade and dialogue at this forum, did make some progress and provided lots of hot air…er sorry…soundbites. The outcome of talks was grandiosely dubbed the 'The Lough Erne Declaration'. But before that, the European Union and the US finally agreed to 'start talks' on a new trade pact while not losing sight (or to the detriment) of ongoing negotiations with Canada.

The trade talks had been under threat from a potential French veto, but EU ministers agreed to their demand "or exclusion of the film and television industry from the talks". On to crude notes, the leaders thankfully did not indulge in silly talk of doing something to 'bring down the price of oil' (and leave it to market forces) just because the Brent contract is at US$100-plus levels.

 

There were also no wide-ranging discussions about price levels of crude benchmarks, apart from individual non-Russian grumbling that they should be lower. More importantly, the G8 thinks the state of their respective economies would hopefully act as a correcting mechanism on prices in any case. The leaders agreed that global economic prospects "remain weak".

 

Ironically, just as US Federal Reserve Chairman Ben Bernanke was issuing soundings stateside about easing-up on quantitative easing, they noted that downside risks have reduced thanks in part to "significant policy actions taken in the US, euro area and Japan, and to the resilience of major developing and emerging market economies".

 

The leaders said most financial markets had seen marked gains as a result. "However, this optimism is yet to be translated fully into broader improvements in economic activity and employment in most advanced economies. In fact, prospects for growth in some regions have weakened since the Camp David summit." You bet they have!

 

The Lough Erne declaration had one very significant facet with implications for the oil and gas industry along with mining. The G8 leaders said developing countries should have corporate identification data and the capacity to collect the taxes owed to them and other countries had "a duty to help them".

 

The move specifically targets extractive industries. It follows revelations that many mining companies use complex ownership structures in the Netherlands and Switzerland to avoid paying taxes on the natural resources they extract in developing countries. Hence, the G8 agreed that mining companies should disclose all the payments they make, and that "minerals should not be plundered from conflict zones".

 

Speaking after the declaration was signed, UK Prime Minister David Cameron said, "We agreed that oil, gas and mining companies should report what they pay to governments, and that governments should publish what they receive, so that natural resources are a blessing and not a curse." Good luck with that Sir!

 

And that dear reader is that! Here are the links to this blogger's reports for CFO World on tax, trade, economy and US President Barack Obama’s soundbites (to students in Belfast), should they interest you. Also on a lighter note, here is a report from The Sun about Obama's idiotic gaffe of calling UK Chancellor of the Exchequer George Osborne – "Jeffery" Osborne on more than one occasion and his bizarre explanation for it.

 

So the leaders' motorcades have left, the ministerial delegations are out and the police – who did a great job – are packing it in. Out of the eight leaders and EU officials in Lough Erne, the Oilholic felt Canadian PM Stephen Harper looked the most relaxed while German Chancellor Angela Merkel looked least cranky among her European peers. Guess they would be, as both economies are the only ones in the G8 still rated as AAA by all three ratings agencies.

 

That's all from Enniskillen folks! Should you wish to read the so called Lough Erne Declaration in full, it can be downloaded here. Despite the pressures of reporting, the buzz of a G8 Summit and the hectic schedule, yours truly could not have left without visiting Enniskillen Castle (above right) in this lovely town full of welcoming, helpful people with big smiles.

The location's serenity is a marked contrast from the Russians versus West goings-on at Lough Erne. It's a contrasting memory worth holding on to. And on Syria, both sides agreed to disagree, but expressed the urgency to hold a 'peace summit.' Sigh! Not another summit? Keep reading, keep it 'crude'!

 

To follow The Oilholic on Twitter click here.

 

To email: gaurav.sharma@oilholicssynonymous.com
 

© Gaurav Sharma 2013. Photo 1: Lough Erne Resort, Enniskillen, Northern Ireland © Invest NI. Photo 2: Enniskillen Castle, Northern Ireland © Gaurav Sharma, June 18, 2013.