Sentiment reversal in the oil price?

25th Oct '11 by emptyend

5 comments 5826 reads

Interesting piece in the FT today about the dramatic move of the WTI curve from contango into backwardation in recent days:

for the first time since the start of the global financial crisis in September 2008 the cost of WTI crude for immediate delivery is higher than forward contracts.

The downward slope of the price curve is known in the industry’s jargon as “backwardation” and signals a tight supply and demand balance, while the opposite condition, which has prevailed for more than three years, is known as “contango”.

The speed and magnitude of the shift into backwardation has left the oil market reeling.

...and it goes on to conclude that physical oil traders have got it right - and stocks really ARE tight! ....US commercial stocks of crude oil are nearly 8% below year-ago levels at 333mn bbls - which is a fair-sized move in the context of history and the supplies needed to keep the supply system running (which are generally thought to be 270-280mn bbls.....so the fall in stocks over the last year has trimmed the stocks buffer vs "system need" by around 35% - from c.100mn bbls)

It is worth considering which of the scenarios postulated at the end of that article are the most likely to be the underlying cause of this price move. Is the market expecting future oil demand to fall? Possibly, but there hasn't been any sharp change on the outlook there! Will future production rise? Again this is possible - and perhaps one might argue that Gaddafi's death is likely to make Libya better able to draw a line under recent events and move forward, restoring oil supplies.

But the other scenario is that headline (flat) prices move sharply higher.....

Of course, if that were to happen then I'd guess another SPR release may be on the cards - but perhaps the US may not rush to do that this time.....because the weekend news that the heir to the Saudi throne had died may well have been the main cause of the move into backwardation? As the Telegraph puts it:

The likely decision to appoint a hardline conservative prince as heir apparent to the throne of Saudi Arabia could cause a popular backlash against the rulers…

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marben100

25th Oct '11

Thanks for an interesting article ee.

I'd just light to highlight one fact, however. This sharp move is primarily affecting the WTI price, not Brent. It appears that the anomalous spread may finally be collapsing, having come down from $25/bbl to $18/bbl in the last few days. So, I believe the price move is largely driven by local US factors, not world markets. I suspect the FT authors may be missing some local logistic factors around Cushing.

I'm riding the wave down, at the moment, but unfortunately missed the start of the move. However, if this article is right, the mve could be driven by speculation (resulting from the fall in Cushing inventories you report), so I guess I'll have to watch that wave like a hawk for signs of a turn. The big question is: what has caused Cushing inventories to fall? Has there been a change to the supply/demand balance due to pipeline reconfiguration or is it merely a temporary factor?

Best,

Mark

Correction: the spread is now below $17, having fallen another $1 in the last hour. WTI continues to soar whilst Brent is roughly static.

I wonder to what extent the US consumer has been shielded from high world prices by the suppressed Cushing price? If they have (and the spread wasn't just used to boost refiners' profits) the political ramifications could be grim for Obama, if this rebound is sustained and pump prices catch up.

emptyend

Hi Mark,

This sharp move is primarily affecting the WTI price, not Brent. It appears that the anomalous spread may finally be collapsing, having come down from $25/bbl to $18/bbl in the last few days. So, I believe the price move is largely driven by local US factors, not world markets. I suspect the FT authors may be missing some local logistic factors around Cushing....

...the mve could be driven by speculation (resulting from the fall in Cushing inventories you report), so I guess I'll have to watch that wave like a hawk for signs of a turn. The big question is: what has caused Cushing inventories to fall? Has there been a change to the supply/demand balance due to pipeline reconfiguration or is it merely a temporary factor?

I doubt that the FT have missed local factors - the author of the piece I referenced has been all over the technicalities of the spread for many months now.

One factor (not unlinked to the spread) behind the curve move may have been that players on the WTI/Brent spread may have been positioning in the long end of the curve, in the expectation that pipelines would close the arb in the coming years.....and they may simply have decided en masse to close those positions, resulting in the narrowing of the spot spread at prompt WTI contracts rise.

The other factor that may well cause the spread to narrow is the greater certainty of the restoration of Libyan production following Gaddafi's death. Don't overlook potential weather influences either.

It is impossible really to say what is going on regarding the various plays on that spread. As I have pointed out many times previously, the private punter is at a massive informational disadvantage compared to the insiders who know where the big positions are and how they are held.....so whilst the spread looks to be collapsing, I personally wouldn't think that can be counted upon to continue.

What I would say though is that speculative positions of some sort are being unwound - and that looks to be providing support to oil prices. That may be reflected first in the WTI - but I don't think there is enough information to conclude that it is ultimately WTI-specific.

That may be reflected first in the WTI - but I don't think there is enough information to conclude that it is ultimately WTI-specific.

But there is certainly no evidence that it is not WTI specific. Since 14th October, Brent has been down; closed 14th @ $112.69 - now $110.98; whereas WTI has risen from $87.50 to $93.45 now. Those figures seem to paint a pretty clear picture of what has happened over the last couple of weeks.

27th Oct '11

If that is the case, then the price of buying off such political pressures will have to be a trickle-down of wealth - and that will demand bigger social budgets .....and a higher oil price to fund them!

Interesting to see press comment that the Saudis and Iran seem to be coming together in terms of oil price objectives - with the Saudi's cutting oil output by more last month than at any time since December 2008 in an apparent attempt to keep oil prices over $100 for the OPEC basket....

Sentiment reversal in the oil price?

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Emptyend

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