As the U.S. market begins its recovery from the double whammy served up by hurricanes Harvey and Irma, my earlier projections of where crude oil prices are headed have come true.
Just a little quicker than anticipated.
As I am writing this, WTI (West Texas Intermediate, the benchmark crude rate for futures contracts written in New York) has moved above $50 a barrel for the first time in over five weeks.
In fact, it’s up 6.1 percent in barely three days. Meanwhile, Brent (the equivalent and more globally used benchmark set daily in London) is approaching $56.
Two months ago, I said WTI would be at $52-$54 and Brent at $55-$57 by the end of September. Currently, WTI is within $2 a barrel of its predicted range and Brent has already reached it.
What’s interesting is the fact that this rise is taking place while much of the Gulf Coast refinery infrastructure either remains offline or is running at partial capacity.
After all, refiners form the bulk of crude end users. A reduction in refinery flow rates usually cuts into crude demand and, thereby, pushes prices down.
Despite that, oil prices are going up this morning. There are three reasons for this…
Ignore the News – Oil Demand is Rising
First, the crude oil balance we’ve talked about for some time has been coming in quicker than anticipated. That’s the case even with the rising U.S. production levels.
But remember, oil prices are set by global developments, not (primarily) by what happens in North America or Western Europe.
Both the International Energy Agency (IEA) in Paris and the U.S. Energy Information Administration (EIA) have recently reported that the balance between supply and demand should be realized in the first quarter of 2018. That is much earlier than previously forecasted.
Now, the arrival of this balance means the price floor will rise.Related: EIA: Coal Is Dying As Renewables Rise
As I’ve noted several times, it’s the floor rather than the ceiling of the oil price range that’s most important to an investor.
That rise prompts oil traders to peg the price of contracts to an expected higher cost of the next available barrel, rather than simply to take a standard estimate of where that barrel will be.
Of course, this increases the market price with a resultant knock-on effect in all manner of oil-related stocks.
Second, demand is intensifying.
Once again, this is happening more in other places in the world than in the U.S. Globally, IEA, EIA, and OPEC have now all revised their expectations for oil demand up (again).
But even in the American market, demand is moving up.
Third, the ability of American producers to ramp up production in short order always puts a damper on any short-term race back to $70 levels and higher.
Then, there’s also the possibility that OPEC members may choose to loosen their present restrictions on production.
On the other hand, as we’ve talked about before, Venezuela’s production is rapidly declining. That, combined with growing pressure on Libyan, Nigerian, and Mexican production offsets U.S. production growth.
Remember, American oil is now increasingly exported into higher-priced foreign markets, cushioning the impact on the domestic market from any rise in volume.
Exports have been adversely impacted by Harvey in parallel to the pressure put on refineries. But that situation is now also improving in Corpus Christi, Houston, and The Channel.
And note that the WTI price is rising despite the dent Mother Nature put on exports.
The “Oil Spread” Keeps Showing Higher Prices are Coming
Finally, we continue to see a wide spread between WTI and Brent. That spread has been above 10 percent for five consecutive daily trading sessions.
This is a matter I specifically addressed on August 25. At the time, I wrote:
“For the first time in two years, the spread of Brent price to WTI as a percentage of WTI (the more accurate way to measure the spread) has exceeded 8 percent for four consecutive daily trading sessions.
The last time this happened, it came at the end of a significant trend in which the spread expanded to a double-digit percentage difference, with early September 2015 comprising the end of the cycle. Two periods of major pricing advances occurred during that trend.
Admittedly, these pricing spikes emerged from low price bases. But by the time we reached the end of the cycle, prices were about the same as they are today.
All of this seems to indicate that the rise in the spread, occurring early in a new process, may well be a harbinger of a higher overall pricing dynamic moving forward.”Related: Does Russia Really Need The OPEC Deal?
Well, that spread has been increasing. Over the 18 sessions since August 21, the average daily spread has been 9.6 percent.
It’s been almost a decade since the last time something like this was recorded.
This doesn’t mean that oil prices are once again off to the races.
But it does mean that the steady incremental improvement in the outlook is settling in.
By Dr. Kent Moors