Oil Markets in Disarray – What's On the Horizon?

by Stuart Burns on

Never, it would seem, has the oil market been in such a state of disarray.

Brent crude, the global benchmark, hit US$117 per barrel this week for the first time since August. The spot price has been rising on concerns over where the showdown with Iran is leading. European consumers have begun to cut back on purchases ahead of an outright ban when sanctions are introduced.

Meanwhile the Chinese, usually buyers of some 20 percent of Iran’s output (or about 550,000 barrels a day) are said to have cut back by 285,000 barrels in January and February, and are now extending this to March. This has less to do with supporting the Western embargo and more to do with slowing domestic demand and possibly some gamesmanship in applying pressure on the Iranians for bargain-basement prices.

Likewise, while India, Iran’s second-largest customer at an average 341,000 barrels per day, continues to buy, they too are applying pressure for discounts. Saudi Arabia has increased production, as has Russia, and both Iraq and Libya are increasing output every month.

No Worries, We Still Got Texas Tea

In fact, the world is not short of oil yet, to the irritation of North American producers (and the delight of North American consumers.) West Texas intermediate crude prices are at a record discount to Brent.

For a number of reasons, including outages at Midwest refineries causing a drop in demand, tight pipeline and storage capacity and a rise in supply (notably from the Canadian oil sands and from the Bakken shale oil region of North Dakota), the US is awash with oil, forcing not only WTI to trade at a widening discount to Brent, but Canadian synthetic crude to trade at a discount to WTI. From a discount of $31.25 per barrel a month ago, Western Canadian select heavy crude is at a $31.25-per-barrel discount to WTI this week, about 50 percent of the spot Brent price, according to the FT.

Spread ‘Em

Maybe the most interesting disconnect in the market is the forward spread curve for Brent crude. Throughout the boom period of 2004-08, Reuters reports the spot and forward oil prices moved in tandem, but now forward prices for 2015 are at a $19-per-barrel discount and have remained remarkably steady even as the spot price has risen in the wake of rising tensions with Iran.

While the forward price curve is not a prediction of the price of oil in the years ahead, it is often taken as an indication of where the market expects supply and demand to balance out. The paper postulates that the rise of oil shale fracking will have a similar (if less pronounced) impact on the oil market that gas fracking had on the natural gas market.

They also suggest rising conventional supplies from Libya, Iraq, Brazil and elsewhere will supplement current supplies, and point to Saudi Aramco’s decision to cancel investments planned to lift the kingdom’s production from 12.5 to 15.0 million barrels per day as evidence of that. Lastly, although much demand growth is predicated on the rise of an emerging market middle class, a combination of greater efficiency in the use of oil and falling Western demand will diminish the impact of that effect.

One element that does seem likely to persist (for the medium term, at least) is North America’s energy advantage globally. Neither lower natural gas nor lower oil prices are likely to equalize with the rest of the world anytime soon and while no one is suggesting it will lead to long-term energy-intensive investments like aluminum smelters, it will provide a welcome boost to more energy-dependent industries in North America relative to many other parts of the world for some time to come.

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