Thursday, April 7, 2011

Plentiful Crude Oil and Rising Prices - Apr 7th

Plentiful Crude Oil and Rising Prices
April 7th, 2011

Reading the daily headlines about unrest in the Middle East, restricted if not frozen output from Libya, and a falling U.S. dollar (the currency in which most crude is traded), there isn’t much mystery as to why crude oil has been so strong.  Year-to-date, crude oil has risen almost 19 percent in the U.S.; overseas the Brent crude has gone up over 28 percent.  While this makes sense in light of recent geo-political developments, a closer look at the local supply situation raises some interesting questions.

Abundant Stockpiles

Energy traders pay close attention to the Department of Energy’s weekly survey of crude oil inventories in the United States.  When inventories decline, crude tends to go up as traders infer greater demand or less supply in the market, conversely when inventories rise, the price of crude usually falls.  Since 2008, this relationship has shown a strong negative correlation, averaging about -60%.  More recently, since the beginning of 2011, the relationship has reversed, and crude continues to rise despite swelling inventories.  The correlation between stockpiles and crude oil is now positive, at around 21%.  The chart below shows total U.S. crude inventories (excluding the Strategic Petroleum Reserves – SPR), overlaid against the benchmark WTI (West Texas Intermediary) crude oil futures traded in New York. 

Total U.S. Inventories and WTI Crude
Courtesy of Bloomberg

As you can see, they have tended to move in opposite direction, but both are now trending up.  Surely, crude oil is a global market, and is easily transported from one place to another via tankers and pipelines, so prices in one place tend to stay very close to those in another.  Though even that relationship has been breaking down of late…

Cushing, Oklahoma

As mentioned earlier, WTI crude futures traded in New York have served as the global benchmark for the price of crude oil.  When the news reports on changes in the oil market, this is the price they are referencing.  The other popular benchmark is the Brent crude futures traded in the UK.  Historically Brent crude has traded at a slight discount to WTI, reflecting the slightly lower quality of the crude oil (a discussion of crude types will be reserved for another day), and the price of cross-Atlantic transport.   Due in part to the contract specifications of the two futures contracts, a large divergence from the historical relationship has developed in the past few months.

WTI crude futures are physically delivered in Cushing, Oklahoma.  While most futures contracts are never physically delivered, the theoretical ability to take delivery of actual crude is the mechanism by which futures contracts are able to reflect the true market price of the underlying commodity.  The Department of Energy began tracking crude stored in Cushing in 2004, as supplies in this particular hub are readily available to be delivered against the WTI crude futures.  As we can see in the chart below, inventories have been rising steadily and currently sit at the highest level since the DOE began keeping records. 

Crude Inventories in Cushing, Oklahoma
Courtesy of Bloomberg

As a result of the rising demand for storage space in Cushing, the cost of stockpiling oil has risen dramatically, depressing the price of WTI crude as compared to other global benchmarks.  Looking at the spread between WTI crude oil and Brent crude oil, which is sourced from the North Sea (located between Great Britain and Scandinavia), we see a large divergence from historical norms.

Brent-WTI Crude Spread
Courtesy of Bloomberg

What this all means for the future of crude price is anything but clear, but it does reveal the difference between perception and reality.  While there are a lot of market moving headlines and bullish sentiment, the reality is crude oil is plentiful, at least in the U.S., which is the world’s largest consumer. 

-Jaime Macrae, CIM
Account Executive, Friedberg Mercantile Group

No comments:

Post a Comment