Saturday Oil Report — November 5, 2011

November 7, 2011

NOTE: Images in this archived article have been removed.

More evidence for the disconnect between Nymex (WTI) and Brent prices surfaced this week. Although the spread has narrowed, Nymex rose to $94.16/barrel, almost seven dollars more than it was two weeks ago in my as Saturday report. Brent came in at $112.55, only a few dollars higher than it was on October 22. The alarm level remains the same.

Oil Alarm Level —Yellow

As the endless European Debt Crisis waxed and waned last week, oil traders demonstated just how financialized the American price has become. This should come as no surprise. Cullen Roche of Pragmatic Capitalism quotes Dan Dicker, author of Oil’s Endless Bid.

“In the mid-1990′s, the participants and performance of oil trading slowly started to change, and by 2003, the dominating forces in oil trader were no longer with the oil companies.

The list of NYMEX seat owners again shows just how deep the change was.  Right before going public in 2006, only 22 seats remained in the hands of the oil companies that had direct involvement in the buying and selling of oil and oil products.  But a much more significant percentage of seats were owned by companies that ostensibly had nothing to do with the buying and selling of physical oil.

  • BNP Paribas: 9 seats
  • AIG: 6
  • Merrill Lynch: 5
  • Bank of America: 4
  • Barclays: 4
  • Citigroup: 4
  • Deutsche Bank: 4
  • JP Morgan: 4
  • Morgan Stanley: 4
  • UBS: 4
  • Bear Stearns: 3
  • Goldman Sachs: 3
  • Lehman Brothers: 2

That’s a total of 56 seats owned by investment banks! (And yes, I include AIG, which was an enormous booker of bets on oil too, not just in famously bad mortgage swaps.

There you have it. Read it and weep. There’s a lot more proof in Dicker’s book. The Nymex price surged upward as the on-again/off-again European Debt Crisis went into “on” mode this past week. Brent did not.

Regarding the oil price trend for Brent, analyst John Kemp, whom I respect greatly, recently wrote an excellent analysis which I’ll quote at some length.

Oct 28 (Reuters) – For all the bullish talk about tight supplies next year if the global economy skirts renewed recession, and occasional sharp short-covering rallies, benchmark oil prices are softening.

In the past six months, each of a series of sharp short-covering rallies has pushed the front-month Brent futures contract to peak at a lower level than the previous one: $127 on April 11, $126 on April 28, $121 on June 15, $120 on Aug. 1, $116 on Sept. 8, $114 on Oct. 14 and now $112 on Oct. 27…

It stands in marked contrast to the continuous uptrend in prices through 2009 and 2010, which culminated in April 2011, in which each temporary peak was higher than the last (with one limited exception in the late spring of 2010).

Sustained downtrends have been rare since the great upsurge in oil prices started in 2003.

Prices have eased despite several potentially bullish factors: (1) reported tightness in the cash market evidenced by premiums for quality crude and steep backwardation in the Brent forward curve; (2) the Fed’s commitment to keep interest rates lower for longer and attempt to pull down long-term rates; (3) rallying equities; (4) continued demand growth in Asia; and (5) warnings from prominent forecasters at major commodity banks about continued upside price risks from a tightening supply-demand balance in 2012.

Note that I am one of those who has talked about tight supplies and an oil price shock next year if the global economy avoids recession. Yet the Brent price trend has trended downward since the April highs.

The downtrend started back in the late spring, long before there was an end in sight to the disruption of Libyan oil supplies and also before the markets began to fully appreciate the risks of a synchronised global slowdown.

The downtrend is probably due to a combination of factors: (a) expected resumption of Libyan oil exports; (b) cuts to projected global growth; (c) downward adjustments in forecast oil consumption; (d) liquidation of the record long positions in oil derivatives taken by money managers in late 2010 and early 2011; and (e) improved confidence in medium-term oil supplies as a result of tight oil and other technologies.

[My note: This “tight” oil  Kemp refers to is shale oil from plays like the Bakken or the Eagle Ford.]

Market perceptions of ever-increasing supply shortages and escalating prices appear to have given way to greater confidence (complacency?) about the supply-demand outlook.

It is also possible market participants now perceive oil prices have reached a threshold or ceiling where further increases generate slower global growth and are therefore not sustainable except in the very short term, capping gains.

Are we confident about the supply/demand situation in the next year? Or are we complacent? This is the question we’ve considered for many weeks now on DOTE. Kemp has listed the factors that might cause the Brent price to rise and those which might cause it to fall further.

As for the Nymex price, I think this “benchmark” price is damaged beyond repair. The price is set by the banks on Dicker’s list, not by physical traders. Brent too is a flawed benchmark, but we might at least hope that it more accurately reflects the supply and demand fundamentals. And it is the Brent price which is most affecting gasoline prices.

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But in the past year WTI prices have decoupled from those in the rest of the world. WTI now trades for about $91 per barrel, fully $20 a barrel less than Brent. There are a variety of reasons for the split, including limited storage capacity at the Cushing, Okla., oil hub where WTI is traded and surging demand for oil in Asian markets, which are more tightly connected to Brent than WTI.

All of this matters to American drivers because U.S. refineries get a lot of their oil from overseas — and therefore often pay prices that are linked to Brent, not WTI.

That’s especially true of refineries on the coasts, which is part of why a gallon of regular unleaded costs $3.54 in New England and just $3.36 in the Midwest. Nationally, gasoline prices generally track Brent much more closely than WTI.

Therefore, we should probably disregard the Nymex (WTI) price and ask what will the price of Brent be in two weeks? As Kemp said, the price trend is downward. The price only moved a few bucks despite these recent shenanigans in the Eurozone. I don’t know what the price will be, but the world economy certainly isn’t getting any better.

Tags: Fossil Fuels, Oil