Take the Spread
The latest attacks on oil tankers near the strategic Stair of Hormuz produced another spike in crude prices on Thursday only to have those levels pull back shortly thereafter. While WTI ended up 3.1% and Brent moved better by 3.4% over the last two sessions, they still were down for the week by 1.1% and 0.7%, respectively.
Risk uncertainty remains a destabilizing influence but remains discounted by two factors. The first is a combination of the manipulation noted in the last ECRG Intelligence and continuously persistent shorts on futures contracts.
Both are ongoing, despite the brief spike in global prices witnessed after the latest attacks in the Gulf of Oman. And, as might be expected, this continues to impact the global price more than the US market.
This is borne out by the spread between Brent and WTI. Brent is more often used as the international pricing yardstick against which more actual oil trades are made than is WTI. At least 70% of daily oil commerce is on grades of crude that are below either benchmark.
When this is because of sulfur and other impurities (the oil traded is sourer), the market is discounting the price to reflect increased costs in processing the oil. However, when the differential is because of weight (i.e., a lower APIº), the heavier crude actually allows for a greater range of oil products to be processed.
Overall, Brent is a slightly inferior grade when compared to WTI. But given its wider usage globally, gluts in the transfer of WTI via domestic pipeline, and the approaching effective ceiling in how much additional US production can make it to the international market (where these days the price of oil is set), Brent has traded at a higher price than WTI for all but a few daily sessions since mid-August of 2010.
Brent is thereby more susceptible to what is occurring outside North America. The spread between the two is a good barometer of the impact geopolitical and other events are having on the valuation of oil.
As of the close of trade on Friday, the spread as a percentage of the WTI price (the more accurate way of calculating the difference) had expanded to 15%, 14.7% over the past nine sessions and 14.2% since May 13. These are the highest sustained spread readings since last December.
This tells us that, despite the downward pressures on oil prices, ongoing concerns in the international market are restraining a more pronounced decline. In early trading this morning both WTI and Brent were down, although, yet once again, the decline in Brent was more restrained.
Crude Price Distortion
To add further credence to the artificial nature of some of this movement, anecdotal evidence emerged late last week that the manipulation I discussed last issue – futures contracts (“paper” barrels) against the available volume of physical oil in trade (“wet” barrels) – had expanded to plays in crack spreads. These allow the speculative trade in futures contracts for crude against contracts for primary oil products. This latter category essentially involves high octane gasoline and low sulfur heating oil (with low sulfur diesel as a surrogate since it arises from the same refining cut).
Sources are acknowledging that triggering indicators have surfaced in European trade, where the prices set in futures contracts and the amount of physical volume available signals similar moves to what has already been identified in straight crude trading.
To put this in perspective, such manipulation is subject to prosecution if originating in the US. However, it is not illegal in Europe, especially if the trade originated in Switzerland with derivative paper then carried elsewhere.
Currently, this “placing thumbs on one side of the scales” is being used to depress prices, thereby enhancing the run of short profits. The dip from market indicated price is remarkable. As I noted in the last ECRG Intelligence:
Almost two years ago, I developed a second yardstick to determine the actual market price of crude in trade, labeled the Effective Crude Price (ECP). The rationale was to ascertain what factor was played by artificial attempts to influence price.
ECP weighs several factors to estimate the external pressure to influence price.
It reviews external attempts to influence price (i.e., those reflecting intentions of traders rather than the play of fundamentals). In rising price trends, ECP estimates moves to increase the price by limiting either “wet” barrel volume (actual crude available for trade) or changing the ratio of that volume against “paper” barrels (futures contracts).
However, the most effective calculation emerges when an estimation is made to gauge the influence of trading short contracts to force down the price of oil. We are in another of those cycles presently.
To be sure, what the ECP concludes is more comparative than absolute. Running sequential calculations will allow over time to approximate base line ranges of ECP results versus what the shipping carriage and futures contracts convey as market indicators. This exercise, therefore, seeks a relational divergence.
OK, with all such disclaimer out pf the way, this is what the number crunching concluded after trading through Friday (June 7). The closing price of WTI was a full $8 (14.8%) and Brent was $12.50 (19.7%) below ECP estimates.
Initial calculations are indicating at least a similar dynamic in evidence for the week ending June 14.
The reason why these moves can continue and the broader market effect on price is still pointing down – despite the rising crisis in the Persian Gulf – lies in the second overall factor.
Demand Revisions Tentative
Reports from the International Energy Agency (IEA) and OPEC last week were the latest to indicate a shallowness in global demand. Now this needs to be taken with some reserve. Overall, demand internationally is still going to come in this year at all-time records. Much of the data pointing to demand “weakness” is knee-jerk.
The earliest indicators of a genuine demand decline trend take at least three months to develop, with the better ones emerging only after six months. As such, all current discussion remains quite provisional.
But it is there, and it is succeeding in restraining price. The main reason involves concern over trade wars and sanctions initiating a round of worldwide economic slowdowns. Once again, there is nothing substantive to justify that such a trend has developed.
Nonetheless, demand worries combined with shorts remaining a readily available way to generate trading profits in the very near-term are succeeding in keeping prices low.
This also illustrates what is perhaps the most sanguine aspect of today’s market environment. A noticeable rise in geopolitical crises and tensions will certainly spike prices.
However, unless there is a direct and measurable impact on oil supply availability, traders can regard them as just another day at the office while overreacting to any rise in US production figures.
At least for now.