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As I write this, oil prices are retreating (again) and approaching two-month lows. This decline is underway despite some rather heavy supply pressures that should be moving it up.
Thus, the question is: Why?
The overall dynamics would seem to indicate higher prices:
Things like the reimposition of U.S. sanctions against Iran; a continuing collapse in Venezuela; widening impact from a festering civil war in Libya; a Russian export suspension mess on the world's largest pipeline remaining unresolved; an OPEC+ emphasis on production restraint; extraction problems in Mexico; and even discount pricing spreads in Canada have moved supply concerns to the front burner.
And that's just the warm-up.
Now, all this needs to be put in perspective...
The Big Question Emerges
There remains plenty of oil available globally; this is hardly a "Peak Oil" Armageddon.
What should be happening is a squeeze that rachets oil prices up in a sustained, but controlled, rise.
Of course, geopolitical tensions could explode at any time in several parts of the world (e.g., the Persian Gulf, the South China Sea, or Venezuela), dramatically spiking oil prices. And these cannot any longer be considered outliers. Managing such crises has become a staple of estimating where oil is heading.
So, with all of this on one side, why is oil moving south?
Well, there are four primary reasons.
The "Tit-for-Tat Tariff Spat" Is Having Far-Reaching Consequences
First, the intensifying U.S.-Chinese trade war is casting a major pall on demand projections.
I have no interest whatsoever in discussing partisan spin at this point, political justifications, or the banter over who is responsible - reminiscent of raising kids ("it's not my fault, he started it").
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Rather, the effect on markets becomes the central issue. Here, the inevitable rise of emphasizing knee-jerk projections emerges. Despite any statistical reasons to be concerned that demand will take a hit a quarter or more into the future, the crystal balls are all out.
Underlying international demand remains strong and is still expected to reach historic levels before the year is out.
Simply put, it is less the realized demand itself and more the uncertainty of what happens next that is prompting the angst.
That translates into projections that have little basis in fact, at least at this point.
Yes, a concerted "tit for tat" with U.S. tariffs and Chinese responses could at some point adversely impact both production and economic prospects in both countries. But it hasn't.
Nonetheless, the cloud remains and has affected how near-term oil prices are perceived.
When the U.S. Doesn't Perform As Expected
Second, this places how U.S. production levels are perceived by market participants.
American volume is not part of any OPEC+ agreement to restrain production. Furthermore, the availability of large extractive reserves puts U.S. production in the center of any global supply-demand discussion.
If one thinks a demand contraction is coming, an increase in U.S. production for any given week will instantly transform into predictions that the price will decline, along with the corollary enticement to short crude and make a quick profit. To the extent that the shorts work, they simply provide another artificial (i.e., non-market) cause of a pricing decline.
Here's the factor to remember on this one.
Accelerating U.S. production may well depress West Texas Intermediate (WTI), the benchmark rate used in New York, but it is having a more subdued impact on Brent, the more widely used international benchmark, set daily in London.
This introduces the fact that the ability of U.S. crude to be exported is reaching a ceiling.
Totaling between 3.2 and 3.5 million barrels a day, current port and infrastructure capacity pretty much limits further increases to about 10% on average. There are expansions underway, especially in and around Corpus Christi on the Gulf Coast, that will increase the numbers. But these developments are still at least eight months or more out.
The inability of additional U.S. exports to balance out global demand should be reflected in the spread between WTI and Brent.
And it is.
The spread as a percentage of WTI (the more accurate way of calculating the market impact) is once again over 15%.
Traders Hate Uncertainty in the Market
Third, the uncertainty of impact on demand puts oil traders in a tight spot.
These guys need to peg futures contract prices on where they think the cost of obtaining oil is likely to be at some point further on.
Once again, as I have noted previously in Oil & Energy Investor, that requires estimates of what the next available barrel is likely to cost. In periods of uncertainty, similar to what we are presently experiencing, that means traders will gravitate to using the least expensive next available barrel cost, offsetting moves in the other direction by more energetic use of option plays as hedges.
That further drives the price down.
And that leads to the most interesting development in all of this.
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Futures Contracts Are Impacting the Price of Oil
The final reason for the downturn in oil prices is this.
There is a widening disparity between the volume of oil specified in futures contracts and the actual oil being traded.
There are always more "paper" barrels than "wet" barrels. The futures contracts are investment vehicles. But aside from end users also attempting to hedge their prices, those writing contracts are looking to make a profit not to own any oil once the contracts expire.
The most salient indicator that the uncertainty is affecting price is this one.
More contracts are being cut as compared to oil for delivery than normal. This reflects trader inability to determine the cost-price relationship with any conviction. The increasing number of futures contracts is not translating into rising the volume of oil in trade.
But those contracts are further pressuring the oil price.
Again, there should be a statistical way of identifying this, and there is.
Examining the "strip" (the number of contracts entered into extended by month into the future), there are excessively more short-term (one month to three months out) contracts than normal.
This indicates the downward pressure is seen as temporary, with the near-month (next month) contracts predominating.
All of this does not mean the current trend will end suddenly.
But it does mean that it is more the result of matters having little to do with traditional ideas of where the oil is and who needs it.
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The post Oil Prices Should Be Going Up - Here's Why They're Not appeared first on Oil & Energy Investor.
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.