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Crude Oil at a Crossroad of Inventory and Fed’s QE2
By Dian L. Chu, Economic Forecasts & Opinions
Oil prices have continued to soften at $82.51 a barrel for November delivery on the NYMEX Friday after a Federal Reserve Chairman Ben Bernanke’s speech sparked some uncertainty as to how far the central bank will support the economy.
Crude was also weighed down by the weekly inventory report from the U.S. EIA. Despite a week-on-week draw of product and crude inventory, and supply interruptions from Canada due to Enbridge Inc. 670,000 b/d crude pipeline shut-in since Sep. 9, and at the Houston Ship Channel after a barge knocked down a power line, the overall stocks are still well above the 5-year average with a year-over-year increase (Fig. 1)
Decoupled from Equities and Metals
Crude oil prices had generally correlated with the base metals and equities on U.S. dollar weakness and strong Asian demand. However, due to the abundance of inventory and supply, crude has remained range-bound despite improved market sentiment, and started to decouple and underperformed other commodities with tighter supply conditions, such as copper, as well as equities. (Fig. 2)
According to Barclays, over the past month, the average price increase of base metals has been 11%, compared to only 3% for WTI crude. While this has surprised some traders, it is nevertheless a reflection of diverging market fundamentals, particularly in terms of supply.
Transparency Kills the Mystery
Crude oil prices are also at a “disadvantage” due to the lack of a cross-sector transparency. As one of the most widely traded and liquid commodity, oil has relatively better transparency in the form of weekly inventory / demand detail reporting and various widely available forecasts and analyses, while other commodities remain more “shrouded in mystery.”
So, from that perspective, crude is subject to more volatility cue to the weekly inventory report, and agencies’ demand/supply forecasts. (Just imagine if there’s a weekly inventory report with similar detail, say for gold, silver and copper).
WTI and Brent Disconnect
The persistent inventory overhang at Cushing, OK, the delivery point of NYMEX crude contracts, has also rendered WTI at a discount to the North Sea Brent (Fig 3), whereas WTI is a sweeter and higher grade crude than Brent, and should trade at a premium. This, in turn, has made WTI somewhat disconnected with the global picture, and diminished the status of WTI as a global oil price benchmark.
OPEC has voiced its concern about WTI, which culminated in Saudi Aramco’s decision last November to ditch WTI for the Argus Sour Crude Index to its oil for sale in the US market. (Saudi Aramco had priced its U.S. deliveries against WTI since 1994.)
And Reuters reported there’s new push from Asia-Pacific--user of a third of global crude-- in favor of European Brent to price Southeast Asian crudes. A Reuters survey of traders showed that by 2012, Brent is expected to replace other Asia-Pacific regional benchmarks.
This move will further extend Brent's influence--currently tops WTI and referenced in about 70 percent or global crude supplies--and most likely divert the trading volume from NYMEX into ICE, weakening the U.S. status as the world’s leading financial trading hub.
Meanwhile, widespread strikes, sparked by the pension reform, at all of France's 12 refineries have caused supply concerns among oil producers including Total, and if prolonged, could further widen the WTI-Brent spread. (However, it most likely will not have much impact on the U.S. since France is not one of the major importers of crude product into the U.S.)
"We'd Love to See $100 a Barrel"
While high stocks level traps crude, the 13 percent decline in the Dollar Index since June, on the other hand, has prompted some OPEC members to support $100 oil. For example, Bloomberg reported that Libya indicated “We would love to see $100 a barrel” to help offset the loss of revenue from the weaker dollar. And Venezuela claims the U.S. currency’s weakness means the “real price” of oil is about $20 less than current levels.
QE2 Brings New Normal To Crude
Federal Reserve Chairman Ben Bernanke said in a speech on Oct. 15 that the Fed is prepared to buy Treasury bonds to stimulate the faltering U.S. economy, i.e. a second round of quantitative easing (QE2), and that the interest rate will remain low and longer than the markets' expectation (meaning probably through 2012, instead of 2011).
Such policy typically will further weaken the U.S. dollar, while artificially pushing up prices of dollar-denominated commodities such as crude oil, which could lift crude oil into a New Normal of trading range from $80 to $95 a barrel from the current $70 to $85 price band, through the end of the year, along with lots more jabs from OPEC, particularly Hugo Chavez.
“Trader’s Market” Through Year End
For the remainder of the year, a “miracle story” in either the demand or supply side of the equation is highly unlikely. Barring geopolitics and/or an exceptionally freezing winter season, crude oil probably will be a “trader’s market” before 2011, and prices will be mostly dictated by its inverse relationship to the U.S. dollar, and the timing and extent of the widely expected QE2 from the U.S. central bank.
Asia Holds the Demand Card
For now, Asia and the Middle East are expected to account for the majority of the world's oil demand growth over the next few years, while in the long term, demand is still looking to outstrip supply. (Fig. 4)
Furthermore, China might just put some extra excitement into the crude market next year as Bloomberg reported that China’s new strategic petroleum reserve storage tanks are expected to come online next year. This means Beijing could be ready to stockpile on strategic petroleum reserves to safeguard the country’s rapidly rising hunger for energy.
Related Reading - Saudis Ditch NYMEX WTI - A Global Paradigm Shift
Dian L. Chu, Oct. 17, 2010
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The graph is wrong. Oil production (all liquids) is down from 2006.
Poor research work by the writer. Didn't double check the graph against other sources.
Nice article, and dangerous cross currents to factor into risk from over supply to QE to infinity.
Don't buy it. Demand is about return, not about anything else.
If you don't make money using the oil you won't buy it. This seems to escape the analysts. Believe it or not, nobody is making money @ +$80 oil.
They don't make enough money @ + $50 oil so the past few years have been a form of holding or rear guard action where momentum buys some time until Santa Claus can deliver some new oil fields.
Without return there is no support for the high price. Speculators are driving the price of crude the same way speculators are driving the price of dollars, yen, gold, wheat, euros, whatever. QE has not really started yet, it does not create new money but swaps funds into Fed reserves, it cannot effect the dollar since in deflation PPP does not set FX rates, any QE funds will go into the zombie- bank rathole.
The foreclosure fiasco is murder on real estate which is strongly in deflation and represents most US wealth. The high price of crude is murder on output and returns on output. Crude is - as it has been since 1999 - pricing its customers out of business.
I don't see $100 oil except as a bubble - and bubbles in a sector are never blown twice ... right?
It's ridiculous to quote the paper hawks Libya and Venezuela (or Iran's another) as if they speak for Opec. They never accept big cuts, and they don't live by the small cuts they accept, except sometimes by accident if their production happens to fall due to their incompetence. Nobody with any real weight at Opec listens to a word they say.
The Saudis may dress in robes, but they wear the figurative pants in the Opec house. If you're writing about Opec, quote a Saudi, or at least one of the other Arab gulf states if that's the best you can get. The rest are just squawking birds.
The decision by the gov't to increase the % of ethanol allowed in transpo fuel was not made in a vacuum. Do some simple math. Take a look at how this affects demand for oil (hint -400k barrels a day). What they don't say is although we may see some temporary easing in the price of oil....it will be tacked back on in the form of $2 Bln a year in additional ethanol subsidies, an increase in wear on engines and lower mileage/efficiency using gas with higher ethanol content. But, hey, at least there will be a 'perception' that things aren't worse.
You would think China is definitely getting into the strategic reserve game bigtime. If for nothing more than to feed its people
Talking about strategic oil reserves...
http://cryptome.org/eyeball/spr/spr-eyeball.htm
I would think oil, in the same manner as gold, would track the debasement thru QE of the USD, but for that pesky supply and demand problem. But in the long run, oil is going up, even more than gold.