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Crude Oil Spikes Like An Egyptian
By Dian L. Chu, EconForecast
Images of mass Egyptian protesters clashing with police in Cairo broadcasted around the world shook global financial markets on Friday, Jan. 28. Dow and S&P 500 both dropped more than 1%, while some asset classes such as gold, silver, U.S. Treasuries were hot commodities from safe haven demand.
NYMEX West Texas Intermediate (WTI) also spiked more than 4%, closing at $89.34, while ICE Brent crude for March delivery surged 2.1% to $99.42 a barrel, and touched $99.74 intraday, a new post-2008 high.
Egypt - Home of Two Oil Transport Chokepoints
If you are wondering the significance of Egypt related to the curde oil market. Here is a quick overview.
Egypt, with oil production of about 685,000 barrels of oil a day, is ranked in the top 30 among the world's oil producers, based on U.S. government data. The country is not a significant oil exporter as its production is mostly used for domestic consumption.
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| Graphic Source: U.S. EIA |
However, since Egypt is home to the two world oil transit chokepoints--Suez Canal and Sumed Pipeline--the surge in crude oil prices was partly on worries of potential supply transport disruptions.
Suez Canal Shutdown = Higher Oil Price
Suez Canal is a key water transportation lane between Europe, Middle East and Asia. An estimated 1.8 million barrels per day (b/d) of crude oil and refined petroleum products flowed through the Suez Canal, according to the U.S. EIA. The 200-mile long Sumed pipeline is an alternative to the Suez Canal for transporting oil with a capacity of around of 2.5 million barrels per day.
In the event that the canal is closed, thousands of ships and oil tankers would have to go around Africa, adding about 6,000 kilometers (3,729 miles) to their journey, slashing the availability, while adding to the cost of crude oil.
Increasing Middle East Tensions
Furthermore, since crude oil typically is very sensitive to geopolitics, markets are also nervous because the unrest in Egypt has raised tensions in the Middle East- the world’s major oil-producing region.
As riots first started in Tunisia, spreading to Yemen, and now Egypt, anger over rising prices and high unemployment has also prompted political protests erupting throughout the Arab world in Morocco, Algeria and Saudi Arabia.
Crude & Equities Diverge
Crude oil and equities were mostly trending in tandem since the 2008 financial crisis on the prospect of global economic recovery. And geopolitical events typically tend to spur a broad market risk-off trade, i.e. selling off equities and commodities like crude, going into bonds and dollar. However, since the situation in Egypt is very specific to the supply risk of crude oil, this time around, it is risk-off for stocks, but risk-on for crude, resulting in a divergence. (Fig. 1)
WTI-Brent Spread at Record High
The North African turmoil also strengthened North Sea Brent Crude and widened its premium over WTI to a record $12.49 before ending the day at $10.08 (Fig. 2). Historically, WTI, a lighter and sweeter crude, has enjoyed a roughly $2 premium to the North Sean Brent.
This reversal and widening of the WTI-Brent price differential could be most attributed to seasonal and fundamental factors such outages at North Sea, cold weather in Europe, but more importantly is the “Cushing Syndrome.”
“Cushing Syndrome” Distorts WTI
Cushing, Oklahoma is a major crude oil trading hub and price settlement point for the NYMEX WTI. However, Cushing has a capacity and logistic problem, and the resulted land-lock tends to further exaggerate the already weaker U.S. demand, thus distorting against the WTI price. NYMEX WTI is also gradually losing its influence as global crude oil demand growth is shifting to Asia and away from the U.S.
Inventory at Cushing gained 2.3% in the week ended Jan. 21 to the highest since August, while the overall inventory in the U.S. also rose to 340.6 million barrels, 4.25% higher than a year ago, and above the 5-year average, according to the data from the U.S. EIA.
And the glut could get worse as TransCanada Corp.’s Keystone pipeline starts to pump as much as 156,000 barrels of Canadian crude to Cushing in February.
Lack of Transparency Boosts Brent
To be fair, with all the problems WTI seems to have (mostly associated with Cushing), Brent also has one unfair advantage over WTI which has helped boosting its price. That is, unlike the detail crude and product inventory report issued by the U.S. EIA weekly for the WTI crude, Brent does not have such (or any) reporting structure.
So, for all the criticism about WTI and that Brent is a better benchmark reflecting global demand, Brent could actually have been more easily manipulated to its current near $100 levels, due to its lack of transparency, and the considerably lower volumes on ICE (25% of NYMEX WTI, according to the CME Group as quoted by FT Alphaville.)
Higher Price = Better Benchmark?
I personally think most market players probably just pick whichever has the higher price point as being “the better gauge.” So, when the spread flips back to its historical pattern, either by the U.S. working off the excess at Cushing, or by some change of the WTI pricing structure, we could see headlines touting WTI as the better benchmark.
Fast & Furious WTI Short Squeeze
Meanwhile, the record differential has attracted some new spread traders piling into Brent, while shorting the WTI. Bloomberg reported that open interest for Brent futures rose to a record 968,565 on Jan. 21, based on data from ICE Futures Europe.
This not only further distorts the Brent and WTI differential, but also means a fast and furious short squeeze on the NYMEX WTI, with any unexpected events such as the Egyptian unrest. This is why you see WTI move 4% vs. the 2% of Brent on the same news.
Europe Is Not $12 Stronger
Moreover, the fact that the U.S. has more than sufficient crude inventory, a steady global product demand outlook (Fig.3), and plenty of OPEC spare capacity also suggests the world oil is currently well supplied, and there’s little reason Brent’s fundamentals should continue to be that much stronger than the WTI.
As such, I believe the current wide spread, while partly supported by regional and seasonal market fundamental factors, is not sustainable.
Be A Brent Bear & WTI Bull
And with this new crisis in Egypt, shorts will likely come off on the WTI as nobody will be shorting crude anywhere, not even the WTI, regardless of the Cushing build. So, from what I've discussed here, I’d be more bearish on Brent and more bullish on WTI.
From that perspective, sometime in the next week or so, I expect WTI to break above $90 a barrel and could make a run at $93 as protests escalate, and Brent could break above $100. Meanwhile, the WTI-Brent spread will likely narrow to around $8 next week, and have the potential to move below $6 over the next few weeks, if chaos continues.
Crack Spread To Narrow Further
In the U.S., with both gasoline and distillate stocks continue to build staying above the average range, and declining gasoline demand (Fig. 4), the independent refiners like Murphy Oil, Frontier Oil, Tesoro, will likely bear the brunt of this unexpected spike of crude prices further pressuring the crack spread.
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| Source: U.S. EIA |
Several U.S. refiners - Tesoro, Western Refining, and Alon USA each has short float of greater than 10%, while Valero short float stood at greater than 20%.
Tanker Stocks Get An Egyptian Pop
Similar to Brent, shares of tanker lines like Frontline, Teekay Tankers, General Maritime, Overseas Shipholding, and Nordic American Tanker, also got a pop due to speculation that that tankers would be in high demand if the turmoil in Egypt causes the Suez Canal to close.
So far, the Canal has been operating normally since the riots started, and there’s no indication of a possible shutdown. Nevertheless, since it takes some time for portfolio managers to reallocate funds, and as long as the North African situation remains unresolved, there could be some more upside before the sector’s fundamentals set in again.
Among the tankers, Frontline, the world’s largest oil tanker operator, would be the best of the bunch from a risk/reward standpoint. I’d stay away from General Maritime for the time being mainly due to its high leverage and its struggle with debt in recent months.
Start of a Political Shift in the Arab World
So far, the protests in Egypt seem to have no clear leader or organization, but could be ongoing for a while. For now, they have not spread into the major OPEC countries such as Saudi Arabia in a significant way; however, longer term, this movement could signal a change of political structures of possibly all Arab World in the years to come.
Priceless - Geopolitical Premium
Meanwhile, Bloomberg reported that oil options volatility increased to 30.1%, up 9% in one day as the underlying futures surged the most since Sep. 2009.
So, depending on the development in Egypt and the Middle East, volatility will likely rule crude oil in the near term as there has not been a geopolitical event such as this for a long time, and the “geopolitical premium” rises and falls based purely on markets’ “fear perception.”
Related Reading - Saudis Ditch NYMEX WTI - A Global Paradigm Shift
Dian L. Chu, Jan. 30, 2011 | Read Me on Kindle | Facebook Page | New Article Alert | Google Profile
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no one is shorting Brent or WTI, probably were positions on Brent, but then Egypt went nuts. causing their sovereign funding costs to blow out, divergence with the oil price etc.
Anyone betting that Egypt is going to get worst?
"Spikes" like an Egyptian?? That's the most retarded thing I have read in awhile. Better save the word games and poetry for native speakers, 'cause you suck
aaww. give the contributor a break. It is easy to troll from the bleacher section. Take it from me!
This always happens to me and why a trader needs to know his own psychology. I have an itchy trigger finger and don't like to miss an opportunity. This has in the past caused me to make trades too frequently and usually too soon. I am going to close all my energy long positions in the next few days, but I'm not going to short it right away. I'm going to wait until it looks totally ridiculous because I can't rule out an irrational fear induced mini-spike. If the mini spike doesnt occur soon, and oil starts falling then I will have missed the opportunity to short, but I have realized that it is better to be discipline and let a few opportunities get away from me, and wait for that ridiculous slap you in the face shorting opportunity that occurs only a few times a year in the markets. If by waiting a week to short I miss out on the shorting opportunity because a mini spike doesnt occur then I am ok with that. However a year ago I would have already pulled the trigger and shorted the march contract, and if history is a good guide, I would have shorted way too early and been a typical retail speculator who capitulates at the real oil top. I used to frequently short at the top of the bollinger bands and did ok, but I have learned to look at other indications of buyer exhaustion. At least half the time I did that the damn thing would go five or ten percent above the top of the bollinger band or in a week or two when moving averages started catching up the commodity would stay right at the top of the bollinger band and keep moving up for another month, like silver did. Incredible. It shows a strong silver market that demands respect, but I still think the intermediate term top is in for quite a while
Selling oil volatility now would be a great idea also but a bit more complicated than just shorting the fucker.
Straddles on USO....
What happens when there is a run on Egyptian banks due to economic instability, withdrawals by fleeing wealthy and end of remittances by Egyptians overseas? Todays NYT reports fraud and mismanagment of Afgans largest bank causing loss of $900million and impending broad financial panic. Karzai no better then Mubarak which makes you wonder which way Egyptians will turn for better governance. Little wonder Israel is terribly concerned as is Obama. Bush no doubt enjoying retirement with guaranteed pension
If USA had any balls, which it doesn't because it is both broke financially and politically, it would immediately seal off it's borders as tight as a mummy's tomb. Then call home its vast overseas resources to defend the homeland. Then give a big fuck you to the Middle East warring factions and let them settle up on their own stinkpile of issues they've been involved in since the beginning of time. We have enough problems. Attack the USA homeland and pay hell.
And fuck the oil while they are at it too. We can hitch horses, walk or bike or die. The people who hate this country think we're all a bunch of hand-wringing pussies.
The U.S. has spent its "balls" setting up dictators with our tax money. The founders would be appalled at the direction our foreign policy took. We should have cheered for self-determination in other countries, instead of manipulating things and making enemies. Read "Confessions of an Economic Hitman." The CIA has overthrown over 50 gov'ts. All peoples and governments are being manipulated by the elite, I have come to believe reluctantly.
We are broke because they are now sucking us dry after having done it to most of the world. Open borders with 20% unemployment? Suicidal spending? Why? We are being played. Enjoy Superbowl Sunday....that is what you are suppose to focus on this week.
Ironic that a spike of 40% of oil in the U.S would create a similar hardship to that the Egyptians are experiencing with a 40% wheat increase. Localism and self-sufficiency are the solution. Globalism sucks!
Localism and self-sufficiency are against Anglo-American law. The sun never sets on the Empire. Were it not for the Industrial Revolution, you and I would probably not exist. It runs on oil.
It's prolly not possible to feed 80,000,000 Egyptians with the wheat that is harvested in Egypt.
Obama's idea to cut on oil drilling in the Dead Gulf Of Mexico was just BRILLIANT!!
And I bet when their food starts to run out, things will get VERY exiting. Give it 2 to 3 more days before the warehouses in the docks get looted and burned. 2 weeks before all the ships are blocked.
3 weeks before gangs start to take over parts of Egypt.
5 weeks before the UN steps in
9 weeks before they start walking on water and attack Israel.
Anything to speed up the collapse is welcome.
"From that perspective, sometime in the next week or so, I expect WTI to break above $90 a barrel and could make a run at $93 as protests escalate, and Brent could break above $100."
Done.
BUT..BU..B... Bernanke said there was deflation?? :(
Black gold
Texas Tea
My big fat arse in my cadillac
Consumption baby, consumption
$800 to fill my oil tank.. I burn wood as much as possible but oil has to kick on at night. Blew through 1/2 tank last month.
Going to be building solar air furnace on side of entire house for next year.
If the Bernank has his way soon you will be using dollars in your furnace.
I would look into changing your wood stove. If you are in the North East not a lot of sunshine in the winter.
You can buy or build a wood furnace that can tie into your existing hot water system (you can have both a oil furnace for back up and your wood furnace) that have a "hopper" style feeder, wood slides down the hopper as it burns. These will go 24 hours or more depending on wood type, moisture content etc. Air supply to the combustion chamber is adjusted with demand for heat, so you can just about choke the fire off when your themostat. doesn't call for heat. (Watch your creosote build up!!!). You can also incorporate your household hot water into this design.
Many years ago (1960) my Dad built one for a very old large house with poor insulation, kept us very warm but we went through 30 plus cords a winter.
Prior to that we had a huge wood furnace in the basement that was not as efficient but that too would go through the night without a recharge.
I heat with wood and unless it goes below zero never get up at night to recharge the stove. But I can stack 8 to 10 pieces of wood in the stove at a time and choke the air back. I burn about 24 cords per year. I use a high efficiency kerosene Toyo stove for back up, to keep the place from freezing if I am going to be gone for a bit.
<<I burn about 24 cords per year. >>
24 cords @ $200/cord where I live comes to $4,800 per yr. Seems like a lot to stay warm. Wouldn't it be cheaper to move to Florida?
Unfortunately, there exists no wood air conditioner...
Sympathy. I designed my home to heat with a central wood furnace ( I live surrounded by acres of hardwood available for cutting), with electric back-up.
Sometimes I get tired of the daily mess with the wood and wish for an oil furnace. But then posts like yours remind me of the shortcomings in that direction. I hope your solar experiment works--I hear the components are considerable better these days than even a decade ago.
Have you considered geothermal?
Good idea.... hope it works out
Ok here is what this semi newbie trader does. I want to get out of oil and go short the march contract. My problem is that i have itchy trigger fingers and usually bust a cap too soon. I am still selling oil in a few days, but i am going to wait a little longer to get my short on. I might miss the opportunity in the meantime but a temporary spike from here is a distinct possibility. It doesnt matter what the charts say. Anybody else thinking of shorting the march contract and what entry points are you looking at?
No disrespect, but do not outsmart yourself. If you do short, you had better hedge it in some manner. They are easier ways to make money if you think oil will pull back.
crude goes apeshit = drag on economic fundamentals
more apeshit it gets, the more we are back in double dip territory.. RISK OFF
...amen.....a 2008 redux as people start trading off the mortgage bill for the fuel bill. Plays hell with margins too. Mr. Short might get roused from hibernation. Any and all of the above bow to the apeshit meter.
Stay long till $120 (avg Brent-WTI) and then start fading risk assets
Risk off for stocks? Not in the Feds eyes...
Cushing Syndrome, bitchez!
It's all priced in the market already :P
baked like a fruitcake