Only a few weeks ago, pundits were bemoaning the collapse of oil prices.
Then, these self-proclaimed soothsayers became doomsayers, and started predicting oil prices would decline to $40 a barrel (or below).
When Hurricanes Harvey and Irma hit, these self-same founts of wisdom declared Mother Nature had hurled at us a double whammy, guaranteeing problems in oil infrastructure, refinery demand, and distribution interruptions.
Certainly, both hurricanes had an impact.
With refineries – heavy users of crude oil – shut down, demand for oil declined.
And as residents in South Texas and around here in South Florida quickly learned, the availability of gasoline soon became a major issue.
Oil exports – another big “use” for American oil – also took a big hit.
Now, it’s only been just under two years since Congress lifted the U.S. oil export ban.
But in that time, American companies have raced ahead to more than 1.1 million barrels a day of oil being moved out of the country, largely from the Gulf Coast.
That, of course, is where Harvey hit. Especially the coast from Corpus Christi to Galveston and beyond was badly affected, and that’s were many of America’s oil export terminals are located.
This would seem to set the oil market up for a major fall.
But despite what the doomsayers would have you believe, the effect in each case turned out to be very short-lived.
The pundits’ fear quickly went by the board. Related: Aramco Optimizes Oil Trading Operations Ahead Of IPO
That’s because in today’s oil market, demand is a combination of elements that are much more difficult to understand than any talking head on TV can get out in thirty seconds…
Even if they had the genuine experience and knowledge required.
Here’s what these doomsayers are missing…
Despite All the Doom and Gloom, Oil Prices are Heading Up
As of 2.30 p.m. Eastern yesterday (the close of oil trading in New York) WTI stood at $52.22 a barrel, while Brent was at $58.87.
WTI stands for West Texas Intermediate, the benchmark crude rate for futures contracts on the NYMEX. Brent is the other primary global standard, set each day in London.
Despite two hurricanes and the Chicken Littles appearing on the tube, wailing that the (oil) sky is falling, WTI was up 3.1% yesterday alone, 5.5% for the week, and 9.1% for the month. Brent is on an even greater tear – 3.6% yesterday, 6.7% for the week, and a hefty 12.8% for the month.
That, by the way, is where I predicted oil prices would be by the end of September. Yesterday, WTI hit and Brent blew past the pricing floors I’d called for – $52 and $56, respectively.
Here’s what’s happening.
First, the run-of-the-mill oil prognostication you see on TV is often less objective than it may appear.
“Analysts” are often fronting for their brokerages… and those agencies are taking short positions on oil.
In other words, if the Chicken Little on TV can persuade the market that oil is going to decline, then his “The Sky is Falling” parent firm makes a nice trip to the bank.
That’s not to say shorts don’t have their place in a market; they do. But that place is hardly as the first reaction, and never to satisfy a self-justifying manipulative move.
Over the past several days, as oil prices rose, these guys have had to quickly wind down their short positions. That’s an expensive proposition.
It only goes to show that there may be some justice in the world after all.
Second, when you get down to the actual oil market fundamentals, you notice some interesting developments…
Oil Demand is Rising Faster than Expected
Oil demand is accelerating, not just in the U.S. but globally (where the price of oil is really determined). The International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), and OPEC all agree on this.
There’s certainly more than enough excess supply that can be easily extracted, especially in the U.S. But this surplus does not factor into the equation unless it’s actually lifted.
Managing the amount of excess in the market is a necessary component of keeping prices higher. Most oil companies now understand this.
As such, the IEA, EIA, and OPEC are all now projecting that a balance in the oil market will emerge much earlier than initially expected.
However, it’s important to understand what that balance actually means.
This is not a case of supply meeting demand exactly. That “just in time” provision of crude to the market would be disastrous, with no one being sure whether they’d be able to buy another barrel of oil or not.
If that were to happen, excessive volatility would rule and average oil prices would be flirting with $100 a barrel.
No, the balance we want requires a surplus, as a safety cushion. It’s the size of that surplus, not simply that one is present, that determines the impact on prices.
The balance currently in the works takes this into account, and provides some leverage for producers in the process.
There is also another sort of offset in play…
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The OPEC-Russia agreement to limit production will be extended into 2018.
Now, there is some excess production seeping into the market despite the accord. In addition, American production has never been a party to this accord.
Nonetheless, production declines have intensified in Venezuela, Libya, Nigeria, and Mexico. These moves down are offsetting higher production elsewhere. It may not be an exact match, but it’s close enough to sustain the wider balance.
Finally, the perception of oil traders has moved decidedly away from the doomsayers.
As you’ve seen several times here, setting futures contracts (the “paper” barrels that control forward consignments of actual barrels of oil – “wet” barrels) requires a different view of pricing.
In a “normal” market (and to be honest, I’m not sure what that really means anymore), traders peg prices to the expected cost of the next available barrel. They will then run options on those futures contracts to hedge their bets.
Related: Is This The End Of U.S. Dominance In Global Energy?
However, if traders see oil prices moving down, they’ll peg prices to the least expensive next available barrel. That’s because the trader is more concerned with a surprise fall in price, so they try to lock in as low a price as possible to begin with.
If, on the other hand, traders see prices rising, they start pegging prices to the expected most expensive next available barrel. Here, it’s the upside that the trader must protect against.
We are rapidly entering this latter environment. The best indication of that is the consistent rise in the floor of the pricing range.
As veteran readers of Oil & Energy Investor well know, the floor is far more important than the ceiling. A rising floor provides for traders’ higher expectations of barrel prices.
To this, the doomsayers have no effective response.
Of course, no price trajectory is straight up or down. But oil prices are beginning to ratchet up – meaning more moves up than down, even if it’s not a straight line.
And that’s all we need for some nice investment profits.
By Dr. Kent Moors
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