The markets have looked a lot shakier in the past two weeks and that certainly applies to more than the bond and equity markets. As treasury rates have risen and bond prices have fallen, we’ve seen a massive deleveraging from the Japanese stock market that has hit currencies hard as well, particularly the Yen.
Whew – all of that has made a safe haven for investment hard to find and commodities have continued to suffer as well: Copper is reeling as is iron ore and most of the grains.
But not oil. Oil has managed to stay sticky in price with Brent remaining above $100 a barrel and West Texas Intermediate hovering close to $95 a barrel. How can oil stay so strong in the face of almost universally weakening markets?
The answer lies in two reasons unique to oil – and they are both financial and not fundamental in nature.
First is the Brent oil market, which has become the global benchmark for pricing. Brent crude is priced mostly upon North Seas crude, which has continued to experience a weakening supply profile: the production from the North Sea continues to disintegrate. And even though new supply from deep water and shale plays in the US augment the already increased supply from Saudi Arabia and Iraq, the financial connection to a small North Sea market with an inherent supply shortage continues to put upwards pressure on prices.
And while it would be far more useful for consumers to find a more logical financial benchmark for pricing global crude, don’t expect one to emerge any time soon. Competitive contracts to Brent and WTI crude have been tried several dozen times in the history of financial oil without success, and most of the oil trading world now accepts these two as the only legitimate benchmarks with which to basis the price of other, more local grades.
The second reason for oil’s stubborn high price is a concept I concentrated on in my book, “Oil’s Endless Bid”: The financialization of oil has turned crude into another asset class, much like stocks and bonds, that doesn’t react as easily to the fundamental inputs of supply and demand. And while almost all other asset classes have reacted negatively to bond rates and the Yen trade in the last two weeks, oil has seen relative strength in the same way that other tangible assets, like housing, have seen. Oil has become a ‘value repository’ in a way that even Gold has lacked and has managed to resist the weakening forces that other markets have recently succumbed to.
That’s why I continue to think that the risk to oil is on the upside and not on the down: Oil markets continue to make ‘higher lows’, with 2012 higher than 2011, which was higher than 2010. I don’t expect 2013 to be any different, and still maintain that even if oil remains in a range, it’s downside limit is somewhere in the mid $80’s for WTI.
And that makes for some interesting trading ideas, which I’ll discuss in my next column.