Food for Thought from Summit Energy UK – Crude Drivers Collide

This week is shaping up to be more crucial than most for crude oil, as we see some important developments in key price drivers of Black Gold, Texas Tea. So […]

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By Summit Energy UK

This week is shaping up to be more crucial than most for crude oil, as we see some important developments in key price drivers of Black Gold, Texas Tea. So here are some details which have already been gleaned, and some which are yet to be revealed.

First up, the pressure in general markets is building to a crescendo this Friday, as we await a speech by the Chairman of the Federal Reserve, Ben Bernanke, from the Fed’s annual symposium at Jackson Hole, Wyoming. The reason for such high expectancy is twofold: there is hope of further monetary stimulus from the US central bank to kick-start the US economy (third time’s a charm apparently, after QE1 and QE2 – discussed here on the burrito recently), and secondly, because of its timing.

Last year’s meeting at Jackson Hole produced the announcement for QE2, prompting an almighty run-up in stock prices for the duration of QE2; this rally was mirrored by crude, with Brent prices rallying 47% (and 26% on WTI) over the same time period. With the recent downturn in economic data, there has been a corresponding upswing in anticipation for a repeat scenario this year.

An announcement of QE3 by the Federal Reserve on Friday seems unlikely, with the more probable weapon wielded by them being that of supportive rhetoric for further intervention should the economic outlook deteriorate. But given the optimism in both equity and crude markets this week for something more substantial, these markets are facing the prospect of being disappointed.

Next up, I want to highlight something which continues to sit on the back-burner, simmering away: Chinese oil demand. Data from Platts this week shows demand in July averaged 9.05 mb/d, up 7% on the prior year, rebounding from weakness in June caused by seasonal refinery maintenance.

Despite ongoing efforts by the Chinese government to keep inflation in check by raising interest rates, these headwinds to growth are not impacting oil demand…as yet. Further, China’s Ministry of Industry and Information Technology (MIIT) projects crude will maintain the pace seen already in 2011, with consumption to pick up again later in the year. Lest we forget, China is the second largest consumer of oil (behind the US), making up approximately 10% of global demand, and growing.

Third up, homeboys and girls, is the small matter of Libya. Libyan production has dropped off a cliff since the beginning of the year with the civil war. There are enough wide-ranging estimates about how quickly oil production is going to come back online to prove that no-one really knows at this juncture. All we do know is that its return hinges on two key factors: how much damage has been done to infrastructure, and secondly, how organized the Libyan rebels are in getting the oil industry back up and running again. The drop-off in production is set for an imminent turnaround, but as for how much and how quickly, we will just have to wait for further details to emerge.

Finally, this factor is more of a slow-burner than a revelation: stockpiles at Cushing, Oklahoma. The wide spread between Cushing, OK-based WTI crude oil, and UK-based Brent crude oil remains at a near-record, despite a 20% fall in stockpiles at Cushing (which had spurred on the large disparity betwixt the two prices in the first place). WTI is now somewhat disregarded as a global benchmark as the near-$25 spread between the two prices means WTI is of little relevance to US product prices, as the lion’s share of refining in the US is based off Brent prices (as only the refineries in close proximity to Cushing can access and benefit from its large discount).

Although this disparity is not going to immediately disappear given the triumvirate of an influx of supply from shale plays in North Dakota, from Canadian oil sands, and from the continued delays to the Keystone pipeline, a drop-off in stockpiles at Cushing should have some sort of impact on narrowing the spread and increasing the relevance of WTI. But it hasn’t as yet.

These four factors remain at the helm of the crude complex, driving it forward. Equities and general risk appetite look set to play a further key role as we try to gauge how well the economic recovery is going. Resolution to the war in Libya and the subsequent return in oil production will be seen as a welcome development, especially for Europe which has seen a tight crude market since production went offline. The timeframe for this, however, remains very much up in the air.

As for Chinese demand, continued strength is encouraging for the global economy, but will also be the canary in the coal mine should it take a turn for the worse. And finally, should we see Cushing stocks considerably drawn down, the more relevant WTI will become as a global benchmark once more. This scenario, much like a return in Libyan production, may be a ways away yet. Many factors to watch, but all fascinating.

Matt Smith – Market Analyst
Summit Energy International
www.summitenergy.com
www.energyburrito.com

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