The two major global crude oil benchmarks saw solid advancements this week, marking the start of what should be a weekly rebound.
Both gained a bit less than 1% on Monday, with New York-traded West Texas Intermediate (WTI) adding 0.79% and London-traded global benchmark Brent gaining 0.82%.
Still, as the pundits are quick to point out, both are down for the month, with WTI off roughly 6.5%, and Brent down about 5.7%.
What’s driving the talking heads’ fretting? The fact that oil was on a largely unstoppable tear through the first half of the year. WTI pushed above $74 a barrel by the end of June, and Brent was close to touching $80 at the time.
Still, I remain bullish on both benchmark prices. I don’t think triple-digit prices are too far off in the future.
And there are three overarching facts to keep in mind when examining this bullish oil pricing environment…
Oil’s Downward Action Actually Means Gains Ahead
First, remember that those talking heads typically talk down prices in hopes of generating a play by running a very quick short to squeeze some profits out of a brief dip in the price.
Despite that, though, the overall market conditions remain quite strong. As of earlier last week, WTI is up a whopping 163.4% since its lowest price in early 2016. Brent is better by 164.6%.
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And, while rolling weekly and monthly averages have been mostly negative over the past 10 or so trading sessions, both WTI and Brent are at roughly the same pricing level as recorded in mid-July.
In other words, this has actually been a lateral move following a major pricing spike.
What’s more, the daily spreads between the two benchmarks (calculated by the difference between Brent and WTI as a percentage of WTI, the more accurate way of measuring it) averaged 5.9% over 28 trading sessions since July 2. The same spread averaged 11.6% over the previous 28 sessions.
In addition, the price of WTI is rising to meet Brent during the more current period. While Brent remains the more expensive (as it has been for all but three sessions since the middle of August 2010), the narrowing price difference between the two benchmarks points to a strengthening of WTI.
There are other factors as well coming into view, but the bottom line is this: The oil balance is tightening.
Traditionally when considering the price of oil, analysis would focus primarily on supply and demand. After all, that is what commentators look at in their 30-second sound bites even today, and there is certainly still a place for that view.
Nonetheless, the picture has become more nuanced.
Here’s What’s Tightening Oil’s Balance
Worldwide global demand continues to rise. Yet the increases are very unevenly distributed.
The lion’s share has been gravitating away from developed countries of North America and Western Europe and toward the economies of the developing world, especially to Asia.
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In fact, Asia alone is poised to provide over 65% of the absolute increase in demand over the next three decades.
Coming in second is a market rarely discussed – Africa.
Given the intensifying need for energy in such markets, the usual calculus has to be revised. This no longer becomes a game of matching supply with demand viewed merely in terms of deliveries. Rather, supply today must relate to end user need, while at the same time factoring in forward-looking expectations.
Remember that an adequate market must also include (by design) a built-in guaranteed surplus. Otherwise, oil trading would distort and accelerate pricing dynamics higher, and spot shortages would be more frequently experienced.
For our purposes today, avoiding a range of other factors and considering only these two themes, one conclusion is emerging…
Each interruption of supply globally is having a more pronounced impact on how the oil balance is being regarded.
These interruptions span just about every single continent and include…
- Supply declines from Venezuela, Libya, and Nigeria;
- Persistent production problems in Mexico;
- The Syncrude production shutdown in Canada;
- A Saudi decision to interrupt Red Sea exports following Yemeni rebel attacks;
- And early indications of difficulties in continuing high extraction levels from mature Western Siberian fields in Russia.
The situation is no longer merely a balance concern arising from interruptions on the supply side.
It is instead becoming a situation in which the market expects that the balance will be pressuring prices higher.
An actual tight oil market may not yet be with us in fact.
But traders are already presuming it will be so.
The number of predictions expecting triple-digit prices per barrel is increasing. Two veterans have already suggested to me that a $200 per barrel price is coming. Another recently made news by claiming it will go as high as $400. Even the conservative bank estimates are now in the $90s.
Some of this, of course, is hype. Yet the single most important factor used to offset concerns of a tight market emerging is itself undergoing major transformation.
The ability of U.S. shale and tight oil production to add ample additional supply is undergoing some important changes.
That will be the subject of an Oil & Energy Investor out soon.
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