Oil is priced in a global market, right? Differences in regional prices are small, right? That is conventional wisdom. But prices at West Texas Intermediate and Brent are challenging our understanding of oil pricing.
Yesterday West Texas Intermediate spot price was $84.81, while Brent was $102.33. The price spread reached nearly $18.
A year ago WTI was $74.13 and Brent $71.64: a price spread of less than $3. Price spreads in that range were the historic norm.
The WTI and Brent price signals are flashing different futures.
Brent indicates a growing global economy, with supply stretching to meet demand, plus a bit of nervousness about political uprisings affecting oil production.
WTI portends near zero growth rates, with supply easily meeting demand, and almost no geopolitical risk.
Both cannot be right. Or could they be?
Perhaps they are signaling a new world, where oil is less valuable in North America? Many have predicted that US demand for oil peaked in 2007 and will inexorably decline as efficiency and substitutes cut demand and eat oil's market share.
In addition the shale drilling techniques that have created a glut of gas are increasing US oil production, and Canadian tar sand oil production seemingly has but one major market: US consumers.
So is the Brent or WTI price a more "accurate" indicator of the future? Or will both prices be as different as they are now in the coming years? Thoughts are very welcome.
Neither is an indicator of the future. What these huge price spreads should make obvious is the huge role that speculators have in the oil futures market. When world events create periods of high volatility as we are seeing now, institutional investors (hedge funds, prop trading companies, prop trading desks at "investment" banks, flock to the markets like sharks to bloody water. What we know to be true based on these huge price spreads is that there are probably major arbitrage trading strategies to be implemented and institutional investors are likely mobilizing huge amounts of capital (and leverage) to take advantage. This has probably contributed to and exacerbated the current state of the global oil market.
ReplyDeleteNot to say that the oil markets are not important to watch as indicators of global growth and energy usage, however I would argue the current price choppiness in the market are the result of commodity traders, not companies who actually use oil.
Interesting comment. These price spreads are likely attracting speculation. Not so sure that the price differences are the product of speculation. Would love some more thoughts on why the price spreads exist? And on what market action the price spreads then are causing? Will these spreads last? Or are they fleeting?
ReplyDeleteto continue the discussion after a little background research on my part...these spreads are for crude oil contracts for March delivery...ie buy the contract now and you get the oil delivered march. NYMEX has them at 84.81 for march delivery but what is interesting is that you cannot even buy March delivery Brent contracts, Brent contracts for April 11 delivery settled at 103.81 today...to my untrained eye it means call your broker and buy some NYMEX contracts ASAP and then go find a broker in europe who will sell your contracts on the Brent market and count your profits-transaction costs!
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