Oil price brave new world

Oil prices have never been easy to predict and despite the vast amount of data points out there, making sense of it all remains a big challenge. Two themes have emerged in the past decade that has changed the landscape and makes understanding the oil markets difficult: emergence of non-sophisticated traders and US exports.

Non-sophisticated traders have replaced traditional traders. These new (and now established) entrants trade off newsflow rather than fundamentals. Whilst the fundamentals have pointed to a positive supply demand picture for oil prices in the past few years, consistent bombardment of rig count and inventory data has meant fundamental trends have not surfaced to the front of mind leading to what can be viewed as depressed oil prices throughout the period 2015-17. With global inventory rebalancing now taking place and this making its way to the headlines, oil prices have begun to correct in 2018. The problem of non-sophisticated traders has been exacerbated by the financialisation of the market leading to increased volume of trade and exit by some traditional traders.

Secondly, US exports has completely redrawn the map for oil trade flows and the market is still learning what this means. Some of the characteristics that the US has exhibited which the market has never seen before is the short-cycle/ability to ramp-up and turn down production in a relatively short space of time, anti-fragile nature of production resilience, ability to store crude behind pipe (drilled uncompleted wells or DUCs) and wide range of crude blends it can produce. In particular OPEC (i.e. Saudi Arabia) has been experimenting with prices to elicit US production data points in order to study US producer behaviour.

A recent topic around US exports is the divergence of the WTI and Brent benchmarks with the widening spread. This has raised the question of the US’ ability to cater to any demand. WTI has been under pressure recently (vs. Brent) as bottlenecks in export pipeline infrastructure have depressed prices. However, there is significant capacity build-out over the near-term which will alleviate this problem and the persistent discount of c.USD10/bbl of WTI along the back-end of the curve is likely unfounded. While WTI and Brent appear to be showing signs of catering to different markets right now rather than a single global market, trends (and spreads) should converge again over time.