In August 2018, as the dollar index scaled new heights, the price of copper sank by nearly a third on the commodities markets. Other commodities, including sugar, coffee and platinum, dove even lower. The bearish behavior seen was attributable to more than just the unusual strength of the dollar. The threat of high interest rates and the stress on the world markets brought on by the U.S. trade war were among the factors involved.
These influences have their effect on crude prices, as well. Over the months of July and August, nearby, short-term energy prices fell to about $64 on NYMEX. Yet crude didn’t fall to the levels seen on other commodities. Oil has been resilient. While pricing behaviors are often hard to fathom, crude has been transparent. The reasons why oil has resisted the steep drops seen with other commodities and why it will rise in the near future are clear.
Inventories Are Tight
A state of backwardation arises when there is anxiety over short-term availability, rather than availability in the long-term. Since backwardation appears in states of short supply, it is often described as a bullish phenomenon. Data by the Energy Information Administration and the American Petroleum Institute has indicated a decline in inventories by 2.6 million barrels. This has brought on confidence that prices will remain strong.
The Brent-WTI Premium Has Soared
The Brent crude pricing benchmark describes the pricing levels of oil from the Middle East, Africa and Europe. The WTI crude benchmark, on the other hand, follows the pricing of North American crude. The differences in price levels on these indexes may come about as a result of variance in quality (North American oil is better suited to the refining of gasoline, and Brent crude tends to be better suited to the refining of distillates).
Risk is another factor involved in the way prices tend to follow different paths on these indexes. The greater the level of political risk seen in the Middle East, the more expensive oil from that region becomes. At this point, there is a high degree of spread between the Brent and WTI benchmarks. Over the past couple of months, the spread on futures for October rose from about $4 a barrel to close to $8. A high Brent premium shows a bullish sentiment, an indication of prices trending upwards.
The Crack Spreads Are Tight
The term crack spread is used by futures traders to describe the differential in price between crude oil and the derivative products that it is cracked or refined into – gasoline, heating oil and so on.
The gasoline refining spread for August was at $14 a barrel, which is well below the $20 levels seen in 2017. On the face of it, this might appear to show a fall in prices and a softening of the market. The high spread seen for 2017, however, came from other factors – Hurricane Harvey shut down refineries in Texas and Louisiana, for instance. To have a $14 spread this year with no refinery shutdowns, and with demand as high as it has been at the end of the traditional driving season, makes it very impressive. Prices are likely to remain high.
The Unrest in the Middle East
With a large part of the world’s oil coming from the Middle East, the political climate in that region can greatly affect what prices the rest of the world sees. Sanctions against Iran take effect in November, for example. Iran isn’t taking it quietly. The leaders of that country have vowed to disrupt oil shipments by other countries transported through the Strait of Hormuz, a waterway that Iran controls. With 20% of the world spoil going through that particular region, there is a lot that such disruption can do to raise prices. Other unrest in the region includes the war in Yemen and the blockade of Qatar.
When the price of oil from the Middle East rises, it can raise prices around the world.
According to Sigma Drilling Technologies, manufacturer of suction dampener equipment, pulsation control equipment and other critical components used to keep drilling operations running, the bullish sentiment in the commodities markets is ample sign that drillers need to take the idea of future investments seriously in order to profit from the tight pricing foreseen.
