Benchmark oil prices have firmed from their January lows, providing some reassurance to regional markets that the worst of the oil price plunge may now be behind it.
However, the contrasting performance between West Texas Intermediate (WTI) and Brent, where the gap between the two benchmarks is currently at a two-year high, suggests that all may not be as it seems. WTI is still trading near US$50 a barrel, while Brent has pushed much higher and is now above $60, close to the average consensus forecast for the whole year.
As recently as January, when average oil prices were at their nadir for the year in the low $40s, there was hardly any difference between the benchmarks, with a gap of just $1.50 in late January, with WTI having rallied by 13 per cent to Brent’s 27 per cent the gap is now at $10. This suggests that there is greater uncertainty about the future path of oil prices and even greater selectivity, depending on which contract is actually being traded.
Over the past few weeks there has also been greater divergence of opinion among analysts, with some forecasting fresh lows for the year while others have called for a return to $100.
Not surprisingly, fundamental arguments offer contrasting theories about what is driving oil prices and why there are seemingly different trends between WTI and Brent.
The WTI contract would seem to reflect the underlying supply dynamics related to the US market, which has been one of the main sources of oversupply in recent years. Brent, on the other hand, is responding more to dynamics related to international markets, with an eye to political risk as well as to the improving growth outlook in parts of Europe and Asia.
In the near term, WTI prices will probably remain under pressure from seasonal refinery maintenance when demand will be limited. A strike by the United Steel Workers union has also affected about 20 per cent of US refining capacity, which comes amid cold weather also freezing up east coast facilities. But these seasonal and one-off factors are apart from surging shale output – the major factor in US oil prices.
The latest US government data estimates a crude oil supply of 9.2 million barrels per day in mid-February, up by about 17 per cent year on year. The sharp sell-off last year has led to major spending cuts for US shale oil producers, with many preferring to leave wells unfinished rather than produce at low prices. But these cuts and the falling rig count will probably not bite into the market until summer, setting the stage for relative WTI weakness to continue for now.
However, towards the end of 2015 and into next year, the resilient US economy should support a tighter market and oil prices above current levels.
On international markets, Brent’s trajectory has diverged somewhat from WTI’s, with average losing sessions since January smaller than those of its US counterpart.
Oscillating reports of disruptions or improvements in supply from Libya, where militias continue to affect output, and weather-related bottlenecks affecting loading from Iraq have helped to keep Brent trading near $60 since early February.
To the extent that demand was also a factor in depressing oil prices earlier in the year, signs of recovery in the euro zone recently are no doubt also now helping, along with a slight upturn in Chinese economic data. Encouragingly, both Saudi Arabia and Abu Dhabi have recently raised their official selling prices on signs of stronger demand.
One other thing we know is that Opec is showing no signs of capitulating in its battle to maintain market share. The latest data shows that Saudi Arabia continued to expand output in the latest month, showing that it feels little pressure to slash production and underpin the price.
Opec has been consistent in saying that it has no desire to set the price for oil and that it is prepared for the long haul, letting the market find a new equilibrium. Few probably expected oil prices to go back up as quickly as they fell, and the behaviour of WTI and Brent illustrates the complexities that remain.
Tim Fox is the head of research and chief economist at Emirates NBD
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