Wars all over the Arc of Instability – the world’s major oil producing areas – so the oil price is rising, right? … Wrong! (Paraphrasing Lombard Street Research.)
A little over a month ago, I wrote about the Arc of Instability – Eastern Europe, the Middle East and North Africa – and crude oil’s forward curve. Let’s see what has changed, what has not, and what we can read into it.
The first chart (Fig: 1), depicts the Brent Crude Oil forward curves one month ago (green) and one day ago (orange). We can clearly see that the whole pricing structure of the Brent forward curve is substantially lower that it was a month ago. In addition, the September delivery futures are at a significantly greater discount to the December & March futures, than they were a month ago i.e. there is greater contango in the front end of the curve than there was a month ago. This is a sign that there is ample supply available, and the sellers are becoming more anxious to sell before the price falls further.
As an interesting aside, this discount has become so great that oil traders & hedge funds are now beginning to buy oil, store it in shipping tankers, and simultaneously sell the March futures short. The cost (i.e. interest rates) of borrowing US$ is so low and the contango so great, that this trade guarantees a profit, provided the trader can manage the logistics of storing & delivering their cargo. See also in the graph (Fig: 2) how it has pushed up the price of the Baltic Dry shipping index by almost 50% in a month.
So, what has driven this falling price? Aside from the fatigue from having geopolitical risk broadcast, twittered, emailed, headlined and generally rubbed in our faces 24/7, there is a very fundamental reason: the US production of oil continues to rise and rise and rise. US Crude Oil inventories have been at, or near, the upper end of their range for the whole of 2014 (as per the graph Fig: 3), to the extent that the oil supply from the Atlantic Basin is being diverted away from the USA to the Brent market, contributing to the current oversupply conditions in that market and the unusual shape of the forward curve.
So, is this all a very long-winded way of saying that the global demand for energy, and hence the global economy, is not as strong as we thought (hoped?) it is? Or is it signalling that cheap energy will stimulate the global economy and that the difficult times of 2008-2013 are behind us?
I’m sure Janet Yellen will tell us soon!
