Small US town a poor oil guide
By Javier Blas
Published: January 8 2009 16:38 | Last updated: January 8 2009 16:38
With oil prices below $50 a barrel, it would appear commonsense to look to Saudi Arabia, the world’s largest oil producer for clues on whether prices will fall again or start a recovery. Many oil traders, however, are looking at a small town in the US.
Cushing, Oklahoma, is the hub of America’s oil pipeline network and the delivery point for the Nymex West Texas Intermediate crude oil contract, the world’s most closely followed oil benchmark.
For sure, the global economic crisis and the collapse in oil demand is the main reason behind the fall in oil prices from July’s all-time high of $147.27 a barrel to less than $50.
But factors specific to Cushing explain the rare weakness of WTI oil against other benchmarks, such as North Sea’s Brent or Middle East’s Dubai.
Those parochial factors also account for much of the atypical depressed price of the WTI front-month contract versus the second front-month contract.
“The price of WTI is now disconnected from the rest of the world,” says Michael Wittner, senior oil analyst at Société Générale in London. “Very specific local conditions at Cushing are dictating the price of WTI oil,” he adds.
This is a problem for the industry. WTI is the preferred global benchmark for crude, used frequently for commercial players such as airlines to hedge energy exposure. It is also popular among investors in commodities indices, such the S&P GSCI.
A long-time critic of the contract, Ed Morse, chief economist at LCM Commodities in New York, says that the problem is that WTI is a “landlocked” crude oil, without access to a waterborne market to relieve the surge in inventories.
In the last few weeks, a drop in demand for refineries in the region surrounding Cushing and steady supplies have pushed inventories sharply higher there, with tanks brimming. The US Department of Energy said this week inventories were now at 32.2m, the highest level since it started tracking supplies there in 2004.
“The phenomenon can only be alleviated by higher demand from US Midwest refineries or lower regional supplies,” Mr Morse says. “Or by the construction of pipelines to move oil from Cushing into the US Gulf of Mexico.”
The inventories’ surge has depressed WTI prices, as traders have ample supplies to fulfill their delivery commitments, triggering the benchmark to flip from a premium of about $1.5 a barrel against Brent to a discount of $3.6 on Thursday.
In Thursday’s afternoon trading, while Nymex February WTI was at $42.64 a barrel, up 1 cent on the day, ICE February Brent traded at $46.62 a barrel, up 72 cents.
Olivier Jakob, of Swiss-based consultancy Petromatrix, says that with Cushing stocks being filled to capacity, “a two-tier crude oil market is likely to continue for a while”.
The local factors also explain the large price difference between the contract for immediate delivery – February – and the second front-month contract – March –, which on Thursday widened to a near-record of $4.7 a barrel.
Since 2000, the front and second-front contracts have only traded a few days – and often due to the expiry of one contract – at spreads larger that the current one.