Monitoring the Rising Oil Markets: Transportation, Energy, Plastics, Chemicals and Beyond (Part 2)

In the first part of this post, we shared a summary of the oil market situation, including rising prices for Brent Crude and general global demand characteristics. At the end of the article, we highlighted MetalMiner's reporting that Brent Crude oil pricing (which as risen at a significant clip in recent weeks) is separating significantly from West Texas Intermediate (WTI) pricing. As of February 13th, there is a roughly 20% spread between the two. As background, Wikipedia notes, "Brent Crude is a major trading classification of sweet light crude oil comprising Brent Blend, Forties Blend, Oseberg and Ekofisk crudes (also known as the BFOE Quotation). Brent Crude is sourced from the North Sea."

In contrast, "West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. This grade is described as light because of its relatively low density, and sweet because of its low sulfur content. It is the underlying commodity of Chicago Mercantile Exchange's oil futures contracts...Historically the different price spreads are based on physical variations in supply and demand (short term)."

Stuart further reports that perhaps "the most interesting disconnect in the market is the forward spread curve for Brent crude [relative to WTI]. Throughout the boom period of 2004-08, Reuters reports the spot and forward oil prices moved in tandem, but now forward prices for 2015 are at a $19-per-barrel discount and have remained remarkably steady even as the spot price has risen in the wake of rising tensions with Iran." Summarizing Stuart's argument and research -- which is worth reading if you're curious about the subject -- he then suggests that emerging supply dynamics would favor price stabilization or decline (e.g., rising conventional supplies from the Middle East including Libya, Iraq, etc. and the rest of the world combined with oil shale fracking in Canada).

Moreover, "although much demand growth is predicated on the rise of an emerging market middle class, a combination of greater efficiency in the use of oil and falling Western demand will diminish the impact of that effect." But perhaps most interesting, the current spread and price dynamics of lower costs in the US for WTI contracts do confer at least a short-term advantage and perhaps even a peek at what might come. "Neither lower natural gas nor lower oil prices are likely to equalize with the rest of the world anytime soon and while no one is suggesting it will lead to long-term energy-intensive investments like aluminum smelters, it will provide a welcome boost to more energy-dependent industries in North America relative to many other parts of the world for some time to come."

In other words, the competitive advantage the US currently has for lower oil prices relative to Europe and Asia may not last forever -- or transform fundamental industry dynamics. But insofar as it lowers production, transportation and consumer costs, it's a welcome addition to the overall economic dynamics for North American businesses and households.

- Jason Busch

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