LIKE GLOBAL WARMING
Recent news from scientists of the British Antarctic Survey and partner research institutions examining ice cores showing the climate record for tens of thousand of years is that ice sheet retreat due to global warming often suddenly stabilises, "for decades to centuries”, despite the warming still going on. This is also what is happening in the oil patch: all the supply-demand fundamentals say that prices should decline - but they stay high or go on growing.
As far back as October 2012, Goldman Sachs analyst David Greely in what reads like a mea culpa from GS, said that the broker-banker firm's previous oil price forecasts - made in 2011 and repeated many times - that "the right price of oil" in 2012 is $125 per barrel for the US marker blend WTI, and $130 for the European and Asian marker blend Brent, were too high and are now history. Not explaining why the previous forecast had been too high, Greely, in his October 2012 review market fundamentals and forecast of 2013 prices, used oil market traders' coded language for overpriced oil.
He said that oil markets are now "cyclically tight but structurally stable". He went on to say that GS now sees long-dated Brent crude oil stabilizing at around $90/bbl in 2013, a price level which is a whopping $40 lower than its previous forecast.
As of 22 January 2013, Brent prices are around $112 per barrel. There are no shortage of market analysts who say that $120 is easily possible, and plenty others who forecast prices as low as $50 per barrel, or less. With that range of price forecasts, somebody has to be right!
CYCLICALLY TIGHT-STRUCTURALLY STABLE
The new forecast could or might save face for GS, when oil prices decline, depending how fast and how much they decline - and who pulls the skids away from overpriced oil. Prices might decline a little - in the 10% to 15% below current levels - but oil producers and exporters would take a tougher line on who gets what from global market trading.
Crude oil trades, valued at as much as $10 trillion a year, are in fact only the tip of the iceberg. Other trades cover every other possible type of oil-related trading such as arbitrage bets on the spread or premium between Brent and WTI, refined product price bets, crack spreads on the refining value gains from different types of processing, tanker, pipeline and rail transport trades, and others. Total turnover on the oil trading casino probably runs far above $20 trillion a year, about $100 billion every single trading day of the year. This is of course "nominal or paper value": at most the ratio of real or "physical" trades on oil and refined products, to paper bets on future prices, is 1-to-80.
Financing of this casino is certainly not tight, and is also not structurally stable: it can dry up overnight, and it can surge the next. Goldman Sachs, and a select band of other major international banks, broker-traders, oil producer corporations, refiners, pipeline companies, oil transporters and offset trade operators know all about it. And what they know about oil prices is drastically simple: things are better, for them, when prices stay high.
This in fact is "the dirty secret" of global oil trading - and a total reversal of how the straight majority of market actors and players in the oil trading casino operated until about 2005. Previously, they consistently "played low" and acted to push down oil and oil product prices. For at least 8 years, however, they now consistently act to maintain or increase oil and oil product prices.
Oil traders and analysts were in no way fooled when they read the mea culpa by Greely of GS: if Goldman is now saying it exaggerated "the right price of oil" and prices should now fall in a pretty spectacular way, it is a good time to buy calls on oil futures, because prices will probably rise! That is oil market trading psychology, call it trench warfare.
One supporting rationale for this "contrarian" readout was embodied in Greely's published analysis. He said the famous Brent premium feeding huge volumes of arbitrage trades on the unreal mark-up of Brent prices against WTI - hitting highs up to and more than $25 a barrel - was now set to almost totally disappear, the same way it was set to almost disappear, on the upside, in the previous "high price forecast" of GS. In other words, GS forecasts the premium will disappear whether prices soar or collapse: so the premium will stay.
Greely claimed he now sees a return to the oil pricing regime that characterized the crude oil market in the 1990s when long-dated Brent prices were anchored at $20/bbl, and although he made a point of not mentioning it, a year average oil price of $11.90/bbl in 1998.
We can do the math for him and put that in 2013 dollars: this would mean a price of about $16.75/bbl. In the 1990s, we can add, the Brent-WTI mark up counted for toast, it was close to zero. The potential for that "new-old stability" coming back, today, reads like science fiction or a rather crude attempt to fool rival brokers and traders (and even customers and clients of GS!) into wrongfooting their bets.
HELLO OPEC, GOODBYE TO GS
In an interesting exhibit of oil trader schizophrenia and related double talk from high paid oil analysts, Greely of Goldman Sachs now claims that rising OPEC and Russian spare capacity is no longer a mortal threat to global security, a hammer blow for the global economy or a triumph for al Qaeda because it will not guarantee high oil prices. In fact the exact opposite. Greely's words from the GS Tribeca building in New York are that OPEC and Russian spare capacity anchored longdated prices in the 1990s, keeping them sweet and low, so this can happen again, now. Greely's argument is that future oil prices will be anchored not only by growing OPEC and Russian capacity, but also by "substantial growth in crude oil supplies from US shale, Canadian oil sands, and global deepwater oil provinces".
Making a point of not adding that world oil demand and demand growth is either close to straight line, or declining not only in the US, Europe and Japan but also in Emerging countries - Greely talks his way around the fact that US WTI grade crude is at present a low-priced snip relative to Brent, "but nobody seems to have noticed". All and any outside observers, which include OPEC and NOPEC producers, can see that at present Brent grade crude costs about $25 more, for each barrel, than WTI. The world economy seems easily able to digest this differential - and the high prices - but as OPEC and NOPEC producer country oil ministers regularly say, they only get a part of this windfall. Cutting their own export prices for crude or for refined products makes no sense at all, to them. Cutting production makes a lot more sense, to them.
The GS fairy story to explain why WTI prices trade at a now "traditional" and massive discount against Brent is that barrels delivered to the "basing point" for WTI, located at Cushing, Oklahoma - the Nymex oil pricing "hub" for physical deliveries of the few percent of all paper contracts taken to final delivery - cannot be onward transported south to the US Gulf Coast for refining. They are even less able to be shipped outside of the US, earning an instant $25-a-barrel mark up.
Making a pitch for the growing trades based on oil transport, Greely cites the lack of US pipeline and rail transport capacity, truck transport capacity, possibly even a few barrels given a ride in the back of a pick-up! Greely says that what the US needs is the Big Thing of the Seaway pipeline expansion, ramping up from its current capacity of 150 000 barrels/day to its new capacity of 400 000 b/d in 2013. Conversely and in the meantime, the addition of substantial new rail loading and unloading capacity in 2012 has created excess capacity to move Bakken crude, from the north, to the Gulf Coast and especially to the Pacific coast - for export to Asian markets where Brent pricing rules.
Outside of the US, these arguments and rationales read like old time fairy stories: In theory, anybody who can get WTI-priced oil out of the US, to anyplace in Europe and Asia, has a guaranteed winning business plan. The only problem is that if that was possible, the US would at present, and for several years, import even more Brent-priced oil to compensate. For OPEC and NOPEC producers, price decline for both WTI and Brent is no real threat, if the decline is moderate, but the "fraternity" of oil traders, brokers, banksters and fixers like GS are taking too much. For as long as they do, prices have to stay where they are - shown by recent growls from Saudi Arabia and Russia, that these two "players", the world's two biggest oil exporters, will have no problem cutting production - for any number of reasons, they say - and watching prices rise.
By Andrew McKillop
Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights
Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012
Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.
© 2013 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.
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