Financial headlines for the past couple of months have focused on the plunging price of oil, and the impact those oil prices have had on various segments in the market. As you would expect, there's been some major league speculation on what's causing the decline, but at the end of the day it really comes down to the old fashioned supply and demand curve.
There is no question in anyone's mind that oil supply is driving extreme downward pressure on the price. OPEC is in political disarray and they are no longer able to exercise the muscle they once had in controlling the supply side of the equation. The Saudis are pumping oil as fast as they can pull it out of the ground. Iraq is once again a player in the oil market, and their supply is an added bonus. The US is poised to become the world's largest oil producer. The North American (US and Canadian) shale fields are demonstrating amazing potential. So yes, there is certainly a glut of oil on the market today.
What about the demand side of the equation? To answer this, we have to look at two aspects of demand. The obvious one, and the one most often cited, is demand for the finished product. With Europe once again heading into recession, there's a decrease in end-product demand there. Demand in China is reportedly down, although US demand is reportedly up a bit. That's not surprising given the very attractive gasoline prices across the nation.
That, however, is not the "demand" that's currently driving that side of the equation. Rather, we need to look at the demand for the raw product - crude oil - not only the demand for the finished product. US Oil Refineries, as of last week, are operating at 94% capacity. That's about as close to full capacity as you can get, and that will continue until April when refineries begin their semi-annual maintenance cycle. Demand for oil, at least in North America, cannot increase simply because there is no additional capacity to refine it. With North American demand being a constant in this regard, the increasing supply can do nothing but drive the price down.
The refinery side globally is a bit different. Refining capacity is increasing globally, with an additional 8.3 million barrels per day being added by 2019, and it's not currently operating at or near capacity. There is where end consumer demand is coming into play because European and Middle Eastern oil is available however the demand for the finished product is down.
What threw the pundits into a tailspin today was a change in the relationship between West Texas Intermediate Crude (WTI) and North Brent. Typically, WTI trades at a discount to North Brent, however today the two prices converged. For a brief period, they even reversed with Brent trading lower than WTI. The question on the table is what to make of that, and several pundits are pointing to weakness in the European economy as the answer. I'm not so sure. Rather, I'm speculating that this is a bit of a political reaction.
Now that we are into the second week of the new Congress here in the US, bills to move the Keystone Pipeline forward are starting to surface. For the first time, the Republican controlled Senate has a super-majority in support of bringing the legislation to the floor. (They have 63 votes - 3 more than the 60 needed.) Now, that is still 4 votes shy of the number needed to override the threatened Presidential veto, which means this bill is going to live or die based on the amendments that are attached to it.
The Democrats have already stated they will be attaching climate change related amendments to the bill. The substance of those amendments haven't been discussed yet, however they will certainly be countered by Republican amendments equally distasteful to the other side. One amendment that has been discussed would allow a resumption of US oil exports. Now, trading based on amendments that have yet to make it onto a bill let alone having passed a vote is folly, but short term reactions tend to do just that. The brief stabilization in WTI without a corresponding stabilization in North Brent coincidentally coincides with the news about Senate support for the bill and the various amendment proposals that will likely be attached. Exporting WTI, especially with the excess global refining capacity while the US is at full capacity, will stabilize the price and likely assist in moving that commodity back into a normal trading pattern.
The behavior of these two commodities should be closely watched. Once oil prices stabilize, there is a tremendous investment opportunity across that entire sector.
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