The following ran on the May 31, 2013, edition of the Energy Trends Insider. Economist James Smith provided expertise for this story.
June 7, 2013
By Jennifer Warren
The Unbearable Lightness of Oil Prices
What could be behind the recent observation that oil futures prices are out of sync with the physical market? It’s true that the U.S. continues its march towards less imports as of the year 2005 to the present, according to the 2013 U.S. Energy Information Administration’s Annual Energy Outlook. At the end of 2012, the U.S. upped its crude oil production to 6.5 million barrels per day, from 5 million in 2008. This U.S. oil supply boon is thanks to our Western producing states plus North Dakota and Texas. Alongside hydraulic fracturing and horizontal drilling, enhanced recovery methods such as CO2 injection have played a role in the production gains.
In general, the market is well supplied. As OPEC concluded its May 31 meeting, the cartel is not restricting supply to push up prices in the near term, though some member states would like to. Surprisingly, they have not systematically calculated the impact of U.S. shale oil production vis-à-vis their own members’ production.
A disconnect was emerging however between the oil futures market prices (financial) and the physical market, or spot prices. The U.S. benchmark (WTI) crude-oil futures were up 4.6% since the start of 2013, according to a Wall Street Journal article of May 19, while the futures prices of the global benchmark Brent was down. One analyst suggested that the investment demand for exposure to oil prices was supporting these numbers, not physical demand growth. So what information content is behind oil prices, and how do we parse reality from the hype?
The idea that excessive speculation drove the oil price spike of 2004-2008 still resounds in some corners, in spite of evidence to the contrary. Expectations regarding crude oil market fundamentals still mattered most, according to research by financial economist James Smith of Southern Methodist University’s Cox School of Business....