Transcript EMT & Associates, Inc

The Interplay of Fundamentals and
Financials in
NYMEX Crude Oil Price
Determination
USAEE/IAEE North America Conference
October 12, 2011
Washington, D.C.
William H. Brown III
President
WHB Energy Research LLC
David Knapp
Energy Intelligence Group
Outline of Presentation

Overview

Conclusions




Methods of Analysis
Tactical
Strategic
Fundamental
Financial
Results
Price components in yet another “recovery” year: 2012
Broad fundamental view
Non-commercial influence
Seasonality
Decipher all factors into a price perspective for an uncertain 2012
Overview




There has been substantial debate over the last few years with regard to
the role of financial players, i.e. so-called “speculators” or non-commercials,
in determining the path of crude oil prices since 2004, and how these
players have or have not distorted what many believe to be strong
underlying trends in the fundamental, or physical, oil market.
We believe 2004 marks a watershed in this regard because in late
2003 a few major and influential pension funds were searching for ways to
enhance returns, given the mediocre performance of fixed income
portfolios.
These pension funds recognized that in the preceding years, Commodity
Trading Advisors (CTAs) had realized attractive returns, and thus sought to
diversify their portfolios by allocating incremental capital to
commodities in general and oil in particular.
In contrast to “traditional” CTAs who had the option of being
either long or short and thus could capitalize on market moves in
either direction, however, most pension funds had to be long, and
thus began to have a “one way” influence on oil prices as they increased
their capital allocation to oil, to be joined progressively over the years since
2004 by hedge funds, other financial institutions, and individuals.
Overview (cont’d.)



We have studied the role of various players in both in the physical and
paper markets on both a micro and macro level over the last few years.
Given what we believe to be a “modified” profile of participants in
the paper futures markets, understanding the factors that
determine NYMEX crude oil prices is critical from the standpoint of
price forecasting, identifying producer hedging opportunities, and
U.S. energy policy.
We wish to emphasize at the outset that we regard non-commercial
participation as neither “good” nor “bad.” We view it as a fact of life
and one component of the equation, and do not believe that
“speculation is evil” or that funds “have no right to hit a home run”.
We have believed ever since the 1980s that commodities represent a
legitimate alternative asset class, but on both the long and short side. The
fund influence on oil prices has played a major role in rebalancing
demand with supply in an industry that is not characterized by
discrete, annual, and predictable price increases.

Finally, we believe that legislation and/or rule making will have little or no
effect on crude oil prices.
Conclusions




From both a qualitative and quantitative standpoint, both fundamental and
financial factors have played significant roles in NYMEX crude oil price
determination over the last few years, but neither group of factors is
perfectly consistent and continuous in its “explanatory power”.
Rather, it is the interplay of both sides of the equation over time with
varying degrees of influence, either independently or together, during
discrete time periods that link to form a continuous chain, ultimately
yielding the actual path of NYMEX crude oil prices.
We would note that as NYMEX/Brent crude oil prices exceed the upper $60s
per barrel, our estimate of the underlying cost of marginal resource
development, the larger the periodic, but once again not continuous,
influence of financial factors.
On balance, we believe it is counterproductive to “blame” exclusively either
one or the other side of the equation, particularly in the context of a debate
on the appropriate path of U.S. energy policy.
Methods




Our approach to the problem, of necessity, was both qualitative and
quantitative in nature.
From a qualitative standpoint, we are “in the market” on a daily basis on
behalf of our clients, tracking NYMEX and ICE price movements and the
factors that influence them hour by hour, which affords us a “tactical”
perspective on price.
From a quantitative standpoint, the broad fundamental framework includes
our detailed macro analyses of the international and U.S. petroleum
industry which affords us an overall “strategic” perspective and a
fundamental view of price. Our “strategic” perspective also includes a
broad analysis of financial elements and players in the price equation.
A good example of our “tactical” perspective which strikes us as adding
merit to our arguments and yet admittedly has no ability to be
quantitatively proven, is an early month pattern we saw developing in 2010
illustrated as follows:
The “Tactical” Perspective
Perceived Month-by-Month Capital Allocation Patterns in 2010
Cumulative Gain/Loss,
First Three Trading Days of the Month
Prompt NYMEX CL Settlements
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Net
Investment:
Broad
Economic
Optimism
$3.82
$4.09
$1.21
$3.08
-$6.18
$0.64
-$3.65
$3.52
$2.68
$2.85
$3.26
$5.08
Net “Disinvestment”: Euro Crisis
and “Double Dip” Fever
Net Investment: Ben’s QE II
Discourse and Renewed
Economic Optimism
For 2010 as a whole, the “average peak” in the first three trading days of the month was $81.25 per barrel. The
average for remaining trading days of each month was $79.51 per barrel. Therefore, on average the difference
was an early-month peak that was higher than the subsequent average by $1.74 per barrel, suggesting that
early-month asset allocation played a role. A similar pattern often occurred in the equity market.
The “Strategic” Perspective:
Fundamentals



We have considered a variety of factors based on our detailed models of
world oil demand and supply and U.S. refinery balances, the ultimate price
“bellwether” of which would be the global and/or U.S. “discretionary” crude
oil inventory position as measure in days supply.
In addition, taking into account the rising impact of East of Suez, primarily
China and India, oil demand, we have attempted to quantify the price
impact of what we would term the incremental “China pull” of light, sweet
crudes out of their natural market, the Atlantic Basin.
Also, we have examined fundamental, seasonal patterns that manifest in
crude oil prices within any given year which often “overlay” the underlying
trends in the global oil picture.
The “Strategic” Perspective:
Financials



With regard to financial factors, we have looked at a number of variables
against NYMEX crude oil prices.
These variables include:
The categories of the weekly CFTC Commitments of Traders Report
Changes and/or expectations of changes in Fed policy
The equity market as represented by the S&P 500
The dollar/euro rate
Of course, these factors are not mutually exclusive. If hypothetically there
is a close relationship between oil prices and CFTC fund position data, those
positions are established for a reason, e.g. Fed policy, positive/negative
economic expectations, etc. which implies in turn a close relationship
between oil prices and those catalysts for fund positions.
Results:
Fundamental Relationship Between Price and
Inventory Days Supply





Our research has concluded that from both a qualitative and quantitative standpoint, the global
and U.S. fundamental picture plays a substantial role in crude oil price determination, as it
should.
Prior to 2004, the most relevant variable in terms of the relationship to NYMEX crude
oil prices was the days supply of U.S. crude oil as calculated from the inventory and
refinery run data reported by the Energy Information Administration. The U.S. stock
profile was more relevant than the global inventory position since the U.S. data are more timely
and visible. The relationship also yielded intuitively reasonable results when considering
commodity price behavior. That is, although not always perfect, generally speaking as the U.S.
days supply of crude oil increased prices declined, and vice versa.
Although in theory one would look at inventory at Cushing, Oklahoma versus the NYMEX crude oil
contract, we have found that the market responds just as much or more to changes in the total
U.S. inventory picture.
However, attempting to quantify the relationship between U.S. days supply of inventory and
NYMEX crude oil prices yields relatively poor results in the period post 2004 on average.
Granted, since 2004 oil demand outside the OECD has provided the bulk of growth, with China,
for example, “pulling” light, sweet crudes out of their natural Atlantic Basin markets, as cited
above.
Also, one could make the argument that rising OPEC capacity utilization commands, by definition,
a “security premium.” We believe, however, the abandonment of any intuitively
reasonable relationship with the most visible and “data-timely” crude oil market in
the world suggests additional, non-fundamental factors at play.
Results:
An Historical Perspective
U.S. Crude Oil Days Supply vs.
Prompt NYMEX Crude Oil Settlements
Annual Averages
Days
Supply
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011 to Date
19.4
20.3
20.6
18.4
18.8
20.9
21.9
21.6
21.0
24.2
24.2
24.3
Price
$30.26
$26.04
$26.16
$31.12
$41.43
$56.71
$66.18
$72.42
$99.73
$62.08
$79.60
$96.85
Intuitively Reasonable
Relationships
De-Coupling of Price From “Visible”
U.S. Supply
Results:
Financial Players and Variables

Our correlation analyses for 2010 and 2011 (as well as previous years) did not yield

However, as with fundamentals as gauged by days supply of crude oil inventory, there were a




consistently strong relationships between NYMEX crude oil prices and the financial
variables previously itemized on a continuous basis for the entire time periods under
consideration.
number of discrete time periods within the course of a given year when the
relationships between NYMEX crude oil prices and variables such as Fed expectations,
the S&P 500, and the dollar were closely correlated.
The “financial manifestation” of the non-commercial influence on crude oil prices is of course
subject to much debate. The CFTC and others had previously concluded that speculation had
little or no influence on oil prices. However, we suspect that CFTC analysts were basing
their conclusions on the analysis of an entire year or series of years which yield weak
results when performing a Granger causality analysis.
Also, once the CFTC finally began disaggregating their weekly Commitments of Traders Reports
for these times, there were substantially better and more appropriate data to compare with price
movement, yielding more intuitively “reasonable” results.
We wish to strongly emphasize at the outset that the CFTC data are an imperfect, but useful, tool
to gauge the price influence. Although the CFTC breaks down the weekly Commitments of
Traders Report into 4 categories, we have found the two most “explanatory” to be Managed
Money and Swaps Dealer.
Of the two, Managed Money has been progressively and substantially more statistically
significant over the course of an entire year and particularly, within a given year. Managed
Money is defined as a registered commodity trading advisor (CTA), a commodity pool operator
(CPO), or an unregistered fund identified by the CFTC (e.g. hedge fund).
Results:
CFTC Data: Explanatory or Not?
Correlation Between the Prompt NYMEX Crude Oil Settlement
And
The Net Change in Managed Money Position
2007
0.42
2008
2009
2010
0.41
0.72
0.75
2011 to Date

0.67
The relatively higher correlation in more recent history, on average, suggests that either
Managed Money is concurrently reacting to short-term fundamental developments
(read demand) or is helping to cause prices to rise or fall. This obviously begs the
question of correlation versus causality. To believe that Managed Money is reacting to
fundamentals, however, perhaps presupposes a real-time, continuous, and near-perfect
knowledge of fundamental developments in the physical market, which we believe is
unlikely given anecdotal evidence of the profile of the average oil trader these days
who has come into the market as commodities became a more popular asset class.
Results:
CFTC Data: Explanatory or Not, 2010?
Once again we would make the point that “Managed Money” has relatively
strong explanatory power regarding NYMEX crude oil, but generally during
discrete periods within a given year, with 2010 a good example of
periodic “coupling” and “decoupling” of the influence.

2010 Correlation
Prompt NYMEX Crude Oil Contract vs. CFTC "Managed Money"
300,000
95.00
250,000
90.00
200,000
85.00
150,000
80.00
100,000
Partial uncoupling
post the November 3
"news"
50,000
75.00
70.00
0
65.00
Period of QE II discounting between
Ben's Jackson Hole speech and
November 3 FOMC statement
CFTCNMM
PCL
12/20/2010
12/6/2010
11/22/2010
11/8/2010
10/25/2010
10/11/2010
9/27/2010
9/13/2010
8/30/2010
8/16/2010
8/2/2010
7/19/2010
7/5/2010
6/21/2010
6/7/2010
5/24/2010
5/10/2010
4/26/2010
4/12/2010
3/29/2010
3/15/2010
3/1/2010
2/15/2010
2/1/2010
1/18/2010
60.00
1/4/2010
-50,000
Results:
CFTC Data: Explanatory or Not, 2011?

Our point regarding the influence during periodic, discrete periods can also be illustrated in tabular form for
2011 to date. As indicated, earlier in the year the implied price impact was reasonably consistent, but for the
period in early to mid August was much larger, implying in turn a fundamental as well as financial influence on
price change as the global oil balance became “looser”.
CFTC-Reported, Futures Only Managed Money Net Length
vs.
Prompt NYMEX Crude Oil Settlement
2011 to Date
Summary
of
Discrete Periods of Observation
4-Jan-11
11-Jan-11
18-Jan-11
25-Jan-11
1-Feb-11
8-Feb-11
15-Feb-11
22-Feb-11
1-Mar-11
8-Mar-11
15-Mar-11
22-Mar-11
29-Mar-11
5-Apr-11
12-Apr-11
19-Apr-11
26-Apr-11
3-May-11
10-May-11
17-May-11
24-May-11
31-May-11
7-Jun-11
14-Jun-11
21-Jun-11
28-Jun-11
5-Jul-11
12-Jul-11
19-Jul-11
26-Jul-11
2-Aug-11
9-Aug-11
16-Aug-11
23-Aug-11
30-Aug-11
6-Sep-11
13-Sep-11
20-Sep-11
27-Sep-11
---------------------Managed Money-------------Long
Short
Net
243,085
67,233
175,852
253,290
57,635
195,655
248,173
56,970
191,203
217,026
61,539
155,487
239,160
62,712
176,448
230,615
52,183
178,432
218,807
55,137
163,670
249,629
43,606
206,023
293,884
25,262
268,622
301,202
26,967
274,235
283,647
32,267
251,380
281,134
28,916
252,218
293,308
31,549
261,759
296,432
28,803
267,629
279,198
27,951
251,247
296,915
37,904
259,011
296,609
33,373
263,236
295,640
36,972
258,668
280,900
47,331
233,569
249,943
37,935
212,008
251,438
38,498
212,940
246,234
40,407
205,827
236,116
57,899
178,217
240,024
56,911
183,113
228,586
66,396
162,190
223,022
73,018
150,004
224,114
64,473
159,641
228,578
66,290
162,288
237,123
65,733
171,390
244,362
64,349
180,013
234,633
77,524
157,109
227,268
80,156
147,112
226,918
78,323
148,595
218,941
80,170
138,771
221,311
65,583
155,728
224,199
70,072
154,127
228,362
59,564
168,798
217,699
64,824
152,875
215,424
73,890
141,534
Prompt
NYMEX
PCL
$89.38
$91.11
$91.38
$86.19
$90.77
$86.94
$84.32
$93.57
$99.63
$105.02
$97.18
$104.00
$104.79
$108.34
$106.25
$108.15
$112.21
$111.05
$103.88
$96.91
$99.59
$102.70
$99.09
$99.37
$93.40
$92.89
$96.89
$97.43
$97.50
$99.59
$93.79
$79.30
$86.65
$85.44
$88.90
$86.02
$90.21
$86.89
$84.45
Increase
Increase
(Decrease) (Decrease)
in Net Length
in Price
(40,168)
110,565
(85,019)
30,009
(38,479)
Average
($4.92)
$ Change
per
10,000
$1.22
$20.70
$1.87
($13.12)
$1.54
$6.70
($15.14)
$2.23
$3.93
$2.16
Results:
Prompt NYMEX Crude Oil vs. Days Supply
Such a transition from financial to fundamental influence, though of course not mutually
exclusive, was in evidence late last year, as we illustrate in our graph of 2010. In the context
of our previous discussion of QE II, crude oil price movements were not exclusively a noncommercial response to liquidity and inflation expectations.
U.S. Commercial Days Supply of Crude Oil vs. Prompt NYMEX CL
95.00
27.00
QE II discounting led to counterintuitive
behavior of rising prices and rising days
supply
90.00
26.00
85.00
25.00
80.00
24.00
75.00
23.00
70.00
22.00
Once QE II had been discounted, however,
market reverted to intuitive behavior of rising
prices and declining days supply
PCL
USCLDS
12/20/2010
12/6/2010
11/22/2010
11/8/2010
10/25/2010
10/11/2010
9/27/2010
9/13/2010
8/30/2010
8/16/2010
8/2/2010
7/19/2010
7/5/2010
6/21/2010
6/7/2010
5/24/2010
5/10/2010
4/26/2010
4/12/2010
3/29/2010
3/15/2010
3/1/2010
2/15/2010
20.00
2/1/2010
60.00
1/18/2010
21.00
1/4/2010
65.00
Results:
NYMEX Crude Oil Prices and the Equity
Market

Aside from the influence of monetary policy, another observable, and more
consistent financial influence on crude oil prices has been the S&P 500 as
the barometer of economic growth. Although there are more energy
consumers than producers in the S&P 500, the tendency toward highly
correlated trades across asset classes due to the influence of
hedge funds has inverted the relationship to one of a positive
correlation. Not to oversimplify, but we believe, based on our anecdotal
and statistical evidence, that funds in general function according to
the following “equation”:
Economy = Oil Demand = Oil Prices

That is, funds tend to look only at oil demand and not the entire
fundamental balance as embodied by the net global inventory position.
The tendency toward this approach can be illustrated in the data
below for the years 2008-2010.
Results:
Prompt NYMEX Crude Oil vs. S&P 500
Correlation,
S&P 500 Close vs. Prompt NYMEX Settlements
2004
2005
2006
2007
2008
2009
2010
2011 to Date
.00
.25
.40
.15
.66
.76
.76
.41
Results:
Prompt NYMEX Crude Oil vs. The Equity
Market, 2010
The correlation was “close enough for government work”, given the comparison of a 4:00
equity market close with a 2:30 NYMEX settlement
2010 Correlation
Prompt NYMEX Crude Oil Contract vs. S&P 500
PCL
SP500
20-Dec
6-Dec
22-Nov
8-Nov
25-Oct
11-Oct
27-Sep
13-Sep
30-Aug
16-Aug
2-Aug
19-Jul
5-Jul
1000.00
21-Jun
65.00
7-Jun
1050.00
24-May
70.00
10-May
1100.00
26-Apr
75.00
12-Apr
1150.00
29-Mar
80.00
15-Mar
1200.00
1-Mar
85.00
15-Feb
1250.00
1-Feb
90.00
18-Jan
1300.00
4-Jan
95.00
Results:
The 2011 Falloff in Correlation
Of note is the falloff in the correlation in 2011 to date, and we illustrate this graphically below. We
first would note that the correlation between the S&P 500 and Brent in 2011 to date is just as weak.
Thus far this year there is a “breakaway” of crude oil prices from the equity market because of
supply issues that for a good part of the year have overshadowed “demand discounting”.
Prompt NYMEX Crude Oil Settlements vs. S&P 500 2011 to Date
1,400
$120.00
$115.00
1,350
$110.00
1,300
$105.00
1,250
$100.00
$95.00
1,200
1,150
"Arab Spring" and Libya
Disruption
$90.00
Asset "Re-Pricing"
to Global
Economic Pace
$85.00
IEA Stock
Release
1,100
$80.00
1,050
Quasi "Re-Linking" as Global
Economic Woes Mount
$75.00
$70.00
3/
20
11
1/
17
/2
01
1
1/
31
/2
01
1
2/
14
/2
01
1
2/
28
/2
01
1
3/
14
/2
01
1
3/
28
/2
01
1
4/
11
/2
01
1
4/
25
/2
01
1
5/
9/
20
11
5/
23
/2
01
1
6/
6/
20
11
6/
20
/2
01
1
7/
4/
20
11
7/
18
/2
01
1
8/
1/
20
11
8/
15
/2
01
1
8/
29
/2
01
1
9/
12
/2
01
1
9/
26
/2
01
1
1,000
1/

SP500
PCL
Results:
NYMEX Crude Oil Prices vs. the Dollar






Another financial influence on crude oil prices often cited by the general press is the dollar.
These days, few arguments are offered to defend this “trade”, merely periodically cited by the
media as a presumed influence, but “originally” the idea was that as a dollar-denominated
commodity, as the dollar declined it cheapened oil costs to non-dollar economies, thus stimulating
demand.
Another argument was that as the dollar declines OPEC loses purchasing power, and thus the
market discounted the likelihood that OPEC would take steps to increase prices in dollar terms.
A third argument was that loose money weakens the dollar, creating inflationary expectations,
leading in turn to buying oil as a hedge against the very inflation that higher oil prices are
creating.
r
In our view, based on anecdotal evidence via discussions with hedge funds, the inverse
relationship between crude oil prices and the dollar was a self-fulfilling trade that “worked”, pure
and simple.
As the original arguments emerged once again, some funds initially embraced the idea, leading to
an increasingly favorable technical picture which induced more funds into the trade. It worked
until it didn’t work, if you will, as illustrated by the following data.
Results:
NYMEX Crude Oil Prices vs. the Dollar
Correlations,
Dollar/Euro Rate vs. Prompt NYMEX Crude Oil Settlements
2004
2005
2006
2007
2008
2009
2010
2010, Apr-Nov.
2011 to Date

.04
.43
.02
.93
.73
.87
.22
.60
.36
We show both 2010 in its entirety and the period Apr-Nov of 2010 to demonstrate
a good example of “on again, off again” correlation related specifically to the
“first” Greece crisis and the market discounting QE II as we illustrate:
Results:
NYMEX Crude Oil Prices vs. The Dollar,2010
2010 Correlation
Prompt NYMEX Crude Oil vs. Dollar/Euro Rate
95.00
1.5000
Things started "tighening up" prior to
the Greece crisis and collapse of the
euro
Decouple
Decouple
1.4500
90.00
Things remained fairly tight leading up
to Ben's Jackson Hole speech
1.4000
85.00
1.3500
80.00
1.3000
1.2500
75.00
1.2000
Period of QE II
Discounting
70.00
1.1500
PCL
DVEURO
20-Dec
6-Dec
22-Nov
8-Nov
25-Oct
11-Oct
27-Sep
13-Sep
30-Aug
16-Aug
2-Aug
19-Jul
5-Jul
21-Jun
7-Jun
24-May
10-May
26-Apr
12-Apr
29-Mar
15-Mar
1-Mar
15-Feb
1-Feb
18-Jan
1.1000
4-Jan
65.00
Results:
A Return to Fundamentals: Seasonality


With very few exceptions, crude oil prices tend to rise in the second quarter from a first
quarter trough.
Factors include:
In Q1, lower refiner demand for crude in Atlantic Basin, U.S. stocks recover
In Q1, market discounts end of winter
Consensus invariably “mis-correlates” the first to second quarter downturn in global
refined product demand with crude oil prices
In Q2, refiner crude oil demand recovers
In Q2, North Sea production begins to fall seasonally
In Q2, funds buy gasoline, always believing the U.S. gasoline season will be strong

The exceptions to this pattern tend to lie with global macro developments that more than
offset the seasonal first-to-second quarter price recovery. In the case of 2010, the seasonal
pattern was well defined until the Greece crisis in early May. Summertime “double–dip” fever
led to lower prices than those prevailing in the first quarter, also an exception. In 2011, the
seasonal pattern began well-defined, compounded by “Arab Spring” and the Libya revolution.
Thereafter, once again “double dip” fever has led to lower than first quarter prices at present.
Results:
Fundamental Crude Oil Price Seasonality
Monthly Crude Oil Price Seasonality Since 2004:
Year=1.00, Except 2011
January
February
March
April
May
June
July
August
September
October
November
December
2004
2005
2006
2007
2008
2009
2010
2011
0.83
0.84
0.88
0.89
0.97
0.91
1.00
1.08
1.12
1.27
1.15
1.04
0.83
0.85
0.97
0.94
0.88
1.00
1.04
1.15
1.15
1.10
1.03
1.05
0.99
0.93
0.95
1.06
1.07
1.07
1.12
1.10
0.96
0.89
0.90
0.94
0.75
0.83
0.84
0.88
0.88
0.94
1.03
1.00
1.10
1.19
1.31
1.27
0.93
0.95
1.05
1.13
1.25
1.34
1.34
1.17
0.98
0.78
0.58
0.42
0.67
0.63
0.78
0.81
0.97
1.13
1.03
1.14
1.12
1.22
1.26
1.20
0.98
0.97
1.03
1.06
0.93
0.95
0.97
0.96
0.95
1.03
1.06
1.12
0.94
0.94
1.08
1.15
1.06
1.01
1.02
0.90
0.90
20042010
0.85
0.86
0.93
0.97
0.99
1.05
1.08
1.09
1.06
1.07
1.04
1.00
Price Components in Yet Another “Recovery” Year
2012:
Summarizing the Components
2012 NYMEX crude oil prices will once again be determined by a combination
of fundamental and financial variables:

Fundamental factors:
-Growth in world oil demand
-Growth in non-OPEC supply
-Geopolitical influences on supply
-Global days supply of crude oil and product inventories influenced by:
-Excess refining capacity
-Excess producing capacity, primarily Arabian Gulf sour grades

Financial factors:
-Need/desire by financial institutions to diversify invested assets. However, by the
end of 2011 we believe there is a good chance funds will begin to rethink their longterm commitment to a long-only oil strategy, particularly v. equities
-Global equity market strength/weakness
-Value of the dollar, although only periodically a factor since this argument is starting
to get “old”
-Monetary policy expectations
Price Components in Yet Another “Recovery” Year
2012:
Adding It All Up



Fundamental factors are “straightforward”, but there is still a critical need to
appreciate the importance of the financial factors and the “non-commercial” price
influence.
This is particularly critical for producers (hedge timing) and equity portfolio
managers. The non-commercial influence implies a greater volatility and velocity of
crude oil price movement than if prices were determined solely by fundamentals.
Ever since 2004, the non-commercial influence on crude oil prices has been
increasing, and has had a major impact, even during the global recession. We have
tried various approaches to quantify the impact for the last four years. In our view,
those who argued that fundamentals were primarily, if not exclusively, responsible for
the price run up because there was little consistent, public, and quantitative
“proof” of the non-commercial influence were guilty of the logical fallacy:
Argumentum ad ignorantiam
i.e. asserting that a proposition is necessarily false because it has not been proven true
Price Components in Yet Another “Recovery” Year
2012:
Conclusions




.

The overall fundamental global balance should remain competitive in 2012
with excess producing and refining capacity suggesting lower prices than
$80.00 per barrel, basis Brent.
However, funds and other non-commercials may be intent upon allocating
incremental capital to oil next year, if risk of global recession wanes.
Thus, a higher price “bar” will be established from which prices will rise
seasonally as we move through the first half of next year from a first
quarter trough.
Price elasticity of demand remains alive and well, however, suggesting that
crude oil price strength in 2012 will extend only through summer. In the
fourth quarter, concerns over the impact of higher oil prices on 2013
economic activity once again will lead to fund net length liquidation back
toward, but not to, underlying fundamental value. Funds will limit their
net length liquidation in order to retain some exposure to the
possibility of generating “excess” portfolio returns.
We are therefore suggesting a continued crude oil price cycle of
mini “boom and bust” for the foreseeable future.