Oil Prices Keep Rising
Spot WTI oil prices (Figure 1) have risen year to date from $98 on December 31, 2013 to nearly $104 today. Keep in mind, consistent with consensus bearish expectations for 2014, spot oil prices sold off during the month of January down to $91.25.
At the current $104 level, the price is still well below the $112.24 two-year high of late August 2013. However, given the recent rise, it warrants reviewing whether the potential exists for spot prices to revisit that high.
First, there does exist improving demand for the “paper asset” of oil. However, paper demand alone is not enough to explain the rising price of the past few weeks.
Second, consensus estimates for the spot WTI price are nearing $90, close to $14 below the current price. As for Brent crude oil (Figure 2), the consensus estimate is for $100 – again, well below the current $110 price. So sentiment does not match actual performance, which creates a modest “chase.”
Rather obvious to state is that the escalating tensions in Ukraine have created a premium for the spot price. With Russia, the world’s second largest oil exporter, embroiled in the crisis, it is fair to assume this situation is certainly a contributing factor.
Beyond that, however, there are other fundamental factors that must be given consideration over the next few weeks and months that are not being discussed enough.
- During April 2014, China imported an all-time high of 6.81 million barrels per day. That record demand is despite the appearance of China’s slowing growth. Additionally, 1.4 million barrels per day were dedicated toward the stockpiles of fast growing Chinese strategic petroleum reserve.
- Oil imports to the U.S. are currently at a 17-year low of 6.47 million barrels per day.
- U.S. domestic oil production (Figure 3) reached a 28-year high of 8.43 million barrels per day.
- U.S. inventories are at 391.3 million barrels, down from the 32-year high of 399.4 million barrels on April 25, 2014.
- At 23.2 million barrels, U.S. inventories in Cushing, Oklahoma, the WTI delivery point, are at their lowest levels since 2008, as the Keystone southern pipeline began clearing Cushing inventories to Gulf Coast refineries earlier this year.
- Libyan oil production, at 215,000 barrels per day, is running down 84% year on year. Consensus estimates for 2014 Libyan oil production were for 1.1 million barrels per day.
- Russian exports (Figure 4) as a percentage of its own domestic production has fallen to 38%, its lowest level in nearly a decade.
A couple of things stand out to me, but first let’s get the obvious out of the way. Momentum is on the bull’s side so the market will naturally point higher as a result until a dominant bearish fundamental emerges.
However, there is not enough fundamental evidence to suggest an immediate challenge to $112 is imminent.
Much will be determined based on Libyan oil production coming back on line quickly. Of that I am suspicious. I do not expect the Chinese appetite for oil to be pared back at all. They seem intent on building a massive reserve, which is smart on a social, economic, and political platform. Lastly, the world is responding to the growth in U.S. shale and exporting less oil to the U.S.
Energy equities with a shale presence and proven assets continue to be the optimal strategy for investors. I would argue that energy equities also offer portfolio protection against inflation and the escalation of tensions in Ukraine. Perhaps most importantly, back to the incorrect consensus estimates for 2014, energy earnings estimates continue to be revised higher from lower levels. Not many suggested that energy would be a leading sector for 2014, but at +6.4%, it is the second best performer behind utilities at +9.2%.
Figure 1: WTI Spot Oil, January 2011 to Present
Figure 2: Brent Crude Oil Prices, January 2011 to Present
Figure 3: U.S. Domestic Oil Production, May 1984 to May 2014
Figure 4: Russian Oil Exports as a % of Oil Production, August 2006 to Present