Crude oil spikes like an Egyptian
This post is a guest contribution by Dian Chu, market analyst, trader and author of the Economic Forecasts and Opinions blog.
Images of a mass of Egyptian protesters clashing with police in Cairo broadcast around the world shook global financial markets on Friday, Jan. 28. The Dow and S&P 500 both dropped more than 1%, while some asset classes such as gold, silver and U.S. Treasuries were hot commodities from safe-haven demand.
NYMEX West Texas Intermediate (WTI) also spiked more than 4%, closing at $89.34, while ICE Brent crude for March delivery surged 2.1% to $99.42 a barrel, and touched $99.74 intraday, a new post-2008 high.
Egypt – home of two oil transport chokepoints
Egypt, with oil production of about 685,000 barrels of oil a day, is ranked among the world’s top 30 oil producers based on U.S. government data. The country is not a significant oil exporter as its production is mostly used for domestic consumption.
However, since Egypt is home to the two world oil transit chokepoints − Suez Canal and Sumed pipeline − the surge in crude oil prices was partly on worries of potential supply transport disruptions.
Suez Canal shutdown = higher oil price
In the event that the Canal is closed, thousands of ships and oil tankers would have to go around Africa, adding about 6,000 kilometers (3,729 miles) to their journey, slashing the availability, while adding to the cost of crude oil.
Increasing Middle East tensions
As riots first started in Tunisia, spreading to Yemen, and now Egypt, anger over rising prices and high unemployment has also prompted political protests erupting throughout the Arab world in Morocco, Algeria and Saudi Arabia.
Crude and equities diverge
WTI-Brent spread at record high
This reversal and widening of the WTI-Brent price differential could be mostly attributed to seasonal and fundamental factors such as outages at North Sea, cold weather in Europe, but more importantly the “Cushing Syndrome.”
“Cushing Syndrome” distorts WTI
Inventory at Cushing gained 2.3% in the week ended Jan. 21 to the highest since August, while the overall inventory in the U.S. also rose to 340.6 million barrels, 4.25% higher than a year ago, and above the 5-year average, according to the data from the U.S. EIA.
And the glut could get worse as TransCanada Corp.’s Keystone pipeline starts to pump as much as 156,000 barrels of Canadian crude to Cushing in February.
Lack of transparency boosts Brent
So, for all the criticism about WTI and that Brent is a better benchmark reflecting global demand, Brent could actually have been more easily manipulated to its current near $100 levels, due to its lack of transparency and the considerably lower volumes on ICE (25% of NYMEX WTI, according to the CME Group as quoted by FT Alphaville.)
Higher price = better benchmark?
Fast and furious WTI short squeeze
This not only further distorts the Brent and WTI differential, but also means a fast and furious short squeeze on the NYMEX WTI, with any unexpected events such as the Egyptian unrest. This is why you see WTI move 4% vs. the 2% of Brent on the same news.
Europe is not $12 stronger
As such, I believe the current wide spread, while partly supported by regional and seasonal market fundamental factors, is not sustainable.
Be a Brent bear and WTI bull
From that perspective, sometime in the next week or so, I expect WTI to break above $90 a barrel and could make a run at $93 as protests escalate, and Brent could break above $100. Meanwhile, the WTI-Brent spread will likely narrow to around $8 next week, and have the potential to move below $6 over the next few weeks, if chaos continues.
Crack spread to narrow further
Tanker stocks get an Egyptian pop
So far, the Canal has been operating normally since the riots started, and there’s no indication of a possible shutdown. Nevertheless, since it takes some time for portfolio managers to reallocate funds, and as long as the North African situation remains unresolved, there could be much more upside before the sector’s fundamentals set in again.
Among the tankers, Frontline (FRO), the world’s largest oil tanker operator, would be the best of the bunch from a risk/reward standpoint. I’d stay away from General Maritime (GMR) for the time being mainly due to its high leverage and its struggle with debt in recent months.
Start of a political shift in the Arab World
Priceless − geopolitical premium
So, depending on the development in Egypt and the Middle East, volatility will likely rule crude oil in the near term as there has not been a geopolitical event such as this for a long time, and the “geopolitical premium” rises and falls based purely on markets’ “fear perception”.
Source: Dian Chu, Economic Forecasts and Opinions, January 30, 2010.
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