Wednesday, March 9, 2011

Interpreting Recent Oil Price Moves


The New York Times this morning has a debate between various experts on what the current moves in oil prices mean.  It's framed as a mystery:
The world has lost less than 1 percent of crude oil production during the Libyan crisis of the last few weeks, but crude oil futures have risen more than 20 percent in the same period. In the past six months, gas prices have climbed more than 70 cents, but in the past two weeks alone, they're up 34 cents.
While the various contributions to the debate are worth reading, I always find it a lot more illuminating to actually look at the data myself.  Here is a graph of recent spot prices, both WTI and Brent, since the beginning of Jan 2010.  (Note the EIA data go through March 1st and I have added a point for March 8th based on news reports),   The pale grey vertical grid lines are at four week intervals, and I have added black lines at certain key points in recent Middle East turmoil:


The self-immolation of Mohamed Bouazizi represents the beginning of unrest in Tunisia, then we have the resignation of the dictators in Tunisia and Egypt, followed by the onset of serious unrest in Libya.

There are a number of points worth making:
  • Oil prices were already rising prior to Middle East unrest, due to strong economic growth in developing countries and improving signs of recovery in the US.  That price rise might have continued anyway (or it might not, as prices often show a pattern of advance, overshoot, and then retreat).
  • In the Brent signal, the events in Libya seem to have caused a sharp increase of about $10/barrel in the space of a week, which has been roughly flat since then.  If you thought the price elasticity of oil demand was about -0.05, and given that Libya was exporting 1.3mbd out of global production of around 88mbd (or 1.5%), then you'd expect a price move of around 30% (ie $30, starting at roughly $100 oil).  
  • Thus the mystery is not why prices moved so much, but so little!  The much smaller actual price move presumably reflects some belief that Saudi Arabia is or will be making up Libyan production.
  • Starting in December, a big gap opened between Brent and WTI prices.  This remains somewhat mysterious to me (notwithstanding some good efforts to explain the background).  However, what seems to be happening now is that the gap is closing (something that was entirely predictable given the profit opportunities to arbitrage the difference).  Almost all the WTI movement in the last couple of weeks has been closing of the WTI/Brent spread, rather than comovement of Brent and WTI.  So I don't think we should interpret WTI price movements after about Feb 25th as due to Libya.  US oil is just catching up to what the rest of the world was already paying.
  • And there's still another $10/barrel or so to go in that direction...

4 comments:

Kamil said...

"Libya was exporting 1.3mbd out of global production of around 88mbd (or 1.5%), then you'd expect a price move of around 30% (ie $30, starting at roughly $100 oil)."
"Thus the mystery is not why prices moved so much, but so little!"

Libya is stil exporting oil, so it was not from 1.3 mbd to 0 mbd. I saw estimates, that Lybia's export is about 500 kbd.

Stuart Staniford said...

Kamil:

Yes, you're right - I've seen conflicting reports, but it's probably not zero. Whatever it is, that would change the numbers, but not my main point.

Lanie said...

China is now reporting a trade deficit, so perhaps the global economy is not as robust as thought?

I'm not sure if 2008 is a good comparison anyway. China had been gearing up for the Olympics prior to that and weren't they getting started on their SPR's around that time?

Good post, as always, Stewart!

Kenneth D. Worth said...

Stuart, if you look at the inventory numbers, total petroleum stocks (crude plus gasoline and distillates) fell in the US by 6.7 million barrels last week (API numbers are the same). So one possible explanation (probably the real explanation) for the limited rise in prices thusfar is that importers were eating into their inventories hoping for a quick resolution and a resumption of Lybian exports.

Obviously, inventories cannot continue to decline by nearly a million barrels a day for very long. The hoped for quick resolution looks less and less likely by the day and now oil facilities are being damaged, so we will probably see the full extent of the price impact over the next few weeks.