Monday, 7 February 2011
Oil at $100: Murky
One of my predictions for 2011 has oil above $100 by the end of the year and staying there forever:
... It will cross the 100 line earlier than that, but there is scope for some dithering on either side initially.
Brent hit the magic number a few days ago, then promptly dipped back below. This is in contrast to 2008 when it powered through, and famously peaked at $147 before plummeting.
What does $100 mean this time around ? Firstly we need to note that the Brent-WTI basis differential has mushroomed, from irrelevantly small to a highly significant $10 or more - for background go to Alphaville where they speak of little else (who she? - Ed). Significant ? I have known US oil companies to hedge their North Sea production with WTI contracts, on the grounds that they are active in that market and the correlation is - or was - 99%. Not now. Something is amiss - these markets should arb pretty well. The reasons lie somewhere in the arcane delivery logistics that bedevil both blends: some blame Brent, others WTI. Whatever the 'true cause', and notwithstanding Brent sets the price for more than twice as much oil worldwide as does WTI, we can't say that oil has unequivocally broken through the $100 just yet.
The second point relates to a question I was asked by one of our commenters a while back: when will we know we are seeing something significant ? I suggested that to cancel out the effect of the declining US$, we should watch for a sustained rise in oil denominated in Aussie dollars, i.e. a commodity-based currency.
Look at the graph above. If we go with WTI rather than Brent, oil in AUD remains more or less range-bound. So by this criterion, no significant breakout just yet.
But when it does, strange things may happen. A while back I did some work with a huge buyer of oil - both as fuel and petrochem feedstock - and observed that in risk-management terms they had a tidy and seemingly stable business model, being able to pass through essentially all their oil-related costs to customers. I asked how robust this would be against oil prices in 3 figures, and they said they had tried modelling it, but couldn't. $147 lasted such a short time, it didn't really test anything to breaking-point. So far as they are concerned, above $100 on a sustained basis, all bets are off.
It's significant all right. And coming soon, to an economy near you ...