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OPEC Reference Basket
The OPEC Reference Basket moved between $70 and almost $80/b.
Driven by bullish sentiment in the oil market, the Basket started a three-month high of around $79/b before declining to stand below $70/b on 24 August after market sentiment deteriorated. However, the Basket showed some recovery in the last week of the month to move above $72/b and average $74.15/b, up $1.64 or 2.3% from July and $2.8 higher than a year ago.
All Basket components strengthened in August. Iran Heavy and Qatar Marine led gains with 3.0% and 2.7% respectively, higher than the average, followed by African grades and other Middle Eastern crudes.
Despite the general increase over the previous month, Basket components displayed different trends within the month.
The Middle East crude market started the month strong before weakening on the back of ample supply and poor demand for sour crude in Asia. The weakness in Asian demand was exacerbated by the closure of China’s Dalian port after a pipeline explosion and disruption in the Formosa Petrochemical refinery in Taiwan. In addition to lower demand, Middle Eastern grades continued to face competition from the Russian ESPO Blend, resulting in a sharp cut in official selling price formulae among producers. For instance, the Murban price was set at a premium of just 51¢ to the July average for Dubai crude, the lowest differential in at least six years. Abu Dhabi has also sharply cut its official selling price for exports to Asia-Pacific and Saudi Arabia cut its official selling price formula for September cargoes to Asia-Pacific to very low levels.
Middle East light sour crude came under further pressure in the third week with Murban cargoes for October-loading trading at discounts. The market improved slightly after Qatar sold some cargoes of al Shaheen crude for October-loading at similar differentials as last month and exports of Oman to the US west coast and Abu Dhabi Murban crude to Europe reduced the supply overhang. Middle East light crude market sentiment improved further in the last week of the month, supported by strength in Russian ESPO Blend after Rosneft sold eight cargoes for loading in October and November at record-high differentials of between 45¢/b and 75¢/b to Dubai quotes to the US and China. Market sentiment also strengthened after some cargoes were moved outside Asia as well as improving refining margins.
West African crudes started the month strong, supported by a surge in Indian purchases before they weakened on the back of accumulated supplies, particularly of Nigerian crude. Many cargoes for September loading were still unsold in the third week of the month when many sellers had already turned their attention to October. A drop in Chinese interest for September-loading West African crude cargoes along with subdued US demand have also depressed West African differentials. West African crudes were also pressured by reduced arbitrage to Asia amid a wide Brent-Dubai spread.
Similarly, North African grades – Algerian and Libyan – were well supported at the beginning of the month before they weakened amid reduced buying from European refiners in anticipation of autumn refining maintenance. Both West and North African crude got some support at the end of the month.
The Latin American crude Oriente showed the smallest gain of 55¢ or less than 1% because of low demand for heavy crude in the US.
The oil futures market
Crude oil futures prices broke out of the $70-80/b range in the first week of August for the first time in three months as macroeconomic sentiment turned bullish. The surge of futures prices above $82/b was triggered by positive economic data, a weaker US dollar and a sharp recovery in equity markets amid strong second-quarter earnings. The move beyond 80/b was shortlived as futures started a downward trend of five consecutive days on the back of a sharp sell-off which pushed prices down to around $75/b. On the Nymex, the September WTI crude contract lost $6.24 or 7.7% over five consecutive days to settle at $75.24/b on 16 August. That was the largest percentage loss for a five-day period since early July. Similarly, ICE September Brent crude fell for five days in a row to settle at $74.85/b, the lowest since 8 July. The sharp decline in futures was attributed to growing concerns about economic recovery and its implications on global oil demand, following disappointing economic data from Japan, Europe and the US. Data showed a surprise rise in US new jobless claims to the highest level in almost six months, home-builder sentiment falling to close to a one-and-half-year low in August and European industrial production unexpectedly dropping in June. Japan's economy also slowed sharply in the second quarter to grow at a below-forecast 0.1%.
Indicators of slowing economic growth were also seen in China. This flow of poor economic data also pushed equity markets down sharply, reflecting the strong positive correlation between the oil price and stock markets (see Graph 2).
Futures reversed the downward trend on 17 August, increasing in line with equities as positive data on US industrial production eased some economic concerns. Boosted by auto production, US industrial output grew 1% in July, double what economists had expected and manufacturing output rose 1.1% after a 0.5% decline in June. Prices were also supported by a weaker US dollar as holders of other currencies found dollar denominated crude oil to be cheaper.
Futures fell again in the following week amid bearish US macroeconomic data on shrinking manufacturing activity and growing jobless claims. Prices were also affected to some extent, by rising US oil inventories, which hit a record-high in the previous week. The Nymex WTI front-month fell again over five consecutive days to below $72/b for the first time since early June. The sharp decline in prices came as a result of accelerating sell-offs amid growing fears about the global economic recovery following a record plunge in US housing data and comments by the Chicago Federal Reserve President warning about the growing risks of a double-dip recession. At the same time, equity markets weakened over four sessions in a row and the US dollar showed some recovery against other currencies.
Futures recovered on 25 August, in line with equities, which bounced off seven-week lows. The recovery took place despite bearish data on US oil inventories, confirming the strong relationship between crude oil and the stock markets. Prices rose for three consecutive days in line with strong equities to stand around $75/b on 27 August, after the Fed Chairman said that the central bank was ready to take further actions if needed, to bolster slowing economic growth. The remarks came after a downward revision to the US 2Q10 growth estimate by the Commerce Department.
Again, the recovery was short-lived and futures declined in the remaining last two days of the month to move back below $72/b on 31 August as concerns about the economic recovery remained and expectations showed another build in US crude oil inventories.
On a monthly basis, the WTI front-month averaged $76.67/b in August, up 28¢ or 0.4% from the previous month.
As it appears, the main factor driving oil prices is economic sentiment as reflected in equity markets, rather than supply/demand fundamentals. Oil price movements were led by macroeconomic and financial data as well as expectations about global economic growth. Equity markets and the value of the US dollar has been the main guide of the daily oil price movements. Futures declined when institutions including IEA and OPEC revised up their forecast for oil demand for 2010 and current supply/demand data did not change substantially to justify the pace of the changes in oil prices. Furthermore, it happened that oil prices increased after data showed US crude inventories rose but then declined after inventories dropped, thus implying a disconnection between the oil price and inventories.
ICE Brent crude oil futures followed the same trend as Nymex WTI, but showed a higher gain of $1.76 or 2.3% to average $77.12/b. However, while the WTI front-month rose for the third month in a row, ICE Brent increased for the first time after three consecutive monthly declines.
The WTI front-month continued to trade above Brent until mid-August. Then it switched on 17 August as Brent surged on the back of the stronger economic outlook for Europe, relative to the US, particularly for Germany. This shifted the WTI-Brent spread into negative territory to stand at minus $1.16/b, the lowest since mid-June. The ICE Brent premium over WTI resulted from the strengthening of ICE Brent against Nymex WTI on the back of reduced supplies of North Sea crude because of oil field maintenance and sabotage attacks on Nigerian pipelines. Ongoing oversupply in the US, especially after commercial oil inventories reached a record high and crude inventories at Cushing, Oklahoma, remained elevated, also contributed to the weakness of WTI relative to Brent. Moreover, low refinery runs in the US, because of lower fuel demand and falling crack spreads, also weighed on WTI.
Brent’s premium weakened in the following days before widening again to more than $1.60/b in the last week of the month after news that US GDP growth for the second quarter had been revised lower. That was the highest Brent premium to WTI since May, when WTI futures plunged below $65/b, pressured by bearish macroeconomic news and record high oil inventories at Cushing, Oklahoma. Brent’s premium widened further in the last few days of the month to move beyond $2.70 on 31 August, the highest since the $3.83 of 20 May, resulting in a monthly premium of 45¢ compared to a discount of 83¢ in the previous month.
The large volatility in crude oil futures raised the activity within futures markets. Total Nymex WTI trading volume rose to an average of 636,000 contracts in August compared with some 550,000 contracts in July, but remained well below the 885,000 contracts traded in May. Similarly, trading volume for ICE Brent jumped 10% in August to nearly 372,000 contracts but remained below the 450,000 contracts in May.
Total open interest of Nymex WTI also recovered in August to move from 1,220,000 on the first trading day to more than 1,264,000 on the last trading day.
The relationship between speculative activity on futures markets and oil prices remained strong in August. Money managers sharply increased net long crude oil positions on the Nymex by almost 26,000 contracts to nearly 133,700 contracts for the week ending 3 August, a week when WTI surged to more than $82/b. That was the fourth weekly increase, which coincided with the fourth weekly rise in WTI.
Bearish market sentiment pushed money managers to reverse the upward trend in their net long positions in the following week, in line with a decline in WTI prices. Money managers sharply cut net long positions in the following three weeks to around 74,000 contracts in the week ending 24 August, the lowest since the first week of July.
Similarly, the WTI front-month fell during the same three consecutive weeks to move below $72/b for the first time since the first week of July (see Graph 3).
The futures market structure
Oil futures remained in contango, but the beginning of the curve has become more pronounced because of the weakness in the front month.
The discount between the WTI front month to the second month rose to nearly 60¢, but remained well below the $2.77/b of May. It moved beyond $1.60/b on the last day of August compared with 44¢ on the last day of July.
The spread between the front-month and the 12th month increased by 20% in August, while the spread between the first and the second month rose by 37%.
The front of the curve has also become more pronounced for ICE Brent. The spread between the first and the second month widened by more than 40% while the spread between the first and 12th month increased by just 7%.
A widening contango should encourage more storage as long as the capital costs remain very low.
The sour/sweet crude spread
The premium of light sweet crude over heavy sour grades widened further in August as demand for heavy sour crudes remained under pressure. Light sweet grades were also helped by US demand and lower supply from Northwest Europe due to oil field maintenance.
The WTI premium to Mars sour strengthened for the third month in a row to average $2.26/b, the highest since last May when WTI traded at a discount to Mars.
Urals weakened considerably in the first half of August, amid ample supply and refinery run cuts due to poor refining margins. Urals differentials to Brent fell to a discount of more than $2 for both Mediterranean and Northwest Europe barrels in mid August, pressured by poor refinery margins. The wider discount was also attributed to the strength of Brent in the first week of August. However, Urals strengthened in the following days, supported by strong refining margins and as August cargoes were mostly placed. As a result, the discount to Dated Brent narrowed significantly to move below 20¢ in the last week of the month.
The Brent-Dubai differential surged to $6.80/b in the first week of August – the highest since November 2008 – reflecting the weak sentiment in the Middle East market. The widening of the Brent-Dubai spread came as a result of the strengthening in Brent due to the tighter prompt physical oil market in Europe on the back of oilfield maintenance and weak Asian demand, particularly after port and refinery accidents in Asia caused tanker diversions and postponed crude deliveries. Middle Eastern crude were also pressured by refinery disruptions in Taiwan which pushed Formosa Petrochemical to defer some cargoes for later delivery.
The wide Brent-Dubai spread kept arbitrage open, with some cargoes of Murban moving to Europe and Oman crude to the US West Coast. A wider Brent premium to Dubai usually raises the relative cost for Asian refiners to buy West African, Mediterranean and Russian grades. However, the Brent premium to Dubai started to narrow to move below $1 in the third week, before widening again beyond $3 in the last few days of the month. The decline in the Brent premium was attributed to strengthening in Dubai as Middle Eastern market sentiment improved amid higher demand following a rise in refining margins.
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