September 22, 2018

Oil Price Watch 29 October 2011

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The price of a barrel of Brent Crude was almost unchanged from last week, on the face of it flatlining just below $110 a barrel. But that conceals violent swings during the week with the price falling and then rising by as much as 3% both ways in the space of a few hours. So what was happening?

There was a really good article by Rowena Martin “Why is the Oil Price So High?” in the Telegraph on Tuesday which helped set the scene and also links well with the discussion in the Oil Price Watch Overview. Rowena sets out the mix of physical and psychological factors that are influencing supply and demand here. She notes that the International Energy Agency (IEA) thought a few weeks ago that oil above $100 was unsustainable and damaging to the global economy.

But since then, the world’s financial outlook has considerably worsened (dampening demand expectations) and about 430,000 barrels of Libyan oil have returned to the market (increased  physical supply).

Surely, she asks, the natural direction of the price of oil should be down, with demand shifting left and supply shifting right?  But the price has stuck above $100 and indeed on Monday, Brent Crude even returned to $113 per barrel.

So what is happening?

Rowena concludes the most plausible explanation for such high prices is actually tight supply (even with more Libyan oil) due to factors such as North Sea maintenance and pipeline attacks in Nigeria, more than enough to counteract depressed demand. In her view, both demand and supply are contracting with the supply side dominating for the moment

(I have shown this in stylised and exaggerated form in the diagram on the left with the new supply S2 and demand D2 curves intersecting at what would give a higher equilibrium price)

There is one other key factor at play. She notes Commerzbank says: “One reason for the striking resilience of the oil price could be that a package of measures to resolve the European Union debt crisis is now expected .. Wednesday. We still see potential for disappointment if the big push does not succeed.”

The Telegraph article was published on Tuesday. So what did happen after Wednesday in the light of the expected “package of measures”?

German Chancelor Dr. Angela Merkel

Image via Wikipedia

If you remember, expectation of any effective resolution of the European debt crisis in the meeting of EU leaders were very low right through Wednesday with Angela Merkel, the German Chancellor, doing her bit to depress expectations further.  This was reflected in the oil price which fell from a peak of $113 in Tuesday to below $109 late on Wednesday.  Then when the agreement turned out to be much more positive than had been expected (and with the help of some positive economic data coming out of the US), the price shot back up to near $113 in a matter of hours on Thursday.

Since it has settled back down to around $110 as the markets began to digest the fine print in the agreement (or the lack of it).

So I think Rowena Martin is right, physical supply and also demand expectations have been the main drivers of the oil price over the short term in the recent past.  And for a few hours around Wednesday/Thursday, the mood music put out by a few European politicians overlay everything else.

Price at end of week: $109.91 (up from $109.56 end of last week)

Read the Oil Price Watch Overview