Oil Market Mulls Iran, Infrastructure, Politics
Originally published on MarketWatch, April 20, 2012.
“A cap on the max number of contracts or shares that
firms may own at any time” may be a good way to curb the extent of speculation in the oil market, said Merlin.
Is oil really worth more than $100 a barrel?
That appears to be a big question on traders’ minds since late February when oil futures prices on the New York Mercantile Exchange neared $110, which
has so far marked the peak for the year.
And despite ongoing Middle East threats to global supplies and a complicated background comprised of market manipulation talk, government oversight
proposals and pipeline changes and expansions, many analysts don’t believe prices are where they should be — simply because there’s too much oil in the
“The economic price for (West Texas Intermediate) oil is in the $80-$85 range,” said Mickey Cargile, managing partner at Cargile Investments, basing
his estimate on where he sees supplies locally and in Cushing, Okla., the delivery hub for Nymex oil.
“Our range valuation suggests a 15%-20% risk premium priced for potential supply disruption from Iran,” he said.
On Thursday, crude futures settled at $102.27 a barrel. It’s up 3% year to date, but down nearly 7% from a peak close of $109.77 on Feb. 24, according
to data from FactSet Research.
“If it were not for some of the Iranian oil off the market because of sanctions and the fear of supply interruptions, the price could be lower,” said
James Williams, an energy economist at WTRG Economics.
Demand in the Organization for Economic Cooperation and Development countries is “weak and Asia may not continue to increase consumption at the same
rate it did in the past,” he said. At the same time, “there is sufficient oil in the market.”
Crude inventories of 369 million barrels in the week ended April 13 are “in the upper limit of the average range for this time of year,” according to
the U.S. Energy Information Administration.
Elsewhere, Europe and Asia have been hoarding supply in the last few months, according to Phil Flynn, a vice president at PFGBest. “The market and
countries were basically pricing in and expecting war” with Iran.
There’s nothing in President Barack Obama’s recent proposals for increased government oversight in the oil markets, or changes to the U.S. oil
infrastructure “that will alleviate the supply glut to keep oil prices above $100 a barrel,” he said. “If the Iran risk goes away, so too will $100 oil.”
Middle East mayhem
Earlier this week, oil prices fell with multilateral talks concerning Iran’s nuclear program seen as constructive and negotiations set to enter
another round next month.
“As a supplier of approximately 2.5 [million barrels of oil equivalent], Iran materially impacts global supply and corresponding price,” said Michael
Peterson, managing director of energy research at MLV & Co.
And “given Iran’s strategic proximity to the Strait of Hormuz, escalating tensions pose a risk to nearly 20% of global supply. The significance and
supply risk premium associated with the crude cargoes that pass through the Strait cannot be overstated,” he said.
Iran had threatened to disrupt oil transport through the Strait in the wake of sanctions set by the European Union in protest against the nation’s
The tensions and sanctions have contributed to a decline in production. Iran’s output fell to 3.35 million barrels in March, down from 3.46 million in
January, according to an Organization of the Petroleum Countries report.
Overall, “political instability in the Middle East is a long-playing problem,” said Michael Noel, senior vice president of Edgeworth Economics and a
leading economist on retail gasoline price cycles. The latest escalation in tension with Iran goes back 50 years or more and conflict or potential
conflict “somewhere in the region has never been far from the surface.”
“As the region holds the majority of reserves and produces a third of world oil, concerns of supply reductions, boycotts, embargoes and conflict all
have an impact on prices,” he said.
But although there is “no question that recent losses of supply from Sudan and Iran have had an impact,” said Michael Lynch, president of Strategic
Energy & Economic Research, “if and when the Iranians sell their oil ... the market will look much more bearish.”
Even “if negotiations with Iran proceed with at least modest progress, traders will close out some positions,” he said, and with a mixed economic
outlook, oil prices could trade at around $80 by the end of July.
Threats to Middle East output have driven global oil prices significantly higher, but it’s impact on U.S. crude oil prices has been offset by a glut of
supplies at Cushing.
That could be soon remedied with proposed changes to the oil market infrastructure — the flow reversal of the Seaway Pipeline and expansion of the
Keystone XL pipeline.
“Though there are several factors impacting the future of oil price fluctuations ... it all still goes back to the economics of supply and demand,”
said Mark Stansberry, chairman of the GTD Group, an energy-management firm. The Seaway and Keystone pipelines are “both positive to reducing dependency on
foreign oil” and the Seaway is important for WTI crude prices to come more in line with Brent.
High Brent prices on ICE Futures in London have been a key factor in U.S. retail gasoline prices.
“The glut in Cushing created an actual pricing distortion between WTI and Brent, which will now be negated,” once the flow of the Seaway Pipeline is
reversed, said Seth Rabinowitz, who covers commodities as a partner at Silicon Associates.
The Seaway Pipeline, owned by Enterprise Products Partners and Enbridge Inc., will be reversed to carry crude from Cushing, Okla. to the refinery
complex along the Gulf Coast near Houston, Texas. The flow reversal is seen in mid-May, two weeks earlier than previously expected, and will have an
estimated initial capacity of 150,000 barrels per day.
The change has the potential to cause the “reversal of depressed U.S. prices” in the short and medium run, said Rabinowitz, implying higher WTI crude
But some analysts see the pipeline reversal, along with TransCanada’s planned expansion of the debated Keystone XL pipeline from Hardisty, Alberta in
Canada to the Gulf, more as a reason for a narrower Brent/WTI spread.
The spread between the two crudes reached a record above $26 in August of last year, based on most-active contracts, though fell below $16 recently —
it’s lowest since February.
The Seaway Pipeline and planned expansion of the Keystone XL pipeline “will encourage the WTI price to converge on Brent, so I do not see WTI moving
persistently below $100 until Brent does,” said Kirk McDonald, senior research analyst at Argent Capital Management.
TransCanada’s government permit application for the expansion was rejected by President Barack Obama’s administration earlier this year and the debate
over the project’s environmental impact continues. A TransCanada spokesman said the company is “working on the re-application process” but has not
In the meantime, McDonald doesn’t expect WTI prices to move much higher than the $110 range this year. “The price is converging with Brent due to
pipeline and rail capacity increases, but we still have excess oil in the mid continent at the moment.”
Pain at the pump
Oil above $100 a barrel despite the supply glut — along with retail gasoline prices averaging close to $4 a gallon — certainly caught the attention of
the U.S. government.
Earlier this week, Obama called for Congress to increase federal oversight of oil markets aimed at preventing market manipulation.
The move won’t have any impact on what happens with “big money speculators” since they are not hampered with shallow pockets, said Merlin Rothfeld,
instructor for Online Trading Academy, emphasizing that speculators are not to blame for high oil prices.
Instead, “a cap on the max number of contracts or shares that firms may own at any time” may be a good way to curb the extent of speculation in the oil
market, he said.
Bob van der Valk, a petroleum-industry analyst based in Terry, Mont., pointed out that Obama recently signed an executive order giving the government
more oversight on hydraulic fracking for natural gas. Fracking is a method used to release gas trapped in rock formations.
“The oil industry needs fewer restrictions, not more, and this action will put a damper on the small entrepreneurial drilling companies, which were
responsible for the large finds like the Marcellus Shale and Bakken Shale crude oil formations,” van der Valk said.
Byron King, editor of investment newsletter Outstanding Investments, said “Obama’s blast will harm markets,” prompting foreign traders to “exit U.S.
markets, lest they get slapped with subpoenas one of these days for anything and everything they did, based on some future federal fishing expedition.”
Others believe Obama’s proposal will have little impact.
“Few policy announcements from any administration in DC actually result in direct impacts on demand and supply for oil and [gasoline],” said Tom Box,
an oil-and-gas industry expert based in Richardson, Texas.
“Retail consumerism would like to believe that a president is to be blamed or credited with the rise and fall of energy prices, but the markets are
not that simple,” he said.