Amid the highest Brent-WTI spread in years, the former compliance director for the IPE shares his perspective on the global crude oil market.
With the Brent-WTI spread hitting record highs, you have to wonder: Is crude oil still a fundamentally driven market? To separate the facts from the fluff, Hard Assets Investor reporter Julian Murdoch recently sat down with Chris Cook, former compliance and market supervision director of the International Petroleum Exchange (IPE), to get an expert's take on oil's rise.
Julian Murdoch, www.HardAssetsInvestor.com: For months, Brent crude oil has traded at a premium to WTI. Why is this? And can it continue?
Chris Cook, former IPE director (Cook): If you look at WTI, it reflects that there's actually plenty of oil in the market. If anything, the market is slightly oversupplied; the storage at Cushing is full of oil. Cushing's price, I think, reflects the actual reality of fundamental supply and demand, consumption and production.
But the Brent market is the one that actually sets the global price these days, and it has been this way for a few years. Many people remain under the misapprehension that WTI has anything at all to do with global prices, but it hasn't done that for years. And it's not the Brent futures that set the price, but the price of the physical cargo that comes out of the North Sea.
But the amount of oil in the actual spot cargoes is gradually declining. It's been in secular decline for some time. So the fewer and fewer cargoes there are knocking about, the easier it is for people to actually influence it.
Murdoch: Has the lower North Sea supply led to higher volatility in that market?
Cook: Basically what's going on are these trading games among consenting adults in the Brent market. This does have a spillover effect into the global price of crude, and it accounts for volatility. But it doesn't account for crude's astronomic price. In my view, that has a medium- and longer-term effect, which I don't think people understand. As I said about a year ago, the market has become almost entirely "financialized." The price is artificially inflated.
In any given market, you have two price levels. You have a lower level, the buyer's market - when the market's oversupplied and the buyers can name their price. And then you have the higher-level price, the seller's market. That's when demand destruction sets in. The market tends to be at either one or the other - it'll zoom up and then come back down again.
Murdoch: To what extent do speculators play a role in setting that level?
Cook: It's fund money, not speculators. That's a big misconception. The reason that the oil price is being supported at these higher levels is that there are billions of dollars of index money and ETF money which has gone into the market. With the yield on the dollar at 0 percent, these guys are putting their money anywhere that's in dollars. So stocks go up, commodities go up, oil goes up, and all of the prices are financially inflated - not by greedy money, but by fearful money. So it's risk-averse investors hedging inflation that are responsible for pumping Brent prices higher over the past few months.
Now, there was a speculative spike in 2008. That spike then was caused basically by Goldman pillaging the producers. But now what we're seeing is an unstable equilibrium, one that's gradually ramping up. Brent is being financially pumped up, while WTI is more rooted in the market, because it's deliverable. So I think we're seeing some trading games pump up the arbitrage between the two contracts.