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Brent de-links from global oil balance: John Kemp
July 17, 2012 / 1:11 PM / 5 years ago

Brent de-links from global oil balance: John Kemp

By John Kemp

LONDON (Reuters) - Far too many analysts and commentators are still linking rising Brent futures prices to geopolitical tensions in the Middle East and macroeconomic factors, rather than looking for a more localized cause in the North Sea.

It is always tempting to seize on a single piece of hard evidence to make a larger point, especially when that data confirms an already-held belief (something which behavioral economists call “confirmation bias”). But in this case it could not be more wrong.

Brent futures are not only a global benchmark. They also reflect local supply/demand dynamics for four relatively small streams of crude produced in the North Sea -- Brent itself plus Forties, Oseberg and Ekofisk (BFOE).

In this case, futures prices are being driven by local factors rather than global market trends, as the attached charts should make clear. It is Brent that is moving relative to all the other independently traded crude grades.

Chart 1 shows almost all the increase in Brent futures prices has been concentrated in contracts with nearby expiry dates. There has been little or no rise in longer-dated contracts maturing in 2015 and beyond, and only a moderate increase in the price of contracts maturing in 2014.

The sharp increase in nearby Brent futures coincides with and is most likely explained by the decline in output of the four crude streams, especially Forties, which is normally the cheapest grade and therefore sets the price for the futures contract, as a result of long-term depletion overlaid with a heavy summer field maintenance program.

Chart 2 shows that the nearby strength in Brent prices has spread to other, similar grades of crude oil via the arbitrage. Once again, price increases are concentrated in contracts maturing in the remainder of 2012 and 2013.

In most cases, however, prices for alternative crude streams have risen by much less than Brent itself. Chart 3 illustrates how Brent has seen much larger price increases since late June than competing crudes in the Asian market like Tapis, Su Tu Den and Minas.

Asia remains the strongest region for crude demand as Europe and the United States continue to struggle with the banking crisis and sluggish growth.

If recent price rises were driven by stronger demand or expectations for a tightening global supply/demand balance, Asian grades should have risen at least as much as Brent. The fact Brent has increased much more strongly suggests whatever is moving the Brent price is specific to the North Sea market rather than broader global conditions.

Chart 4 shows how the sharp rebound in Brent since June 21 has been accompanied by an abrupt compression in differentials for Asian grades, for example Vietnam’s Su Tu Den and Malaysia’s Minas. In other words, the evidence suggests Brent is moving as a result of idiosyncratic factors, to some extent dragging the rest of the oil market with it.

Any explanation for what is currently driving headline Brent prices therefore needs to start with local factors rather than global ones.

As my colleagues reported on July 13, North Sea oil exports for 12 key grades (including BFOE) are expected to fall to a new 2012 low next month of 1.905 million barrels per day, compared with an already low 1.965 million barrels per day in July, with depressed volumes expected to continue into September.

Brent’s rise is being driven by local production problems and the falling number of available cargoes, exacerbated by continued buying from South Korean refineries as a result of favorable tariff treatment under the recently implemented free trade agreement with the EU.

Brent’s rise is not evidence for a sudden brightening economic outlook, concerns about the general availability of sufficient crude supplies in the second half of 2012 or a military conflict between the western powers and Iran.

All these expectations might ultimately prove correct. But the current rise in Brent prices does not provide any evidence for them.

Editing by Anthony Barker

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