Global oil markets have been under pressure in the second half of 2015 as the surfeit of oil production at a little under 1 million barrels a day continues to weigh on prices.
That, together with a weak global economy has driven global oil benchmarks to their lowest levels since the depths of the GFC.
The continued excess production is being driven largely by the battle Saudi Arabia is waging to try to drive US shale oil producers out of the market. The Saudis are running the theory that they can keep pumping, drive down prices, and outlast the shale oil suppliers.
But one wrinkle in the Saudi plan is that US production has hardly fallen at all, still holding above 9 million barrels a day. Another wrinkle is that with Iran’s return to official production, another large player is back in the field.
So global oil benchmarks have collapsed again in December. But not all oil benchmarks are created equal.
Take the case of prices traded for light sweet crude on either side of the Atlantic. Those benchmarks are Brent – for Europe and the globe – and West Texas Intermediate (WTI) in the United States.
In the last 24 hours Brent made a fresh 11 year low at $36.04. That’s down 19.24% since the last Friday in November.
WTI on the other hand is only flirting with seven-year lows and is still above the GFC nadir of $32.40. It’s still weak, down 14% since late November, but it’s outperforming Brent.
That’s driven the price differential between the two benchmarks – what traders call the spread – back toward zero. To put that in context Brent crude has, on average, been close to $8 a barrel more expensive than WTI since the start of the GFC. Even since the start of 2014 this spread has seen Brent crude average around $5.80 a barrel more expensive than WTI in the United States.
To put it another way, based on historical price differentials Brent crude is relatively cheap compared to WTI.
But there is little prospect of arbitrageurs coming in and buying Brent crude any time soon. That’s because the oil has to go somewhere if production outstrips supply, as it is globally at the moment. Buyers can’t magic up demand they have to store their oil, stockpile it, somewhere.
That’s the problem for Brent, according to Citibank Research’s Global Commodities team. Europe has run out of capacity.
Its storage facilities are full.
In what could be one of global markets understatements of the year, the Citibank analysts said the need to absorb all this excess supply “can be challenging.” That’s particularly so for Europe with its 99% capacity utilisation.
The report said:
The majority of spare capacity resides in the US. This should continue to mean that global oversupplied barrels need to price to move into US storage tanks; Brent-WTI should remain narrow, and could even move to negative if global oversupply is in enough distress. With 1H’16 looking oversupplied by ~1-m b/d, meaning 180-m bbls, this starts to look potentially challenging compared to 150-200-m bbls of remaining crude storage capacity. With 2H’16 looking more balanced and 4Q’16 potentially negative, this should help ease storage distress. However, if 2H’16 continues to be oversupplied, global stockpiles could move even closer to storage limits.
Of course it also means that overall global oil prices will remain under pressure until supply and demand can find an equilibrium. That may be some time off.