Specious Argument

My expectation for West Texas Intermediate (WTI) oil prices for May is unchanged from April. That is, WTI should range from $75 to $95 per barrel. A narrower range is from $77.50 to $87.50 per barrel.

When I provided my update last month, many seemed optimistic that current prices just above $80 per barrel were a way station on the path to imminent higher prices. I was more cautious, believing that there are geopolitical and economic forces at play that may damp a rapid escalation of prices. China may enter the picture to restrain oil prices. And, of course, there are wars in Ukraine and Israel, and central banks are still fighting inflation.

Nothing has materially changed from last month to change my outlook. I keep hoping for a breakthrough in the war in Israel, not because of its effect upon oil prices but because it would be good for humanity.

Usually, I have an article to reference to bolster my position, but not today. My quick take is that oil markets are still settling out from the OPEC+ cuts.

Eric Nuttall, whom I greatly respect, has a more bullish outlook than I do. Even when you disagree or have a slightly different viewpoint than others, you should always consider their opinions. So I will leave you with his eight-minute YouTube.

West Texas Intermediate (WTI) oil prices for April should range from $75 to $95 per barrel, an increase of $5 per barrel from March. A narrower range is from $77.50 to $87.50 per barrel.

During the last two months, oil prices have slowly been grinding higher. Last month, I expected prices to stay in the high $70s and low $80s. Oil prices closed on Thursday, March 28 at about $83 dollars per barrel.

Now that oil prices have cracked above $80 per barrel, some analysts are calling for $100 per barrel or greater by the end of summer. I am reluctant to be as bullish as they are. When I think about oil prices at these levels, I wonder where OPEC+ wants to stabilize prices. Of course, OPEC+ does not target prices. Instead, it manages oil deficits and surpluses, which many of us view as is just another way of managing prices.

Because 2024 is an election year in the United States, OPEC+ may be more cautious about letting prices rise too high. Just like the central banks, OPEC+ does not want to be seen as affecting the election. It will need to work with the government that Americans elect in the fall.

Furthermore, central banks around the world have raised rates to damp inflation, and they have been successful. If oil prices continue their ascent, that may threaten inflation targets once again, causing central banks to pump the brakes on rate decreases and, in turn, slowing economies around the world.

And, according to Dr. Anas Alhajji, who frequently reminds his paid subscribers on his Energy Outlook Advisors Substack website, China may use its inventories to damp oil prices too.

As WTI oil prices rise above $80 and Brent prices approach $90, I grow increasingly cautious.

How confident am I of my outlook? Not very, because the geopolitical situation can change in a heartbeat, the Saudis may want higher prices than I believe, and China may not be interested in stabilizing the market.

Like many others, I am curious how OPEC+ reacts to these higher prices.

For March, West Texas Intermediate (WTI) oil prices should range between $70 and $90 per barrel. This is an increase of $5 per barrel from last month. A narrower range is between $75 and $85 per barrel.

For most of last month, prices were tightly packed between the low- and high $70s. As the month wore on, prices crept higher. For March, I expect more of the same, just slightly higher prices.

Because of my prior work experience with Syncrude many years ago when I was part of the team that created the oil sands generic fiscal regime and because I invest in oil equities, I have always have an active interest in oil sands developments. One article that caught my attention last month was a Bloomberg article “The $10 Billion Mistake That Will Revive Canadian Oil” (subscription required) by Javier Blas. One paragraph in particular stood out:

Despite its colossal cost, TMX had two advantages that may compensate for the financial folly. One is that it’s likely to narrow the differential between Canadian and US crude, leading to higher revenue for everyone involved in the petroleum industry — and that includes provincial governments which take royalties. How much the discount would narrow is hotly debated. On average, it has averaged minus $17 a barrel between 2010 and 2024. The consensus is, that’s going to trend now toward minus $10 a barrel. Crucially, TMX probably means that the differential will no longer suffer from its perennial blowouts, when it has widened to as much as minus $40 and even minus $50 a barrel. Second, it should facilitate investment in new production, leading to higher tax revenue.

Canadian heavy oil, known as Western Canadian Select (WCS), sells at a discount to WTI. As seen from the quoted paragraph, this differential can vary widely over time.

Intuitively, higher WCS prices for producers is a good thing. But what if that producer is an integrated producer?

Integrated producers upgrade their crude bitumen to synthetic crude oil (SCO), which typically trades at or near the same prices as WTI. Alberta royalties are assessed against bitumen prices. If bitumen prices rise, then so, too, do royalties. An integrated producer, however, does not enjoy increased revenues because its revenues are dependent upon its final product, SCO. In other words, its intermediate product, crude bitumen, has increased in value and requires a higher royalty payment, while its final product still sells for WTI prices.

For those wanting more information on oil sands royalty framework, I refer you to the Alberta government website: “Oil sands royalties – Overview.”

WCS is different from crude bitumen in that diluent has been added to crude bitumen. The end result, though, is that bitumen is more valuable than it was before the change in differentials.

A non-integrated producer or bitumen only producer will have higher revenues, royalties, and profits. Integrated operations, though, will have higher royalties, same revenues, and thus lower profits.

Returning to the main topic, I expect WTI prices to stay generally within $75 to $85 per barrel, with an additional $5 on either side for any minor excursions.

For February, I expect West Texas Intermediate (WTI) oil prices to range between $65 to $85 per barrel. This is the same range I used last month. If asked to narrow the range, I would offer $72.50 to $82.50 per barrel. As I compose this blog entry, WTI is about $78 per barrel.

Last month, I expected prices to hover around $75, and bobble about with the news headlines. For most of January, oil prices were close to $75.

The news during last month has worsened. Middle East hostilities have increased with no clear signs of near-term optimism. Even though the geopolitical situation is deteriorating, oil is still flowing.

While there remains a lot of pessimism about strengthening oil prices, the pessimism is not as strong as before.

John Kemp, an excellent analyst with Reuters, wrote that short positions in US crude futures were reduced. See his article “Funds slash bearish positions in US crude as stocks drain.”

LONDON, Jan 29 (Reuters) – Portfolio investors recoiled from short positions in U.S. crude futures and options in the most recent week as depleting inventories around the NYMEX delivery point underscored the risk of a squeeze on deliverable barrels.

Hedge funds and other money managers purchased the equivalent of 46 million barrels across the six most important futures and options contracts over the seven days ending on Jan. 23.

Incidentally, I encourage you to subscribe to John Kemp’s energy mailing list. Every morning, he sends out links to interesting oil articles and often provides his research.

On January 30, the Financial Times published an article “Saudi Arabia ditches plan to raise oil production” (subscription required).

Saudi Arabia has dropped a plan to expand the kingdom’s daily oil production capacity, in a major policy reversal by the world’s largest oil exporter.

State-run Saudi Aramco on Tuesday said it had been asked by the energy ministry to abandon a plan to increase its maximum sustainable production capacity from 12mn barrels a day to 13mn b/d by 2027.

The multibillion-dollar investment programme had set the company apart from much of the industry, where spending on oil production is generally falling because of concerns about climate targets and future demand. Saudi Aramco accounts for about 10 per cent of the 100mn barrels of oil the world consumes every day.

Given that OPEC has been commenting during the past year on the lack of investment in oil, I am surprised by this development. Perhaps the outlook for oil demand is not as optimistic as originally thought.

Switching away from developments over the past month, I thought I would share with you a quick-and-dirty method of determining price ranges.

You can use the OVX, the Cboe Crude Oil ETF Volatility Index, to determine a price range. Right now, the price of oil is near $78 and the OVX is about 36. That implies that a year from now, a one standard deviation of crude oil movement, up or down, is about 36 percent. When considering different time periods, you need to use the square root of the time. For example, for one month, a one standard deviation move is calculated at the square root of 1/12 times 36 or 0.29 times 36 for 10.4 percent. In other words, a one standard deviation move one month from now means that WTI’s price will fall within $78 per barrel plus or minus times 10.4 percent or $8.11 per barrel. The plus or minus one standard deviation range is from $69.89 to $86.10 per barrel. Remember, though, that one standard deviation is 65 percent. So about one-third of the time, oil will close outside of the range. A two-standard deviation move is twice as wide and captures about a 95 percent probability.

If you want to determine a likely range for one day, follow the same procedure, except take the square root of 1/365 instead of 1/12. Some people use the number of trading days, roughly 252, instead of the number of days in a year. I prefer the number of days in a year.

Wrapping up, I expect WTI to range between $65 to $85 per barrel with the sweet spot being between $72.50 and $82.50 per barrel.