Decomposing Oil Prices

The Federal Reserve Bank of New York’s Research & Statistics Group publishes a weekly Oil Price Dynamics Report1 which provides some interesting insights into global oil price movements.

The chart below shows the relationship between supply and demand on a cumulative basis for the last half of 2018.  Given this analysis considers global supply and demand constraints, versus US prices alone, the price of Brent crude oil is referenced as opposed to West Texas Intermediate crude oil.

When the price of Brent crude peaked around the first of October, demand and supply factors were both higher than they had been mid-year.  Following that time, however, over-supply concerns increased, contributing to about 20% of Brent’s approximate 35% fall from its October peak pricing.  Reduced demand changes contributed to about 10% of the fall, with the term described as “residual” making up the rest of the price change.2  Supply, demand, and residual price changes always sum to the percentage price change in Brent’s crude price.

On a longer-term basis, since 2010 increased supply has been the key factor in keeping oil prices down, given new production in US shale basins.

Although demand has steadily increased, it is the supply swings that seem to be moving oil prices downward on a global basis.

Crude Oil Outlook

While futures markets aren’t a crystal ball, their price levels and related options are useful for estimating future ranges, or “confidence intervals,” for crude oil and natural gas prices.

The graphic below illustrates the crude oil pricing as of December 17, 2018 and predicted crude oil prices based on options on oil futures contracts (ticker /CL).  The blue lines are within one standard deviation (σ) of the settlement price (the middle, green line), and the outside, red lines are within two standard deviations for each month (for a refresher on standard deviations, see the January 2016 blog).

Based on December 17, 2018, pricing, the futures markets indicate that in mid-January 2018 the expected strip price is $50.62, with a 68% chance that oil prices will be between $44 and $57 per barrel.  Likewise, there is about a 95% chance that prices will be between $37 and $64.  For a longer-term view, by mid-May 2019 the approximate one standard deviation price range is between $41 to $66 per barrel with an expected value of $52.03. 

Natural Gas Outlook

The natural gas futures contracts are currently trading at $3.67 per MMBtu for the Henry Hub (ticker /NG).  Although more affected by seasonal factors than crude oil, in January 2018, the expected price is $3.67 with a +/- 1σ price range of $2.95 to $5.00 per MMBtu, and the 2σ range (95%) of $2.45 to $5.00 per MMBtu.  For a longer-term view, by mid-April 2019 the expected price is $2.87 per MMBtu with a +/- 1σ price range of $2.35 to $3.20 per MMBtu.

 

 1. 2018 Federal Reserve Bank of New York Oil Price Dynamics Report / December 3, 2018, https://www.newyorkfed.org/medialibrary/media/research/policy/oil_decomposition/oil-decomp_2018_1203.pdf?la=en, accessed 12/17/2018

2. Residual reflects price movements unexplained by supply and demand factors.

Tags: Oil & Gas Price Outlook December 2018, Gas Price Outlook December 2018, Oil Price Outlook December 2018

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