Oil Prices: Supply, Demand and the S&P 500

It is common knowledge that oil is a commodity, with what economists describe as “elastic pricing” set by the markets.  The following supply and demand factors consistently move oil (and natural gas) prices and are the focus of Wall Street analysts and academics, both in the long and short run.

Supply / Capacity

  • Oil Reserves (BBl’s or Barrels of Oil)
  • Equivalent Oil Reserves (BOE or Barrels of Oil Equivalent)
  • Equivalent Gas Reserves (MCFE or Cubic Feet of Gas Equivalent)
  • Domestic Production of existing reserves
  • Imports

Demand / Consumption

  • Fuel and other requirements
    • Jet fuel
    • Gasoline and Diesel
  • Refining and distribution facilities
  • Export opportunities

However, given the stock market’s recent volatility (with some indices losing almost 5% of their value since the beginning of October) another key driver of oil price has been front and center, the price changes of the S&P 500. 

As shown in the chart above, the recent prices of the WTI index and the S&P 500 have moved almost in lock step.  This relationship can also be shown in a regression analysis, whereby the daily price changes of WTI oil prices are tested against the S&P 500 daily returns.

As shown in the analysis above, oil prices (at least in the short-term) are moving about 120% of the rate of change of the market’s pricing.  In other words, a 1.0% percent change in the S&P 500 would result in a 1.2% change in the WTI.  Also, the R-squared term shows that statistically, the change in the S&P 500 is accounting for approximately 70% of the change in daily WTI pricing.

The key take way from this limited analysis is that many of the same factors that affect the market’s expected returns also affect expected demand for US oil consumption, driving prices and returns in similar directions.

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 October 15, 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 October 15, 2018, pricing, the futures markets indicate that in mid-November 2018 the expected strip price is $71.27, with a 68% chance that oil prices will be between $65 and $77 per barrel.  Likewise, there is about a 95% chance that prices will be between $58 and $86.  For a longer-term view, by mid-January 2019 the approximate one standard deviation price range is between $62 to $81 per barrel with an expected value of $71.11.

Natural Gas Outlook

The natural gas futures contracts are currently trading at $3.23 per MMBtu for the Henry Hub (ticker /NG).  Although more affected by seasonal factors than crude oil, in November 2018, the expected price is $3.23 with a +/- 1σ price range of $2.85 to $3.85 per MMBtu, and the 2σ range (95%) of $2.50 to $4.65 per MMBtu.  For a longer-term view, by mid-January 2019 the expected price is $3.35 per MMBtu with a +/- 1σ price range of $2.65 to $4.50 per MMBtu.


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

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