Possible Transition in the Oil Industry

Includes: BNO, CRUD, USO
by: Wall Street Strategies

by Conley Turner

Crude oil prices have been particularly volatile in recent weeks due to concerns among market participants of the possible disruption in oil supplies coming from the Middle East. The success of the civil uprising in Tunisia and Egypt in toppling their respective leaderships has inspired similar actions across the Middle East, North African (MENA) region. In doing so, protestors have come into contact with security forces in Bahrain, Jordan, Yemen, Libya and Iran, and in many cases with deadly outcomes. It is clear that the leaders of these countries have no appetite for these mass demonstrations and appear determined to aggressively suppress any possible rebellion.

This is especially the case for Libya where the authorities have taken an especially hard line against antigovernment gatherings. As a result, demonstrations have been interrupted with tear gas and according to some reports, the killing of a number of individuals by that nation's security apparatus. A similar crackdown has been reported in Iran, which is the second largest producer among the Organization of Petroleum Exporting Countries (OPEC), following Saudi Arabia.

Up to the minute news and images out of the region are limited as those governments have implemented strict curbs on the flow of information. It stands to reason that there is no accurate way to gauge and verify the effectiveness of the uprisings. Should the full effect of the disturbances play out in full glare of the world media, it is conceivable that there can be a disruption in the supply of oil flowing out of the region.

It is interesting that oil prices rose to the highest level recorded in two years at the onset of the Egyptian crisis when it settled at $92.19 a barrel on January 31. Much of that move had to do with the same anxieties that exist today about supply disruptions among major producers and the flow through the Suez Canal. When that situation ended with the resignation of Egyptian President Hosni Mubarak, the price fell to $85.58 a barrel on the New York Mercantile Exchange, the lowest settlement since November 30.

However, more recent news of two Iranian warships transiting the Suez Canal en route to Syria prompted Israel to declare the move as an act of provocation and could not have been ignored. This development had the effect of heightening stakes in a region that is currently a bubbling cauldron of civil discontent and was reflected in another spike in the price of oil.

To this end, the state of geopolitics is being reflected more so in the price of Brent crude as opposed to the U.S. benchmark, West Texas Intermediate (WTI) crude. The latter is a lighter grade of oil and has historically been easier to refine than the heavier Brent into the various distillates, such as diesel and gasoline. As a result, WTI has traditionally traded at a premium to Brent. However, the sustained high inventory levels at Cushing, Oklahoma, the commodity's delivery point, have caused pressure on the price over the past several months. The result is the current divergence between the prices of Brent and WTI with the latter trading above the $100 per barrel level. This price differential has been exacerbated in wake of the current upheavals in the MENA. Brent crude for April delivery settled at the week ending February 18, at $102.79 a barrel on the London based ICE Futures Exchange. At the beginning of the week it was $103.08 a barrel, the highest since September of 2008.

At this junction, there is emerging a school of thought suggesting that a fundamental shift is occurring and Brent is likely to replace WTI in terms of its industry dominance. This is especially important in light of the fact that WTI represents a relatively small percentage of global oil output while Brent is more representative of the array wide of crude oil types and grades across the globe. U.S. light sweet crude for March delivery settled the week ending February 18, at 87.46 per barrel on the New York Mercantile Exchange. The commodity started that week at $84.81per barrel.