Bearish crude oil market sentiment, risk premiums, oil terminology – Coming up in our podcast this time:
- Oil price sentiment: why so negative?
- Risk premiums in the oil market: What are they and how do they come about?
- Oil terminology every trader should know: Crack spreads, contango and backwardation defined
“The bearish sentiment is depressing not only the flat price but potential increases from there”
This time on Trading Global Markets Decoded, our host Martin Essex is joined by Shin Kim, Head of Supply and Production in the Analytics division of S&P Global Platts, which provides pricing data, news, and analytics across a range of major commodities. Key topics covered: What is driving oil price sentiment? What can risk premiums in the oil industry be attributed to? And what key oil terminology should you learn if trading this asset? You can listen to this podcast with Shin Kim by clicking on the link above or one of the alternative platforms listed below.
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Oil price sentiment: Why so negative?
Talk begins on oil price sentiment: Why is it so negative? Shin points to the macroeconomic risks to demand such as ongoing concerns about global economic health, trade wars, business confidence, and less than encouraging GDP data emerging from the likes of Germany and India.
And it’s not just demand either – Shin mentions the supply overhang weighing on markets too. “Iranian oil is off the market because US withdrew from the JCPOA Iran nuclear deal and imposed sanctions on purchases of Iranian oil. US sanctions are also taking off 500-600,000 barrels a day of Venezuelan oil. We’re seeing growing use of other sources of supply in the form of US SPR government reserves.”
From a contrarian standpoint, does the bearish mood mean it could be time to buy? “If you look at fundamentals, we should be seeing prices 5-10 dollars higher than we see today, as we head into the new year,” Shin says. “If the world was perfect and oil was pricing off fundamentals we’d be much higher, but I think the bearish sentiment is depressing not only the flat price but potential increases from there.”
Risk premiums in the oil market
Talk moves to risk premiums: what are they and how do they come about? “When we talk about risk premium, we talk about the dollars that are added to the price of oil to account for the risk we might see future tightness in supply.”
Today there’s a good reason to have a risk premium, Shin continues. “There are significant geopolitical risks such as Saudi retaliation for their oil field attacks, and circumstances in countries like Libya where instability causes volatility in oil production.
“We could see supply losses and we should arguably be pricing in a premium to account for that, which builds the case for higher prices in the coming months.”
Oil production volume by country
When it comes to oil production volume, the last five years have seen a shift, with the US becoming the largest crude producer in the world at around 12 million barrels a day – a situation that is having some interesting implications.
“The US is increasingly unwilling to get involved in affairs in the Middle East, because the US is less dependent on Saudi oil flows now,” Shin says. “That [unwillingness] is going to continue as long as the US doesn’t need to import as much oil.”
And if Saudi and Russia are facing a stronger competitor with oil coming from the US, it will probably increase the call on OPEC, Saudi and Russia, to band together. “These producers increasingly need to cooperate if they want to manage oil inventories and prices, as they are losing market share to the US.”
Alternative energies and climate change are clearly big news items currently. “There are a lot of challenges facing the alternative energy space and I think costs, economics and government support are major parts of the story.
“We’ll have to figure out the right energy mix and balance, and while it is hard to forecast the future, we have to continue to ask the questions.”
Oil terminology: What to know as an oil market trader
When researching the oil markets traders need to understand terminology. Crack spreads, contango, backwardation: these are the sector-specific concepts to research in order to trade this asset more consistently. Shin clears up a few of them: “Crack spreads are the spread between the price of oil and the price of products that are produced by ‘cracking’ the hydrocarbons in that oil. So, the price of the product less the price of the crude you must buy to produce the product, whether that’s gasoline or fuel oil or whatever.”
Contango and backwardation relate to whether forward prices are expected to be less or more expensive than the spot price. “Oil is traded as futures contracts for any month, so if you’re in a contango market, we’re saying the price for crude delivered this month is below the expected price of a future month’s delivery, whereas in a backwardated market the front month price is above that of an expected futures price.
“So, a backwardated market implies a perceived shortage long term, signaling the release of inventories today, whereas contango is associated with oversupply in markets, so there’s an incentive to buy today and hold it in inventory.”
Finally, and on a different note, Martin asks: Is there a shortage of women in the energy industry? “Women of the space are trying to get out there more and be seen and heard more and set a standard for greater diversity,” Shin says.
And a shift could be occurring: “When I look around the oil market analysis space, there are so many heads of oil analysis companies that are women, and I am proud to see that happening.”
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