Crude oil markets long ago lost their role of price discovery. Since early 2009, they have instead been dominated by pension funds seeking to find a ‘store of value’ as the US$ weakened, along with hedge funds enjoying a money-making ‘momentum play‘. The reason has been the $tns spent by western central banks in their liquidity programmes. As the chart of Brent prices shows, each new programme has pushed oil prices higher:
• The G-20 meeting in April 2009 stopped them stabilising in their historical $10-$30/bbl range, to which they had just returned after the 2005-8 financial bubble
• QE2 stopped the downturn underway in the summer of 2010 and sent prices higher again
• Twist in 2011 and then the European Central Bank (ECB) in 2012 had the same impact
• Now the Bank of Japan (BOJ) has launched its own, equally large programme
However, the BOJ has a slightly different agenda. It aims to devalue the yen, not the US$. And the yen has already fallen close to $1: ¥100 compared to $1: ¥93 before the new policy was launched on 4 April. If it succeeds, then clearly US pension funds will have no further reason to buy crude oil. And so prices could easily start to reconnect with fundamentals. At the same time, the S&P 500 could continue to rise, as yen-based investors seek their own ‘store of value’.
The fundamentals are dreadful, as the blog will discuss in more detail tomorrow. So without pension and hedge fund support, prices could easily return to $50/bbl, and then decline back to their historical trading range. This would also return them to the traditional relationship with US natural gas prices. Whilst this is currently regarded as ‘impossible’, the blog has always seen ‘reversion to the mean‘ as its favourite investment strategy.
Meantime, of course, chemical markets are locked in ‘wait and see’ mode. Q2 has not seen any major increase in demand, so buyers are reluctant to push purchase prices lower as this would merely devalue their own inventory. Similarly producers long ago abandoned hopes of gaining market share, and are content to maintain the status quo.
If oil prices start to slide, however, these dynamics will clearly change. Naphtha fell a further 6% last week, and is now down 14% on its high a month ago. This is an astonishing move, at a time of supposedly peak demand, and highlights the potential weakness ahead as we go into the quieter summer months.
Benchmark price movements since the IeC Downturn Monitor’s April 2011 launch and latest ICIS pricing comments are below:
Naphtha Europe, down 28%. “1-1.1MT of deep-sea naphtha supply will land in Asia in May”
PTA China, down 20%. “Downstream polyester yarn, fibre and PET bottle chip demand are at their peak season in April-May”
Brent crude oil, down 16%
HDPE USA export, down 13%. “One trader believed that prices would begin to fall soon as producers realize their prices are attracting little interest from global buyers”
Benzene NWE, flat. “Domestic market was still relatively quiet and thin”
S&P 500 stock market index, brown, up 17%