Chronicle of an oil shock foretold
Crude times
Given how surprisingly hot economic data has been lately, China’s reopening and all the sudden chatter of a “no landing” scenario, you’d expect oil prices to also tick up. But no.
Brent and WTI both kept sagging since the summer of 2022, and have been ambling around the $85-90 and $75-80 range respectively for most of 2023. What’s up?
Basically, unlike many other markets, oil tends to be the annoying Zen philosopher of commodities and only lives in the here and now. And right here and now, the oil market remains well-supplied, notes Goldman Sachs.
Qualitatively, oil is a spot asset and an anticipatory asset. Spot and future tightening shocks should raise oil prices because both increase the payoff from owning oil. Bullish spot shocks boost demand and prices in the spot market, and lower inventories, while bullish future shocks boost demand in the storage market, but raise inventories (as sketched in appendix Exhibit 14).
Quantitatively, oil prices respond more to spot shocks than to future shocks. While distant future tightening shocks increase the value of holding oil, this should be netted against the significant cost of storage. The price effect required to generate a given adjustment to the level of stocks is smaller for future shocks than for spot shocks because the former leave more time for demand and supply adjustments to accumulate.
Oil prices are less responsive to distant future shocks than metals and equities. The convenience yield from holding a commodity is very much like the dividend from holding a company’s stock. However, zero storage costs for equities and relatively sticky dividend yields compared to energy convenience yields imply that equities put more weight on future shocks. Similarly, smaller storage costs as a percent of the commodity price also make metals more anticipatory than energy assets.
Goldman’s senior energy economist Daan Struyven looked at the impact of 150 spot demand shocks (days when there were major surprises in US, Chinese or European economic data); seven spot supply shocks (natural disasters or strikes); 16 future demand shocks (eg Brexit or fiscal stimulus announcements) and 128 future supply shocks (mostly OPEC announcements).
Spot shocks tends to have an immediate impact, while “future shocks” often takes months to filter through to oil prices (but can on the other hand last for years). Supply shocks are particularly powerful.
To a lot of people this will be a bit “well, duh”. But the point Struyven is making is that the improving growth outlook will probably gradually filter through to the spot crude price, which he reckons will hit $100 a barrel (for Brent) by the end of the year.