The West Texas Intermediate, or WTI, crude oil is regarded as the benchmark for oil pricing in the US. Its light, sweet (low-sulfur) attributes, which makes it suitable for producing products like low-sulfur gasoline and low-sulfur diesel are a big reason why it’s considered as a benchmark.
Being a benchmark, the price of the WTI crude oil is very sensitive to factors that move the price of crude oil in general. And contrary to what you might have thought, these factors are not just driven by the demand and supply spectrum of crude oil. When looking at the price of crude oil from a long-term perspective (five years upwards), the demand and supply spectrum could play a huge role in moving the price of oil. However, since we’re considering futures here, the short-term price movers are of greater concern. Note that short-term in this sense could range from a couple of months to a few years. To put it the way it is, these short-term movers actually alter the market psychology to change the price of WTI crude oil.
As a reference, cast your mind back to 2008. At some point, crude oil traded in the region of $150 per barrel. However, within a couple of months, the price of crude oil had dropped to the region of $30 per barrel. In the real world, the demand and supply spectrum cannot change so much within such a short time to warrant such drop in the price of crude oil. People cannot decide not to buy gasoline within a few days/months. Producers cannot alter the supply chain within a short time as well. These things take years in the crude oil market. In economic term, the supply and demand of crude oil is inelastic on the short run. What actually caused the plunge is a change in investor sentiment. People probably panicked about the financial crises and became less optimistic about the economy, since crude oil is a major macroeconomic element. In just about any market, such panics usually lead to a change in the price of the underlying commodity. Here are some factors that can change the psychology of the market, which in the end alters the price of WTI crude oil.
Geopolitical and economic events
The image above, found on the U.S. Energy Information Administration, or EIA, website, shows that geopolitical and economic issues, historically, bear weight on the price of the WTI crude oil. The effect is usually serious when the issue at hand involves a major oil producer, like Iraq, or major consumer like China.
When the issue involves a major oil producer, there is a fear that the problem might halt supplies from a world’s major supplier, which would affect the crude oil market greatly. For instance, the current insurgency roiling in Iraq is affecting investors’ sentiments, which is affecting the price of WTI crude oil volatile.
On the other hand, if the issue at hand – either economic or geopolitical – involves a major consumer of crude oil, there is a fear that demand from such region would slow down, which could lead excess supply. A second scenario features a situation in which the major consumer is purchasing a lot of crude oil. Again, this changes the way the market values the WTI crude oil, which often leads to a rise in price. This situation is also being witnessed at present, with china stocking its strategic reserves.
Supplies at Cushing, Oklahoma
The price of WTI crude oil has historically responded to changes in stockpiles at Cushing, Oklahoma. As a reminder, Cushing, Oklahoma is the delivery point for the WTI crude oil. The simple explanation is that whenever stockpiles slip at Cushing, the price of the WTI crude oil usually increases. On the other hand, whenever inventories rise at Cushing, the price of WTI crude oil dips. As a reference, the EIA reported on June 18, 2014 that the crude oil stockpiles at Cushing increased by 247 thousand barrels. This was followed by a decrease in the price of WTI crude oil from $106.36 per barrel the prior day to $105.97 per barrel.
Here is an explanation for that correlation from Market Realist. Inventories from Cushing indicate how effectively growing U.S. oil production is moving from major inland production areas such as the Bakken in North Dakota and the Permian in west Texas to end refining markets. A build-up of inventories at Cushing may indicate that oil supplies are growing faster than takeaway infrastructure to end refining markets (many of which are located on the Gulf Coast) can keep up.
OPEC’s production target
Historically, the price of the WTI crude oil responds to changes in the production target of OPEC, as shown by the chart above. In most cases, a reduction in OPEC production targets brings about an increase in the price of oil. According to the EIA, OPEC's oil exports represent about 60 percent of the total petroleum traded internationally. Therefore, due to the large market share, OPEC’s dealings have the ability to affect international oil prices a great deal.
Beyond production targets, there are a number of other OPEC metrics that can move the price of WTI crude oil. Spare capacity is one of them. As the chart below shows, whenever OPEC’s spare capacity drops, the price of WTI crude oil usually increases.
Here is an explanation for that. First, you should note that spare capacity, as defined by the EIA, is the volume of production that can be brought on within 30 days and sustained for 90 days. It is a metric that indicate the ability of the oil market to respond to potential crises that could end up disrupting oil supplies. In other words, if OPEC’s spare capacity is low, the risk that sudden crises in major oil-producing nations would affect oil supply is high. This leads to a fear of a possible imbalance in the demand and supply of crude oil, which, in the end, drives the price of WTI crude oil high.
Note that the actual feared crises don’t need to occur before prices to go high; the thought of it is sufficient to move prices. After all, these fears are the reason people trade futures.