What can oil prices tell you about the market? Not a lot: Bousso

The global oil market is experiencing a series of price spikes due to geopolitical tensions and the opaque stockpiling. Western sanctions and tightening Western sanction are also causing traders to be in the dark.

Prices may not accurately reflect the physical fundamentals of commodities due to the growing influence of unpredictable external forces on this world's most liquid and largest commodity market.

In fact, it appears that the global oil markets are struggling to find a balance between supply and demand. The International Energy Agency predicts that oil production will exceed demand this year by 3.7 millions barrels per day, which is more than 3%.

Prices tell a very different story. Brent crude prices have fluctuated in recent weeks but remain above $65 per barrel.

The forward curve also shows a steep backwardation. This is a characteristic structure that's usually associated with a tight supply.

What is the explanation? The uncertainty surrounding events in the Middle East played a part over the last few weeks. Oil prices have risen to $70 per barrel due to the risk of U.S. strikes against Iran and the potential for the conflict to spread across the entire region.

The CBOE crude volatility index is at its highest level since last June's 12-day Israel-Iran conflict.

U.S. - Iran tensions will be a short-term issue, unless it spirals out of control. However, other long-term trends could obscure the picture for several months.

STOCKS ARE BUILDING

Stocks are increasing globally, which is a sign of a market oversupply. Geopolitical fragmentation creates regional divergences which complicate this equation.

Morgan Stanley predicts that global crude oil inventories will rise by 730 million barrels in this year, or 520 million barrels. According to ROI estimates, the bulk of the stockpile was in China. The country has placed around 800,000 barrels per day into storage during the last year. This figure indicates an increase of over?300 millions barrels by 2025.

China's exact crude reserves and storage capacity are still unclear. The strategic reserves of China are largely hidden underground, beyond the reach of satellites. This makes it difficult to know how much is actually in storage and how much can be added.

China's purchasing strategy is also uncertain. Beijing is known to cut back on purchases when prices increase, so the stockpiling may have been slowed after recent price increases near $70 per barrel. The market doesn't know.

This opacity is a major blindspot for the oil markets and has changed?the way that rising storage levels are interpreted.

In the past, the oil price has closely followed changes in inventories of countries that are members of Organisation for Economic Co-operation and Development, notably those from America and Europe which have long been dominant forces on global demand. A rise in stockpiles was generally considered negative.

Martijn Rats is an analyst with Morgan Stanley. According to him, the buildup of Chinese stocks in the OECD countries has been interpreted as a bullish sign, indicating a strong demand, which offsets any negative signals from the OECD stockpiles.

This could explain why the crude oil prices haven't dropped despite a rise in global inventories.

CONFUSION GEOPOLITIQUE

Western sanctions against several oil producing nations complicate this picture.

Kpler reports that China, India, and Turkey will import around 3.5 millions bpd of crude oil from Venezuela, Iran, and Russia in 2025. This picture is changing, however, following the European Union's ban on fuels refined using Russian crude which took effect on 21 January and President Donald Trump increasing pressure on India in order to reduce Russian oil purchases.

India has cut its Russian crude imports by about 1 million barrels per day this year. This is down from 1.6 millions bpd a decade ago. According to Trump, India also promised to reduce further purchases.

These changes are forcing market adjustments. Western restrictions have increased demand for barrels that are not sanctioned and for tankers that comply with the regulations, increasing costs for refiners. This is especially true in Asia where there is a high reliance on seaborne crude because of limited production.

Since early January, Asian refinery margins are smaller than those of Europe. The former has averaged around $6 per barrel this year compared with $9 for the latter. The main reason for this difference is logistics costs.

Keshav Lhiya is the CEO of HiLo Analytics. He said that freight was a significant regional differentiator in 2018.

According to LSEG, freight rates for a VLCC?sailing between the Middle East and West Africa into Asia are up nearly 150% from the beginning of the year.

Shipping costs for Asian refineries can exceed $3 per barrel, while they are closer to $2 in Europe.

The restrictions are also causing an accumulation of crude oil that has been sanctioned at sea, as sellers struggle to locate buyers.

Russia, Iran and Venezuela are responsible for 30% of the crude oil in transit (1.3 billion barrels) -?which is higher than the share they export. This indicates slower discharge rates because traders are struggling to place barrels.

This leads to a market which appears both oversupplied and unusually tight.

This tension is a reflection of a market that is increasingly driven by geopolitics, and by the behavior of opaque stockpilers.

Oil prices will likely remain out of sync until transparency is improved or political risks are reduced.

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(source: Reuters)