Short-sighted energy market analysis

By Benedict De Meulemeester

By Benedict De Meulemeester on 23/08/2009

Energy market analysts have recently been puzzled by the rise of oil prices. To many observers it looked like this rise was not supported by any fundamental shift in supply or – more importantly – demand. ‘Speculation’ is then easily blamed for the rising price. This was even done in the US Senate during debates over oil market manipulation (click here). As I have said before, I don’t believe that the forces of speculation are strong enough to shift the market direction. My natural reflex in such cases is to wonder whether there isn’t some change in supply and demand which we are ignoring. And more often than not, some piece of information pops up that does indeed show such a ‘hidden’ fundamental.

I was therefore not surprised to find the following piece of information through LinkedIn this week:

 “Chinese imports of oil in July hit a new record at 4.6 million barrels of oil per day, the equivalent of half of Saudi Arabia’s daily output. This eclipsed the previous record of 4.1 million barrels of oil per day set in the spring of 2008”, click here for the full article by Tony D’Altario. (I don’t agree with the overall conclusion of the author that this means that the US is no longer the world’s economic superpower. Impressive though the 4.6 million barrels might look, the US is still consuming at least 4 times more oil. But micro-economic experience shows that it is growth rate rather than sheer size that often defines the economic attractiveness.)

Somewhere on this planet, oil consumption has been growing in the past months. Oil traders must have picked up that signal in the spot markets. Does this justify a 75 dollar oil price? I don’t think that we will ever be able to answer the ‘justified price’ question. If we could, everyone would calculate the price and the market would become sterile. I do believe though that demand growth in China justifies a reversal of the bearish into bullish mood.

Even if the author is perhaps a bit to polemic, I do agree with the conclusion that analysts tend to be too much focused on US data. We could even call much oil market analysis short-sighted as it doesn’t look beyond the reality of the US. This is a profound methodological issue. Oil prices are influenced by so many different aspects that it is simply impossible to keep track of all of them. This means that any analysis system will have some data selection mechanism. Now, as any scientist can tell you, this data selection entails a huge systemic risk. Get your data-set wrong and you get deceptive conclusions.

This short-sightedness of oil market analysis is not strange. I can even see it with the analysts that we have at E&C. The price is rising and the analysts are under time pressure for finding an explanation (as consultants are calling them because they want to inform their clients). The most readily available data is then more easily selected than the information that you have to go after. Fortunately, we are not in the forecasting business, so we don’t make any systematic data selection and we don’t give clients advices on whether to buy or not because we believe that we can calculate what the future price will be from the data that we selected. But for any market analyst on this planet, it is a constant effort to keep reminding ourselves that we need to look further than the information that is in front of our nose. And from what I hear from our clients, we manage to do so quite successfully at E&C.

That US oil data comes in focus is not surprising. No country in the world is better in providing oil market data than the US. Every Wednesday, two reputed institutes, the API and EIA publish data on supply, demand and storage. It is a market in itself. Days and hours before, the market price is being set as traders take positions in anticipation of the news. The moments before, the market seems to hold its breath as liquidity drops and the price stops moving. And then the reports come out and frantic trading activity takes place as computers programmed to give the ‘buy’ or ‘sell’ signal when they find certain words in the API and/or EIA reports start trading. The market takes a first initial direction, but the definitive direction becomes clear only hours of active trading later, when we start to see whether the majority of market players interprets the reports as ‘bullish’ or ‘bearish’ news.

The quality of this and other economic data coming from the US is undeniable. And it stands in sharp contrast to the proverbial shadiness of Chinese statistics. The ‘short-sightedness’ of oil market analysis is therefore understandable. But is not justifiable. Any oil market analyst worth the name should presently be looking for sources for better grasping the dynamics of oil markets in emerging markets. And I refuse to believe that US oil market analysts refuse to do so out of economic nationalism.

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