IMF and Oil Prices

International Monetary Fund released its most recent World Economic Outlook in September 2011. The economic growth forecasts in this outlook, like any other of its past outlooks, are used by all prominent institutions as a crucial input for making oil demand forecasts. For instance, in early October, the IMF’s downward revision of GDP forecasts was interpreted by traders as a sign of a slowdown in oil demand growth.

IMF uses its own interpretation of oil prices for making its economic growth forecasts. Note that throughout its World Economic Outlook with oil price the IMF means “simple average of spot prices of U.K. Brent, Dubai Fateh, and West Texas Intermediate (or WTI) crude oil.”

Historically, WTI has traded at a premium of a few dollars, because it is a lighter and sweeter variety of crude oil. Starting from 28 October 2011 this has changed. For more than once year now Brent has been trading at a premium to WTI. The Brent-WTI spread blow-out from a few dollars to nearly $30 in early September. Of course this development has brought the WTI price as an international price benchmark under scrutiny. The IEA, for instance, switched to Brent price in its monthly Oil Market Reports. Now, more and more people mean Brent price when they talk about world oil price.

The IMF says in its WEO that “Historically, WTI has traded at a premium, because it is a lighter and sweeter variety of crude oil. If this anomaly continues, use of the WTI price as a price benchmark will increasingly come under scrutiny.”  It also says that current futures prices imply that markets expect WTI to be priced at a discount to Brent through 2016.

 If this is the case what is the point for the IMF to continue using an “average” oil price. Using an average price would make sense if the price series that were averaged followed more of less the same path. This is not anymore the case. So, is it meaningful to average the three benchmark crude prices?

By using this “average” oil price the IMF makes a number of assertions that are simply not backed up by the facts. Chapter 1 of WEO makes a blunt remark with saying that “During the second quarter of 2011, oil prices briefly rose more than 25 percent above the levels that prevailed in January 2011. It is hard to determine the extent to which prices were driven up by stronger demand or by lower supply.”

Note that the IMF undermines the role of speculators. IMF further states that “global macroeconomic factors explain a large and broadly stable share of commodity price fluctuations. If noise trading (and destabilizing speculation more generally) had become more important, commodity price volatility should have increased.” How can you justify it if you plot average petroleum spot price (an equally weighted average of WTI, Dated Brent, and Dubai Fateh) against Net Long Noncommercial Positions in Crude Oil in NYMEX? How do you see it if you use an average oil price? More importantly, does it make sense?

The race between WTI and Brent (actually between NYMEX and ICE) for being a representative global crude oil benchmark price continues. Non commercials are more and more attracted to the Brent market's stronger calendar spread structure as well as stronger price momentum. Does this race today make sense?  As I mentioned above, many institutions including the IEA switched to Brent as world oil price benchmark. This is despite the fact that WTI production may be increasing while Brent has peaked and is dwindling. When the new pipeline between the US and Canada is completed, more oil will be flowing to Cushing, the WTI contract's point of delivery. The pipeline connection problem to supply Midwest refineries will most probably be solved in the future. In the mean time, Will we see then a switch back to WTI price? 

 Isn’t this a market distortion? How long will we remain silent to casino capitalism for having a very strong influence on the price of a commodity that affect every one of us. How long will we play the three monkeys that financialization of oil markets has had nothing to do with the oil price movements in the past few years? (And yes, in this post I am biased).