Crude Oil

Prices: The front-month futures price for Brent crude oil settled at $76.50 per barrel (b) on September 6, an increase of $4.11/b from August 1. The front-month futures price for West Texas Intermediate (WTI) crude oil for delivery at Cushing, Oklahoma, increased by 11 cents/b during the same period, settling at $67.77/b on September 6 (Figure 1).

Although crude oil prices were up for August as a whole, crude oil prices and prices for commodities more broadly fell in early August. Significant declines in some emerging market currencies may have contributed to increased concerns about global economic growth and its potential impact on oil demand. However, oil prices rose in the second half of August following reports of reduced purchases of Iranian crude oil ahead of the United States reinstituting sanctions on Iran in November. Other supply developments likely contributed to a pull on oil inventories, which contributed to higher prices. A restart to some Canadian production after July’s oil sands outage is anticipated to be delayed until September, and tropical storm activity in the U.S. Gulf of Mexico led to the shutdown of some offshore crude oil platforms. EIA estimates that global petroleum inventories declined by almost 0.4 million barrels per day (b/d) in August, the seventh consecutive month of net inventory withdrawals.

Apparent hedging activity in the crude oil options market suggests several market participants purchased financial protection in anticipation of an increase in crude oil prices ahead of the November implementation of Iranian sanctions. Call options for the December 2018 Brent crude oil futures contract with a strike price of $80/b have been one of the most actively traded out-of-the-money contracts in recent months. A call option—which gives the buyer the right, but not the obligation, to purchase an underlying security at a specific price by a certain time—is out-of-the-money when the strike price of the option is higher than the price that the futures contract is currently trading.

Trading volume averaged more than 2,000 contracts per day since May, and trading of 10,000 or more contracts occurred on some days in July and August (Figure 2). Third-party ship tracking data indicate that several countries may have already reduced purchases of Iranian crude oil, and August estimates of waterborne crude oil exports from Iran to be 19% lower than the average during first seven months of 2018. EIA estimates that Iranian crude oil production declined 0.2 million b/d from July to August. If the reduction in Iranian crude oil production and exports is larger than expected, the disruption to the crude oil market in the fourth quarter of 2018 could result in price increases. End users could be financially hedging against this outcome through the purchase of call options, which gain in value as the underlying security price increases, among other factors.

Crude oil price spreads: Crude oil prices in the Permian region of Texas and New Mexico traded at wide differentials to those on the U.S. Gulf Coast in August. The WTI-Midland differential to Magellan East Houston reached a low of -$23.95/b on September 4 before settling at -$22.45/b on September 6 (Figure 3). The wide differential between Permian region prices and the Houston prices is the result of constrained pipeline capacity to move crude oil along that route, which has caused producers without pipeline space to ship crude oil using more costly modes of transportion, such as trucks. In additon to this capacity constraint, the differential in August could have been exacerbated by a fire near a storage tank that feeds the Basin Pipeline, which runs from the Permian to Cushing, Oklahoma. The fire disrupted an estimated 50,000 b/d of flow, more than 10% of the pipeline’s total capacity. Although the disruption was brief, prices in Midland declined $2.15/b compared with Magellan East Houston prices on the day of the fire.

EIA’s August Drilling Productivity Report estimates that crude oil production in the Permian region will grow to 3.4 million b/d in September. Current estimates of available regional refinery intake and pipeline takeaway capacity is about 3.6 million b/d. Even though crude oil takeaway infrastructure constraints could contribute to wide price discounts for Permian crude oil through the third quarter of 2019, which would moderate production growth compared with an unconstrained scenario, EIA still expects Permian crude oil production to drive total U.S. production growth next year. Many producers in the region claim they can operate profitably with prices in the mid-$50/b level, and they might use higher cost transportation options to move crude oil to the U.S. Gulf Coast or other regions. Some producers with a geographically diverse portfolio of upstream properties could also redirect capital to other areas or decide to reduce completion activity until the transportation constraints ease.

Open interest: Brent and WTI average daily open interest declined for the third consecutive month in August. Both crude oil futures contracts’ open interest reached an all-time high in May 2018, averaging 2.6 million and 2.7 million contracts outstanding, respectively (Figure 4). Since peaking in May, average daily open interest declined to 2.3 million contracts for both Brent and WTI crude oil in August.

Based on the weekly U.S. Commodity Futures Trading Commission (CFTC) Commitments of Traders data, WTI futures open interest declined from the first week of May to the last week of August as a result of the closure of short positions from the Producers and Merchants category, followed by short position closures from Swap Dealers. Producers and Merchants reduced the largest number of long positions, followed by the Other Reportables category. The Producers and Merchants category, along with Swap Dealers, typically represent participants in the futures market whose primary purpose is risk management in the production or processing of a commodity. Fewer futures contracts held by these traders suggest some producers or end users could be reducing their hedging activity.