Crude Oil

Prices: The front-month futures price for Brent crude oil settled at $60.06 per barrel (b) on December 6, a decrease of $12.83/b from November 1. The front-month futures price for West Texas Intermediate (WTI) crude oil for delivery at Cushing, Oklahoma, decreased by $12.20/b during the same period, settling at $51.49/b on December 6 (Figure 1).

Crude oil prices declined significantly in November but increased during the first week in December amid heightened price volatility. WTI prices experienced three rare and large price declines (each between -6% and -8%) within the span of 10 days in the middle of November, and WTI prices were down by more than 33% from the four-year highs set in early October by the end of November. Several factors contributed to falling prices. Crude oil production from the world’s three largest producers—the United States, Russia, and Saudi Arabia—were at or near record levels in November. Implementation of sanctions on Iran began on November 5, but the United States granted waivers for some of Iran’s largest customers to continue importing limited volumes of crude oil for six months. In addition, concerns about the pace of global economic growth in coming months have led to related concerns about the pace of oil demand growth.

On December 7, the Organization of the Petroleum Exporting Countries (OPEC) and several non-OPEC countries announced a production reduction of 1.2 million barrels per day (b/d) from their October production levels for six months beginning in January 2019. The cuts were in response to increasing evidence that oil markets could become oversupplied in 2019. This potential oversupply was reflected in recent price declines. EIA is revising its 2019 price forecasts for Brent and WTI to $61/b and $54/b, respectively, which are both $11/b lower than forecast in the November STEO. In last month’s STEO, EIA expected downward price pressures could materialize by the middle of 2019 to reduce global inventory builds. EIA expects that the magnitude of the recent price declines combined with the OPEC production cuts will bring 2019 supply and demand numbers largely into balance, which EIA forecasts will keep prices near current levels in the coming months.

The realized volatility in crude oil prices last month, as measured by the difference between the monthly high and low prices (trading range), was the largest since 2012 for Brent and the largest for WTI since 2014 (Figure 2). The two crude oils traded in a $17.49/b and $15.98/b range, respectively, during the month. The implied volatility of Brent and WTI, calculated from options prices, more than doubled during the month, reflecting the market’s heightened uncertainty regarding future oil supply and demand.

The crude oil 1st–13th futures contract price spreads for Brent and WTI declined to the lowest levels since the third quarter of 2017, settling at -$1.02/b and -$1.95/b, respectively, on December 6 (Figure 3). Both crude oils are in contango (when near-term prices are lower than longer-dated ones), reflecting recent increases in global oil inventories. Some recent supply increases in Saudi Arabia and the United States have been larger than expected and likely contributed to an estimated global liquid fuels inventory build of 1.3 million b/d during November.

Third-party ship tracking data suggest some of the inventories have recently built in floating storage. Floating storage is typically the most expensive way to store oil, only occurring in markets where producers and traders have more difficulty finding customers or accessing available onshore storage. However, the increase in floating storage may not entirely be because of the recent market weakness. The increase also likely reflects, in part, the effects of U.S. sanctions on Iran, limiting the country’s ability to sell crude oil openly. EIA estimates that Iranian crude oil exports have declined at a faster rate than their total crude oil production, indicating their oil is being stored. A similar phenomenon occurred during the 2012 sanctions.

Energy high yield bonds: Yields for high yield bonds—those from companies with a rating lower than investment grade from a credit rating agency—for energy and nonenergy companies increased at the same time as the higher market volatility in November. An increase in bond yields, measured by a higher option adjusted spread to U.S. government bonds, reflects higher default risk and could increase the cost of borrowing for some companies. The Bloomberg Barclays high yield corporate bond index increased by 0.7 percentage points from November 1, settling at 4.4% on December 6. For companies specific to the energy sector, the option adjusted spread increased 1.3 percentage points during the same period, settling at 5.8% on December 6 (Figure 4). Even though the energy bonds’ option adjusted spread remains significantly lower than the highs reached in early 2016 when crude oil prices fell to $26/b, the increase during the past two months has brought them to the highest level in two years. The decline in oil prices increases the default risk of some oil producers’ ability to repay principal and interest.