Crude Oil

Prices: The front-month futures price for Brent crude oil settled at $60.95 per barrel (b) on September 5, 2019, an increase of $0.45/b from August 1. The front-month futures price for West Texas Intermediate (WTI) crude oil for delivery at Cushing, Oklahoma, increased by $2.35/b during the same period, settling at $56.30/b on September 5 (Figure 1).

Global economic indicators continued to decline, contributing to oil price declines and volatility. Manufacturing Purchasing Managers’ Indices (PMIs)—which can serve as a leading indicator for economic growth—from several countries for August showed a contraction in manufacturing activity. PMI reports remained mixed for the United States, with the IHS Markit PMI still showing slight expansion, although at the lowest level since September 2009, while the U.S. Institute for Supply Management’s PMI showed contraction for the first time since 2016. Reports on trade negotiations between the United States and China also contributed to daily movements in global crude oil prices. On August 23, WTI prices fell by 2% when China announced a 5% tariff on its imports of U.S. crude oil, the first time U.S. crude oil was included in Chinese tariffs. However, Chinese imports of U.S. crude oil have decreased in 2019 year-to-date compared with 2018, and China has imported more from other countries, including Saudi Arabia.

EIA is reducing its 2019 Brent crude oil price forecast to $63/b, which is $2/b lower than in the August STEO. The lower 2019 price forecast largely reflects recent global crude oil price fluctuations and lower forecast global oil demand growth. EIA has revised its expected global oil demand growth down to 0.9 million barrels per day (b/d) in 2019, 0.1 million b/d lower than the August forecast. Lower expected oil demand growth mainly reflects lower forecast gross domestic product growth and lower forecast demand from countries in the Organization for Economic Cooperation and Development. If realized, 2019 would be the first year when demand growth is less than 1.0 million b/d since 2011. EIA expects that annual average Brent prices will slightly decrease in 2020 to $62/b, which is $3/b lower than EIA’s August STEO forecast.

Notwithstanding the decline in overall price levels in August, several factors specific to the WTI market contributed to a narrowing of the Brent–WTI futures price spread since late July 2019. The Brent–WTI futures price spread settled at $4.79/b on September 5, a decrease of $1.70/b since August 1 (Figure 2). On August 19, the price spread decreased to $3.60/b, the narrowest spread since March 2018. Crude oil prices in the Permian region increased during this period with the addition of two pipelines mid-month that reduced takeaway constraints to the U.S. Gulf Coast. The Cactus II crude oil pipeline added an estimated 670,000 b/d, and the EPIC Midstream natural gas liquids pipeline—repurposed to deliver crude oil—added about 400,000 b/d of capacity. The pipeline additions between the Permian and the U.S. Gulf Coast reduced the need for crude oil to first transit through Cushing, lowering the cost of transportation to refineries and export terminals on the U.S. Gulf Coast. Cushing crude oil stocks decreased by 10 million barrels from the third week in July through August 23, likely as a result of less crude oil flowing to the storage hub from the Permian region. EIA expects the spread to widen slightly from the lows seen in mid-August, as regional markets rebalance and the spread settles closer to the new pipelines’ tariff from the Permian Basin to the Gulf Coast.

Crude oil and inflation expectations: Changes in crude oil prices affect market participants’ expectations of future rates of inflation because energy is a significant input into other areas of the economy. Lower crude oil prices have a deflationary effect because petroleum products are a primary variable cost for businesses and consumers. Recent decreases in Brent crude oil prices have coincided with a decrease in inflation expectations, as measured by the difference in yield between the five-year Treasury rate and five-year Treasury Inflation-Protected Securities (TIPS). The five-year TIPS-Treasury spread decreased from 1.47% on August 1 to 1.35% as of September 5, and crude oil prices remained relatively flat during the same time (Figure 3). Relatively flat inflation growth was an important factor in the Federal Reserve Board’s decision to decrease interest rates, which the Board decided to do for the first time since 2008 in the Federal Open Market Committee meetings in July. Since the Board’s meeting, the market has continued to price in inflation expectations lower than 2%, which is the Board’s inflation target.

Historical 30-day volatility: Unlike implied volatility, which is a calculated measure derived from options prices, historical volatility measures the magnitude of daily changes in closing prices for a commodity during a given time in the past. WTI 30-day historical volatility increased from August 1 to September 5, increasing from 38.7% to 45.1% (Figure 4). In 2019, historical volatility peaked at 59.4% in January, as WTI crude oil prices increased from large price declines in December because of supply-side uncertainty following an extension of the production agreement by producers in the Organization of the Petroleum Exporting Countries (OPEC) and several non-OPEC producers (OPEC+). The mid-August increase in volatility is likely related to demand-side uncertainty as well as the addition of two pipelines out of the Permian Basin. The volatility of copper futures prices has been lower than volatility of WTI prices because copper futures prices almost solely respond to demand-side concerns rather than supply-side uncertainty. In general, the industrial metal is used in many economically sensitive sectors, such as construction and industrial production, and lower prices may indicate expectations of a slowdown in industrial and economic activity. The volatility in the S&P 500 Index, which includes a basket of companies across many industries, was greater than the volatility of copper in late August, possibly in response to global trade concerns and slowing demand.

Market-derived probability: From the beginning of August to the first week of September, the probability that the December 2019 WTI crude oil futures contract will expire above $60/b decreased slightly. The probability that was calculated using futures and options data indicates WTI futures prices have a 25% chance of reaching $60/b at expiration as of September 5 (Figure 5). The probability of reaching $60/b was at 34% on August 1.