Crude Oil

Prices: The front-month futures price for Brent crude oil settled at $62.29 per barrel (b) on November 7, 2019, an increase of $3.40/b from October 1. The front-month futures price for West Texas Intermediate (WTI) crude oil for delivery at Cushing, Oklahoma, increased by $3.53/b during the same period, settling at $57.15/b on November 7 (Figure 1).

Crude oil markets traded in a relatively narrow range in October following heightened volatility in September stemming from the attack on Saudi Arabian crude oil processing facilities. A number of indications suggest that some of the supply- and demand-side risks that affected oil market participants in the third quarter have begun to diminish. Saudi Arabian production has returned to pre-attack levels. In addition, some of the expectations for lower economic growth-related oil demand during the past year may be receding and appear to be providing near-term support to crude oil prices at levels slightly higher than $60/b. Some economic activity remains slower than in recent history—Chinese third-quarter gross domestic product growth, for example, was the slowest rate since at least 1992—yet, other economic indicators improved compared with those of a few months ago. Manufacturing Purchasing Manager’s Indexes (PMI) increased in both China and the United States, and employment growth in the United States continues to support domestic gasoline consumption, which EIA estimated to be at a seasonal record-high level in October. In addition, the U.S. Federal Reserve and other central banks recently signaled a more accommodating monetary policy, including lower interest rates, which could stimulate capital expenditures or other investment spending.

U.S. commercial crude oil and other liquids inventories declined by 0.4 million barrels per day (b/d) in October. EIA estimates that global inventories increased by 0.8 million b/d in October as inventory builds in other regions—some of which was likely the result of Saudi Arabia refilling stocks that it withdrew following the September production outage—offset the draws in the United States. EIA forecasts that fourth-quarter 2019 inventories will increase by more than 0.2 million b/d, followed by further inventory builds in the first half of 2020 that will put moderate downward pressure on crude oil prices. EIA’s price forecast for 2020 is mostly unchanged from the October STEO; Brent and WTI are forecast to average $60/b and $55/b, respectively.

Tanker rates: Freight rates for chartering crude oil tankers reached the highest levels in more than 10 years on certain routes in early October because of U.S. sanctions on Chinese shipping. The cost of chartering a Very Large Crude Carrier (VLCC), a vessel with about 2 million barrels of capacity, from the Arabian Gulf to Japan increased to almost $9/b on October 14, and the cost for chartering a VLCC from the Arabian Gulf to the U.S. Gulf Coast increased to more than $8/b (Figure 2). These two charter routes averaged $1.34/b and $1.14/b, respectively, from January through September.

Trade press reports that, because of U.S. sanctions imposed on certain subsidiaries of Chinese shipping firm COSCO, shippers and other trading firms canceled bookings scheduled for early October for all vessels operated by COSCO amid high uncertainty about which vessels were sanctioned. The disruption contributed to not only higher rates for VLCC charters globally but also for smaller alternative charter vessels such as Suezmaxes (vessels with about 800,000 to 1 million barrels of capacity). Although tanker rates declined in late October, a sustained increase in shipping rates could affect crude oil exports in regions that have higher transportation costs, in turn affecting crude oil prices. For example, WTI prices would likely decline relative to Brent because WTI travels from Cushing, Oklahoma, to the U.S. Gulf Coast via pipeline before it can load for export. Brent, on the other hand, can load on tankers at its production area. However, the short-term spike in rates in October is unlikely to have a sustained effect on the Brent–WTI spread, which EIA forecasts will remain at $5.50/b in 2020, unchanged from the October STEO.

Producer/merchant open interest: Producers, merchants, refiners, and other physical market participants in the WTI crude oil market have been net long for the WTI futures contract since June 2019 (Figure 3). Historically, these traders are net short as a group because most physical market participants are sellers of crude oil, and the value of selling a futures contract short increases if crude oil prices decline. A long position increases in value when crude oil prices increase. The flip to a net long position has been primarily a result of a decrease in gross short positions—which declined by 233,000 contracts since the all-time high net short positions in February 2017 through November 5—but gross long positions also increased 126,000 contracts during this period. Several factors could be contributing to the net long position of the producer/merchant category, including a reduction in the quantity of future crude oil production that oil producers are hedging. Similarly, refiners or other end users could be increasing long positions amid uncertainty regarding the January 2020 transition to low-sulfur fuel oil shipping regulations, which could contribute to higher premiums of light, sweet crude oils such as WTI. Although EIA incorporates a base level of producer hedging when forecasting U.S. crude oil production, a reduction in hedging activity among producers should not significantly affect the forecast growth in U.S. crude oil production.

Options activity: Activity in the WTI options market reflects similar trends as the reduction in short positions among producer/merchants in the futures markets. Total put option open interest for WTI declined to 978,000 contracts in October, the lowest level since December 2015, and was a 32% year-over-year decline (Figure 4). A put option gives the owner the right, but not the obligation, to sell the underlying futures contract for a specific price by a certain time and increases in value when crude oil prices decline. A call option is similar but instead gives the owner the right to buy an underlying futures contract, and it increases in value when crude oil prices increase.

Producers tend to use options as a hedging tool in addition to selling short futures contacts, and the reduction in put contract open interest suggests that producers decreased hedging activity during the past year. Although WTI total call open interest also declined during the past year, it increased in October from September by 99,000 contracts. Some of the recent increase in call open interest could be for similar reasons that producer/merchant longs are increasing—to hedge upside price risk for light, sweet crude oil ahead of low-sulfur fuel oil regulations—but it also could be from the increased geopolitical risk following last month’s attack on Saudi Arabian oil infrastructure.