Will the 2013 Hurricane Season Light up WTI Crude Oil Prices?

In our Match 17, 2013 blog entry, we asserted that WTI crude oil prices may be approaching a bottom (after declining from $98.00 to $93.50 a barrel in six weeks), given the strength in the CB Capital Global Diffusion Index (“CBGDI”). The CBGDI is an advance/decline line (smoothed on a 3-month moving average basis) of the Leading Indicators data for 30 major countries in the Organization for Economic Co-operation and Development (OECD), along with China, Brazil, Turkey, India, Indonesia, and Russia. The CBGDI has led or tracked the MSCI All-Country World Index and WTI crude oil prices very closely since the fall of the Berlin Wall. Historically, the rate of change of the CBGDI has led WTI crude oil prices by about three months, with an R-squared of 30%.

We argued that–despite the projected 1.4 million b/d increase in U.S. crude oil production over the next two years–oil prices will likely remain firm for the foreseeable future, given the strength in our leading indicators, as well as steady oil demand growth from countries such as China, and pockets of strength in the Euro Zone.

Like that of other commodities, the crude oil price is subject to periodic upward spikes (unlike stock market prices, which are subject to periodic crashes). Supply disruptions via embargoes, wars, and shut-ins related to hurricanes have been the norm. The major exception was the spike in summer 2008, when the breakdown in the hedging market–combined with unprecedented financial demand driven by commodity funds–drove WTI crude oil to $150 a barrel, even as the world was heading into a major recession.

Since our March 17, 2013 blog entry, the price of WTI crude oil has bounced to nearly $98 a barrel, despite the recent widespread sell-off in Asian currencies and financial asset prices. We believe WTI crude oil prices could head higher later this summer, driven by an ongoing U.S. economic recovery, a strengthening German economy, as well as escalating tension in Syria. We also do not believe the Federal Reserve will indicate a halt to its QE policies until later this year, the earliest being the FOMC meeting post-Thanksgiving shopping period.

Moreover, while it does not occur every hurricane season, we believe the possibility of a higher WTI crude oil price due to a hurricane-induced shut-in in the Gulf of Mexico cannot be dismissed. Firstly, on a historical basis, it has been five years since Hurricanes Gustav and Ike devastated the Gulf Coast, resulting in major shut-ins of both oil and natural gas production in the Gulf of Mexico, as shown in the figure below.

Image

Immediately before Hurricane Gustav hit the Gulf of Mexico in late August 2008, WTI crude oil prices spiked by $5 a barrel, despite declining oil demand as the world entered a major recession. Despite the recent innovations in onshore horizontal drilling and shale fracking, the Gulf of Mexico remains a very important source of crude oil for the United States. According to the EIA, crude oil production from the Gulf of Mexico makes up 19% of total U.S. production last year–down slightly from 26% during 2007 to 2011. Any major shut-in due to an actual or fears of an impending storm could still have a disproportionate impact on WTI crude oil prices.

Secondly, NOAA–which publishes an annual outlook for the hurricane season in the Atlantic basin (including the Caribbean Sea and the Gulf of Mexico)–calculates a 70% chance of an above-normal hurricane season this year (based on 1950 to 2012 data).

Image

There is a good chance hurricane activity could be higher than that in 2010, and 2008, when Hurricanes Gustav and Ike caused a collective shut-in of over 60 million barrels of crude oil. On the other hand, it is highly unlikely that hurricane activity could approach that of 2005, when Hurricanes Katrina and Rita caused a collective shut-in of over 100 million barrels (I fondly remember evacuating from Houston at that time). It is important to remember that Hurricanes Katrina and Rita were outliers–both in terms of intensities and the paths they had taken. Note that more than 70% of all oil and gas platforms in the Gulf of Mexico were affected by the paths of these two hurricanes. Since the 2005 hurricane season, oil and gas platform infrastructures in the Gulf of Mexico have been strengthened–meaning that any shut-in of production will not last very long. Nonetheless, the chance of a short-term price spike in WTI crude oil is higher than normal, given expectations of heightened hurricane activity this year. We thus believe that the price of WTI crude oil should definitively rise and stay above $100 a barrel this summer.

Image

Follow

Get every new post delivered to your Inbox.

%d bloggers like this: