By Vicki Schmelzer
(MaceNews) – Crude oil prices have backed down from recent highs as speculative accounts take profit and market players reassess the situation in Ukraine.
News that the International Energy Agency members would release more crude oil stocks and hopes for progress in Thursday’s Russia-Ukraine talks appeared to spur long liquidation Wednesday, along with overbought positions.
While oil prices are driven by supply and demand, other factors such as movements in the U.S. dollar and speculation play a key role in determining prices also.
From the FX perspective, the “chicken or the egg” argument persists about whether the dollar drives oil prices or oil prices drive the dollar. Both sides offer short-term correlations that bolster their case, but scant proof that these correlations work in the long run.
In contrast, the speculative element holds clear sway on oil prices in the short term, and on financial instruments in general. To better understand trader mentality, think back to what average citizens did during the beginning of the COVID-19 crisis. Toilet paper disappeared from the shelves as people tried to load up on consumer staples. Prices were driven higher, not only because of a supply shortage, but also due to hoarding.
A trader’s number one goal is to make money and to be the first to buy or sell on any given move in financial markets. Historically, the first whiff of the word “war,” sends commodity prices higher and the market knows this.
So, it was no surprise to see volume and open interest for crude oil futures on the Chicago Mercantile Exchange move higher from late January to early March, when volume surged from around 1.1 million contracts to more than 2.1 million contracts. (https://www.cmegroup.com/markets/energy/crude-oil/light-sweet-crude.volume.html).
The latest data as per March 8, shows open interest at about 1.4 million contracts.
The front NYMEX light sweet crude oil contract is trading around $110.00 per barrel at the time of writing. The April contract topped out at $130.50/bl March 7, which was the highest level since July 2008, when prices peaked at $147.27/bl on July 10.
The sharp drop in volume and open interest seen in the CME data as per Tuesday’s close would suggest that traders have been taking profit on the recent run up.
Those with long memories will note that after posting record highs in the summer of 2008, crude oil prices, along with other asset classes, tumbled into the fall, after the Lehman Brothers bankruptcy and the U.S. financial crisis began to unfold more markedly. The front crude oil contract bottomed at $32.40/bl in mid December 2008 before edging higher into year-end.
In terms of spill-over to gasoline prices, the St Louis Fed estimates that a $10 rise in the price of a barrel of oil is correlated with about a “25-cent increase in the price of a gallon of gasoline adjusted for taxes and markups, which are (relatively) constant over time.”
The St Louis Fed also notes that “if the ratio between the adjusted price of gasoline to the crude oil price (25 cents per $10) falls too out of line with this long-run relationship, gasoline prices will tend to adjust to return to this ratio.” (https://www.stlouisfed.org/publications/regional-economist/october-2014/rockets-and-feathers-why-dont-gasoline-prices-always-move-in-sync-with-oil-prices)
The average national price of regular gasoline stood at $4.252 a gallon as per Wednesday March 9, according to the latest AAA gas price data (https://gasprices.aaa.com). This compared to $3.656 a week ago, $3.469 a month ago and $2.796 a year ago. At the same time, the front NYMEX light sweet crude contract closed Tuesday at $123.70. This compared to closes at $103.41 March 1 (a week ago), $89.36 (February 8) and $65.05 (March 8, 2021)
Using the St Louis Fed estimates, the nearly $60 run up in oil prices in the past year would have translated to six 25-cent increases in gasoline prices or a $1.50 increase. This would put the average at $4.296 or close to current levels. Should crude rise to $300, as Russia warned this week, average national gasoline prices could rise by another $4.41 to about $8.66 a gallon.
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