Slide 7 of 26
Notes:
- One can use a simple model to deal with price/fundamental relationships. This one predicts monthly average WTI price as a function of OECD total petroleum stock deviations from the normal levels.
- The graph shows the model as it begins predicting prices in 1992. It shows how well the model has predicted not only the direction, but the magnitude of prices over this 8+ year period.
- While the model is simple and not perfect, it does predict the overall trends and, in particular, the recent rise in prices.
- It also shows that prices may have over-shot the fundamental balance for a while -- at least partially due to speculative concerns over Mideast tensions, winter supply adequacy, and Iraq’s export policies.
- Prices moved lower in December, and even undershot briefly the prediction based on market fundamentals. This was due to the market’s perception of a rising probability of excess supplies restoring global inventories to normal levels, causing traders to disproportionately bid prices down from earlier, exaggerated levels.
- However, by late January/early February, following OPEC’s announcement that production quotas would be cut by 1.5 million barrels per day, the market’s expectation of excess supplies dissipated. Currently, the WTI price is much closer to what EIA’s model would expect based on supply/demand fundamentals. While the relationship between actual WTI prices and EIA’s model projection may diverge for any given month, the recent return of prices more in line with EIA’s model validates the notion that eventually, fundamentals will impact prices.
