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Brent and WTI spread widens

After a 4% rally last week, Brent finally pulled back on the back of comments suggesting violence in Iraq had not interrupted the country’s oil supplies.

Crude oil
Source: Bloomberg

Just to put it into context, Iraq is OPEC’s second largest oil producer which makes this conflict pretty significant for the global economy. Some analysts have gone as far as saying interruption of Iraq’s supplies has the potential to push oil to around US$200. It’s no wonder the US is frantically trying to bridge the gap with Iran and resolve the matter. The US met Iran officials this week and it seems the two are still in negotiations on how to best resolve the crisis.

On top of that, the US is sending 275 military personnel to assist in Iraq. With a fragile recovery still in progress, the last thing we need at the moment are elevated energy prices. Most of the market feels Iraq is headed towards a civil war and this is the real threat to oil. There is another camp that feels this is merely a terrorist insurgency which can be contained. While this is all yet to play out, crude is likely to maintain its ascent in the near term as the market prices in an escalation of the situation.

WTI lagging

It’s a very headline risk driven environment for oil at the moment. As a result, the pullback didn’t last long at all as another headline suggesting Iraq’s military clashed with militants crossed the wires. The main issue at the moment is that the conflict is still contained in the north whilst the majority of Iraq’s oil supplies are in the south. As the conflict spreads then concerns will only grow. This is likely to remain the case in coming weeks as the insurgents approach the capital (Baghdad). Brent, which is now widely regarded as the benchmark, continued to widen the gap against West Texas Intermediate (WTI). Essentially Brent is more widely followed as it is from a greater sample size and more accurately reflects global supply. As a result, rising tension in key producing nations will naturally result in a spike in Brent prices. Meanwhile WTI is more dependent on US factors and in particular US crude oil inventories. With a spread of over $7 between Brent and WTI, there are clear signs of worry and the wider this gap grows simply means concerns are escalating. The spread is now at its highest in about a month.

Buying pullbacks a preferred strategy

From a price action perspective, the move in Brent over the past week has seen it take out 2011 highs and key resistance at US$110. At the same time WTI has matched 2011 highs with potential to extend this in the near term. The past of least resistance seems to be higher at the moment and I would favour using pullbacks as an opportunity to buy, particularly for Brent which is more sensitive to geo-political tension. There was significant resistance in the $110 region which is now potential support.

There was also a downtrend resistance line which came in from the September highs through to May highs. This downtrend was finally broken last week and this triggered a rally to over US$113 where Brent is currently trading. There is really no way of telling just how far the price can run given the uncertainty of the situation but looking out August highs near US$116 is always a good start.

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