Newspapers agree that oil prices have hit a new high of $77 a barrel because of the latest fighting in the Middle East. This is hardly surprising, as ‘oil prices’ and ‘the Middle East’ go together like ‘house prices’ and ‘dinner party conversations’. It’s difficult to imagine one without the other. As geography is probably not a strong point on editorial news desks, it may have escaped many journalists’ notice that there are no oil wells in Israel, no pipelines to the Lebanon, and no tanker port facilities in Palestine. Nor do any of these countries sit by narrow, busy sea lanes such as the Straits of Hormuz.
A summer of heatwaves and hurricanes
The real reason why oil prices are steadily creeping to new highs has little to do with the latest atrocities being perpetrated in the Middle East. Things may be hotting up in the Holy Land, but it’s because things are hotting up somewhere else that oil prices are on the up. America is wilting in the hottest first six months of the year since records began in 1895. There are
heat alerts in 18 states and temperatures that, with the humidity, feel as warm as 115 degrees. On Monday, it hit 95 degrees in New York’s Central Park, a full 10 degrees above normal for the time of year.
The reason why this is bad for oil prices, quite apart from the short-term demand for electricity to power all those air conditioners, is that such abnormally high temperatures bode ill for this year’s hurricane season. The National Oceanic and Atmosphere Administration (NOAA) had already issued a long-range forecast in May based on high atmosphere wind shear patterns and surface sea temperatures. The NOAA expects nine hurricanes this summer, including five major ones (defined as category three or above). There’s a more than an 80% chance that at least one of these major hurricane makes landfall on the US mainland.
What this means for the price of oil?
The oil price is sensitive to US hurricane activity because a number of oil platforms and a large proportion of US refining capacity is lined up along the low-lying coastal areas in and around the Gulf of Mexico. Damage to these facilities can quickly create a shortfall in gasoline stocks. As it’s harder to refine heavy, sour, sulphur-rich crudes, there is an immediate premium paid for lighter, low-sulphur crude oils that tend to make up the benchmark measures, such as Brent, WTI and Dubai Fateh. Thus oil prices in general appear to go up more at this time of year.
A chart of the main benchmark oil type, West Texas Intermediate (WTI), shows that even though oil prices have trended up, only three times in the last three years have they surged above the upper tramline. Each time was during the hurricane season and two of the three occasions were late in August (by which time the market has adjusted to what sort of a season it will be). It’s a pretty reasonable bet that after the last two years’ storms, the first hurricane in August will get the market’s attention. It wasn’t until late July in 2004 and early August in 2005 that oil prices broached new highs, yet this year WTI crossed to new high territory on 12 July. This is early by recent standards.
Obviously, it’s hard to separate out the seasonal effect from other trends taking place, but at least for the last two storm seasons the oil price gains were in excess of 30% over just a couple of months. A move of a similar magnitude this season, while weather dependent and therefore inherently unreliable, nevertheless has the potential to take oil prices above $85 – and even to the edge of $90 a barrel by late August. The scene is set for another ‘storm surge’ in the oil price; all we need now is some wind.
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