IMF and Oil Prices

International Monetary Fund released its most recent World Economic Outlook in September
2011. The economic growth forecasts in this outlook, like any other of its past
outlooks, are used by all prominent institutions as a crucial input for making
oil demand forecasts.
For instance, in
early October, the IMF’s downward revision of GDP forecasts was interpreted by
traders as a sign of a slowdown in oil demand growth.

IMF uses its own interpretation of oil prices for making its economic
growth forecasts. Note that
throughout its World
Economic Outlook with oil price the IMF means “simple average of spot prices of
U.K. Brent, Dubai Fateh, and West Texas Intermediate (or WTI) crude

Historically, WTI has traded at a premium of a few dollars, because
it is a lighter and sweeter variety of crude oil. Starting from 28 October 2011
this has changed. For more than once year now Brent has been trading at a
premium to WTI. The Brent-WTI spread blow-out from a few dollars to nearly $30
in early September. Of course this development has brought the WTI price as an
international price benchmark under scrutiny. The IEA, for instance, switched to
Brent price in its monthly Oil Market Reports. Now, more and more people mean
Brent price when they talk about world oil price.

The IMF says in its WEO that “Historically, WTI has traded at a
premium, because it is a lighter and sweeter variety of crude oil. If this
anomaly continues, use of the WTI price as a price benchmark will increasingly
come under scrutiny.” It also says that
current futures prices imply that markets expect WTI to be priced at a discount
to Brent through 2016.

If this is the case
what is the point for the IMF to continue using an “average” oil price. Using an
average price would make sense if the price series that were averaged followed
more of less the same path. This is not anymore the case. So, is it meaningful
to average the three benchmark crude prices?

By using this “average” oil price the IMF makes a number of
assertions that are simply not backed up by the facts. Chapter 1 of WEO makes a
blunt remark with saying that “During the second quarter of 2011, oil prices
briefly rose more than 25 percent above the levels that prevailed in January
2011. It is hard to determine the extent to which prices were driven up by
stronger demand or by lower supply.”

Note that the IMF undermines the role of speculators. IMF further
states that “global macroeconomic factors explain a large and broadly stable
share of commodity price fluctuations. If noise trading (and destabilizing
speculation more generally) had become more important, commodity price
volatility should have increased.” How can you justify it if you plot average
petroleum spot price (an equally weighted average of WTI, Dated Brent, and Dubai
Fateh) against Net Long Noncommercial Positions in Crude Oil in NYMEX? How do
you see it if you use an average oil price? More importantly, does it make

The race between WTI and Brent (actually between NYMEX and ICE) for
being a representative global crude oil benchmark price continues. Non
commercials are more and more attracted to the Brent market’s stronger calendar
spread structure as well as stronger price momentum. Does this race today make
sense? As I mentioned above, many
institutions including the IEA switched to Brent as world oil price benchmark.
This is despite the fact that WTI production may be increasing while Brent has
peaked and is dwindling. When the new pipeline between the US and Canada is
completed, more oil will be flowing to Cushing, the WTI contract’s point of
delivery. The pipeline connection problem to supply Midwest refineries will most
probably be solved in the future. In the mean time, Will we see then a switch
back to WTI price?

Isn’t this a market
distortion? How long will we remain silent to casino capitalism for having a
very strong influence on the price of a commodity that affect every one of us.
How long will we play the three monkeys that financialization of oil markets has
had nothing to do with the oil price movements in the past few years? (And yes,
in this post I am biased).
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