August update

Predicting the oil price part 2…

When we posted our last Oil Market Report, the World Cup was imminent and as we know now, so was England’s early exit. On the positive side though, we were able to track down Panini stickers 77, 236, 405 and 621 but do still need 132 (Ron Vlaar of Holland). England’s sorry performances at major footballing events have become rather predictable over the years and certainly a great deal easier to predict than oil prices. However we did state back in April that along with weather, wars tend to be the major factor behind oil price movements and this view was borne out in June/July as the military success of ISIS in Iraq (an organisation so extreme that even Al Qaeda have condemned them…!) drove prices northwards. In fact at the end of June, the oil price went up by $7 per barrel, from $108 to $115.

Things did ease off quickly afterwards – when it became evident that key Southern Iraqi oil fields were not under threat – but an increase of $7 per barrel is a very significant price change and yet consumers in the UK and to a lesser extent Europe, would have been forgiven for noticing very little at the pumps when they went to fill-up. In fact in pence per litre terms prices stayed fairly flat throughput, starting at 103.51ppl (wholesale + duty) and finishing at 104.72ppl – a rise of only 1.21ppl. How so, you ask? Well some of it is due to the supply-chain and the amount of time it takes for oil prices to be reflected in refined products at the pump. But of far more profound influence is the $/£ exchange rate and here is another reason why predicting consumer fuel prices is such a devilishly difficult exercise.

The attached graphs illustrate how exchange rates can and often do have a greater impact on pump prices than the actual price of oil. The first graph shows the price of Rotterdam Diesel in $/tonne (i.e the actual price of diesel as it is traded on the European Wholesale Markets) over the last 12 months. The diesel data is coupled with the £/$ exchange rate for the same period and shows a clear strengthening of the UK Pound against the $ (i.e. the £ is increasing in value). The second graph shows (in red) how the Rotterdam Diesel price was converted to pence per litre (the basis for UK pump prices) and what we can clearly see here is how the pence per litre diesel price has fallen at a much more significant pace than the actual $ price of diesel.

Even more interesting is our modelled diesel price, based on a hypothetical scenario of the £ falling in value as much as it has risen over the 12 month period (i.e. down 0.17 to $1.34, rather than up 0.17 to $1.69). The result of such a drop in exchange rate value would be 12 pence per litre (ppl) difference between our modelled price and the actual diesel price. OK, so it’s a model and not reality, but the fact remains that an exchange rate drop of 0.17 over 12 months is not historically unusual and was in fact seen as recently as 2009. Nor would such a drop be considered as a major event by the general public and yet would mean diesel pump prices of around £1.50 per litre (when VAT is added). Such a high fuel price would surely put the government under significant pressure to do something about diesel costs – even though as the model illustrates, the high price would have very little to do with diesel prices at all!

So once again beware the experts who tell you which way the oil price is going. Even if they could successfully predict the oil price (which we know they can’t), the likelihood that they could also successfully call the exchange rate is slimmer than England’s chances of ever winning a World Cup. Exchange rates are impacted by a whole host of factors and few (if any) have any linkage or correlation to oil markets. When the Bank of England decides to raise interest rates, if and when the economy stops growing or when competing currencies falter/strengthen are just a few of the factors that drive exchange rates and consequently the price of fuel. Many of these factors are as arbitrary as they are obscure and just like oil markets, the reason that so many financial speculators find exchange rates lucrative is because market movement can be both significant and unpredictable – both ingredients for profitable returns. So when we concluded in the April Oil Market report that wars and weather are the two main drivers of oil prices, we really were only talking about oil prices on a world scale. If you want to look at the consumer end of oil pricing, then add in the impact of exchange rates and here is yet another factor that is largely beyond anyone’s control.

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