by Michael Knox

Both Brent and WTI are rallying for seasonal as well as fundamental reasons.

We do not think that oil is going up only for seasonal reasons. We think oil is going up because the growth of developed economies will proceed at the fastest pace since before 2007. This higher growth in developed economies will generate a higher demand for gasoline.
This will lead refiners to bid up oil prices to provide this gasoline. Our model for Brent tells us that it should rise to $US124 per barrel this year.

Still the pattern of the changes in seasonal demand is very interesting in allowing us to understand why swings in price do happen during the year. Anyone who has been in the US in this winter knows that when snow is around, people prefer not to drive. Later in the year when the snow is gone, people drive around a lot more.



In Chart 1 we see seasonal variation in Brent and in West Texas Intermediate grade (WTI). We have calculated a seasonal index for each of these based on the prices of Brent and the WTI over the 10 year period from January 2004 until December 2013. Based on that data, we calculate an average index level for Brent and WTI for each month during the period. The index levels for Brent can be seen in Table 1. The index levels for WTI can be seen in Table 2.



In winter when the snow is around the price of oil is low. Brent reaches its seasonal low at an index level of 0.922 in December. This means it is 7.8% lower than the annual average at its low at the end of the year. WTI reaches its low by a very small margin by falling from a December level of 0.945 in December to an index level of 0.942 in January. This means that at its low, it is 5.8% lower than the annual average.



After the seasonal low in the December/January period, warming weather generates increased demand for gasoline. By the time spring has arrived in April, the demand for oil has significantly recovered. By April oil prices have risen significantly both for Brent and WTI. The seasonal index for Brent in April rises to 1.04. This is 4% higher than the annual average. This means that Brent rises by an average of 11.8% between the end of December and the end of April. The seasonal index for WTI in April is 1.031. This is 3.1% higher than the annual average. This means that WTI rises by an average of 8.9% between the end of January and the end of April.

After the recovery in April, oil prices then decline slightly in May. Brent declines to a seasonal index of 1.013. WTI declines to seasonal index of 1.015. This is a pause ahead of the final rise during the summer driving season.

The summer driving season peak in demand is slightly earlier for WTI than it is for Brent.

Seasonal demand for WTI peaks in June and July for the seasonal index of 1.055 in June and 1.056 in July. This means at the seasonal peak in July, WTI will have risen for purely seasonal reasons to a level 11.4% higher at the end of July than it was at its seasonal low at the end of January.

The seasonal peak for Brent occurs in July and August. The seasonal high for Brent is in July at an index level of 1.067. This is followed by a slight decline in August to 1.066. At the seasonal peak in July Brent will have risen for purely seasonal reasons to a level 14.5% higher at the end of July than it was at its seasonal low at the end of December.

Conclusion

At the beginning of February, both Brent and WTI are rallying from their seasonal low. This seasonal rally will take both types of oil upwards towards a seasonal peak likely at the end of July.

We do not think this is the only reason oil is going up. Still, it is kind of nice to know that a seasonal rally and a fundamental rally are both happening at the same time.