London, 19 August 2011: Reuters

Oil prices have behaved very differently this year depending on whether the market has been focused on the narrow dynamics of supply and demand or the broader macroeconomic picture. The research team at Barclays Capital has taken the lead in this area, arguing commodity market participants risk "being fooled by the gloomy macroeconomic environment and overlooking the bigger picture of a market that remains fundamentally well supported ("Commodities Weekly", Aug 5).

The point has been echoed by analysts at JP Morgan who have warned "current market turmoil distracts from supportive market fundamentals" (Oil Markets Weekly", Aug 11).

In contrast to both research teams, I am not convinced it makes sense to separate the "micro" fundamentals of oil supply, demand, stocks and capacity from the broader "macro" economic outlook. Oil is fundamentally a macroeconomic variable, and the state of the economy is a major driver of oil prices. The two are inseparable and it makes no sense to analyse or forecast them separately.

But whether or not the distinction makes sense, it is clear oil prices have behaved very differently on days when the market has focused more on the micro oil picture rather than broader macro concerns.

Table 1

Table 2

Table 1 analyses daily price movements for the front-month Brent and WTI futures contracts since the start of 2011 depending on whether the day saw the release of significant oil market numbers or major macroeconomic data. For significant oil numbers, I have focused on the release of the U.S. Energy Information Administration's ( EIA) "Weekly Petroleum Status Report" (WPSR) since it is the most timely, widely watched and traded data on the current state of the oil market.

For significant macro numbers, I have selected releases concerned with growth in the United States (GDP and ISM manufacturing), the euro zone and China (flash PMIs) -- as well as U.S. inflation (CPI and PPI) and employment (nonfarm payrolls).

The choice is inevitably somewhat arbitrary but these are the most eagerly anticipated and traded numbers that frame the broader market narrative about growth and inflation risks in the advanced economies. On balance, macroeconomic data releases seem to have been mildly bearish for prices. Brent and WTI were basically flat on days when macroeconomic data were released, compared with small gains on average on other days. The effect is relatively small, however, and hard to distinguish from random noise.

In contrast, the release of the EIA's weekly statistics have been markedly bullish. The effect has been more pronounced in Brent than WTI, which is odd, since the data are only directly relevant to the U.S. market.

But many participants treat the EIA data as a proxy for global supply and demand conditions, and use Brent rather than WTI to express their view on global rather than U.S. markets given the well known problems with the WTI contract.

Table 2 reproduces the analysis but excludes the abnormal price move during the flash crash on May 5 as a robustness check. The results are the same. On days when no major macro data is released, the market has tended to do better than on days with major releases, but the bullish bias is entirely due to EIA data. Once those are excluded, the market has traded flat, worse than average.

The market's focus on the weekly EIA numbers is arguably misplaced and increasingly anachronistic. The United States is still one of the world's largest oil consumers and producers, but its share of consumption is shrinking, and trends in North America are unrepresentative of other regions.

The focus on the EIA numbers reflects data availability bias rather than a fundamental basis. Nevertheless, the market trades the EIA numbers "as if" they were a proxy for the global balance and has clearly seen in them far more reason to be bullish than in the economic picture.

Observers who have complained about the market's schizophrenia -- frenziedly switching from macro risk aversion to micro fundamentals and back again -- are right. The market really has been trading two separate narratives since the start of the year, and the divergence has become increasingly marked in the last four months as the economic outlook has darkened.

Whether such a divided outlook is sustainable remains an open question. Bullish forecasters have cited economic decoupling by emerging markets and the increasing cost of production and social spending needs of the leading petroleum exporters to explain why prices will remain well supported even if there is a slowdown in global activity, or even a mild recession.

That proposition is open to challenge on a variety of grounds. It will face an early test if the macro data continue to show deteriorating performance in the advanced economies. In the meantime, the market appears content.

Ends --

By John Kemp, Reuters market analyst – for Commodities Now.

The views expressed here are his own.