Divergences in the Energy Patch

Crude oil and energy equities have been on a tear for the last two years. But now we are seeing some divergences between oil prices and other related variables. First, as everyone knows, oil prices have been the main driver of rising bond yields this year. Specifically, the transmission mechanism has been via the inflation risk premium—a component of the term premium. The inflation risk premium has faded by over 30bps in the last couple months.

Second, while oil prices continue to march higher, US Treasury volatility has retreated by about 30bps in the last month.

Lastly, oil prices tend to track commercial crude inventories fairly closely. Inventories have been mostly flat all year while prices have surged. Given the historic relationship between inventories and price, crude should be trading under $80/barrel.