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Demand erosion worries markets

Sam Fletcher
Senior Writer

Crude futures prices fell Oct. 13-14 as traders tried to ward off the spectre of demand erosion yet finished the week up by more than 1% at $62.63/bbl on the New York Mercantile Exchange.

The US Energy Information Administration and Paris-based International Energy Agency cited consumers' aversion to high fuel prices as both reduced their outlooks for oil demand growth in 2005 (OGJ Online, Oct. 13, 2005). However, both claimed the decline will be temporary, with increases in US and global demand growth in 2006.

US crude inventories increased by 1 million bbl to 306.4 million bbl in the week ended Oct. 7, while gasoline stocks fell by 2.7 million bbl to 192.8 million bbl. Distillate fuel inventories dropped by 3.4 million bbl to 124.6 million bbl in that same period (OGJ Online, Oct. 13, 2005). "Even though crude inventories rose less than expected and product inventories declined more than consensus [among Wall Street analysts], the continued slowdown in demand—gasoline demand fell 2.4% for the trailing 4-week period compared to 1 year ago—gained the upper hand in weighing on oil prices," said Robert S. Morris, Banc of America Securities LLC, New York.

Other indicators
US automobile dealers reported sharp declines in September sales of less-economical SUVs, which some see as another sign of consumer unease over energy prices. But SUV sales were strong in July and August on dealer discounts. Moreover, the Department of Energy's newly released fuel economy guide for 2006 lists the Dodge Ram 1500 pickup as the least efficient of all at 9 mpg in city driving. Yet Dodge was reported to have sold more Ram pickups in September than any month since 1999. "It is a bit disingenuous to infer a major change in gasoline demand on the basis of a single month's [vehicle] sales figures," said Paul Horsnell of Barclays Capital Inc., London.

Although demand data warrant careful attention, said analysts at Friedman, Billings, Ramsey & Co. Inc., Arlington, Va., they cautioned "against extrapolating too much from it given that September historically has been one of the weakest periods for [energy] demand and, this year, was impacted by two large Gulf storms."

With refineries still shut down by hurricane damage and demand due a seasonal increase in the fourth quarter, "refining margins should stay high through at least 2006," they said.

Horsnell said, "With some consultants and analysts building up cases based on relatively small implied demand percentage changes, the user needs to be aware that the standard errors on those estimates are large. The market is tending to concentrate on the implied demand numbers to the exclusion of everything else, and . . . that approach will miss the true size of the supply gaps that have opened up."

Natural gas
The November natural gas contract was volatile in trading but trended up from $12.98/MMbtu Oct. 11 to reach $13.22/MMbtu Oct. 14. During the week, UBS Securities LLC, New York, increased its average composite spot natural gas price forecast to $8.60/MMbtu from $8/MMbtu in 2005, to $9.50/MMbtu from $8/MMbtu in 2006, and to $9/MMbtu from $7.75/MMbtu in 2007 because of hurricane damage to gulf infrastructure and production.

A larger-than-expected injection of 58 bcf of natural gas into US underground storage in the week ended Oct. 7 "was more likely due to the resumption of production in state waters and onshore in the Gulf Coast, both of which are not included in the Minerals Management Service's estimate of shut-in volumes, as opposed to any real increase in 'backed-out' demand," said Morris. "Otherwise, natural gas customers are facing a nearly 50%, or more, increase in their heating bills this winter."

Ronald J. Barone, a managing director of equity research with UBS, said: "The American Gas Association expects a 50% increase in heating bills this winter season; others foresee spikes of 100% to 200% based on previous spikes during peak winter days. If this is the case, many experts predict that even slight conservation efforts on the part of consumers could create enough demand destruction to heavily offset the supply shortfalls. A modest conservation of 5%, for example, would reduce normal demand by 500 bcf over the course of the winter season."

In addition to the physical damage inflicted on Gulf Coast operations by the two hurricanes, Barone said, "We expect a longer-term impact with respect to industry staffing levels given the already tight labor market. There are doubts about whether some oil and gas workers will return to Louisiana, which could push up labor costs further."

(Online Oct. 17, 2005; author's e-mail: samf@ogjonline.com)



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