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US inventory comfort zone questioned

Sam Fletcher
Senior Writer

The Energy Information Administration claimed commercial US crude inventories on Mar. 24 were at the highest level since Apr. 16, 1999, but Petromatrix GMBH in Zug, Switzerland, said that is misleading because US production and refining capacities have changed in the last 7 years.

EIA reported Mar. 29 US commercial crude inventories increased by 2.1 million bbl to 340.7 million bbl in the week ended Mar. 24 vs. a 1.3 million bbl drop the previous week. US crude stocks remained well above the upper end of the average range for that time of year.

But US crude production is lower by 1 million b/d than it was in 1999, while US refining capacity is 1.2 million b/d greater, said Petromatrix analysts in a Mar. 14 report. "Having to run on imports rather than the continuous flow of local produced crude oil requires higher stocks for logistics. Counting the import cushion at 20 days, the refineries would need today 20 million bbl more crude oil stocks than in 1999 to replace the lost local crude oil production," they said.

Additional refining capacity requires more crude inventory to provide a comparable extra cushion of 24 million bbl of crude relative to 1999. "Hence, instead of being in the same comfort zone as in 1999, the US would be between 40-50 million bbl lower," the analysts said. That, they said, justifies "the higher flat price and the higher premium given to disruption factors."

US gasoline inventories dropped by 5.4 million bbl to 216.2 million bbl in the week ended Mar. 24, and distillate fuel stocks fell 2.5 million bbl to 124.2 million bbl with most of that decline in heating oil. US imports of crude increased by 769,000 b/d to 10.1 million b/d in the same period. Input of crude into US refineries also increased, up by 85,000 b/d to 14.7 million b/d, with refineries operating at 87% of capacity. Gasoline production increased to 8.3 million b/d, while distillate fuel production decreased to 3.6 million b/d.

That is "was very bullish for the refiners, with a large 515,000 b/d (5%) increase in gasoline consumption leading to a 6.2 million bbl decline in total inventories," said Jacques Rousseau at Friedman, Billings, Ramsey & Co. Inc., Arlington, Va. "Gasoline consumption during the past 4 weeks has been 1.1% above comparable prior-year levels, on average, suggesting positive momentum ahead of the summer driving season.

"Total imports fell by 30,000 b/d (2%) from [the previous] week. At 1.8 million b/d, import levels remain high by historical standards but are substantially lower than the 2.1 million b/d year-to-date average."

After spending some weeks in a holding pattern of $60-62/bbl, the May crude contract shot up to $66.07/bbl Mar. 28 on the New York Mercantile Exchange among escalating concerns about possible supply disruptions.

Crude futures prices were in contango, with prices progressively higher for each succeeding delivery months up to $69.10/bbl for January 2007. A persistent feature in the gold, corn, and wheat futures markets for the past 2 years, the price pattern moved into the crude futures market in 2005.

It's "a bearish development as it typically reflects a market where inventories have risen as a share of overall consumption," said Deutsche Bank AG analysts. "A consumer of a commodity that is in abundant supply attaches a low premium or convenience yield towards the physical ownership of that commodity. This convenience yield is therefore insufficient to offset interest rate and storage costs and consequently the futures curve is upward sloping. Conversely, where a commodity is in short supply a consumer attaches a high convenience yield to the physical ownership of that commodity," the analysts said. "As soon as this convenience yield exceeds the interest rate and storage costs for the commodity the term structure will flip from contango to backwardation," with prices progressively lower in the distant delivery months.

That's why term structures in energy markets, where inventories previously were scarce, have historically been in backwardation. Since 2004, however, oil inventories among members of the Organization for Economic Cooperation and Development have risen rapidly. "This has lowered the convenience yield, or the benefit accruing to a consumer from the physical ownership of crude oil, to such as point that interest rate and storage costs now exceed the convenience yield and helped to push the term structure into contango. Aside from this physical effect on the term structure, the increasing amount of money tracking commodity indices is also likely to be affecting the term structure from a financial perspective," the Deutsche Bank analysts said.

(Online Apr. 3, 2005; author's e-mail:

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