MARKET WATCHWarmer weather pushes down energy prices

Dec. 27, 2006
Energy prices fell as markets reopened Dec. 26 after the long Christmas holiday. Traders shrugged off geopolitical issues to focus instead on predictions of warm weather that would reduce US demand for fuel.

Sam Fletcher
Senior Writer

HOUSTON, Dec. 27 -- Energy prices fell as markets reopened Dec. 26 after the long Christmas holiday. Traders shrugged off geopolitical issues to focus instead on predictions of warm weather that would reduce US demand for fuel.

"This month is expected to end up being the warmest December on record while initial forecasts for January are calling for continued mild weather," said Robert S. Morris, Banc of America Securities LLC, New York. Because of a strong El Nino weather pattern, the National Oceanic and Atmospheric Administration is calling for warmer-than-normal temperatures for the northern two thirds of the country for the rest of this winter.

UN votes against Iran
The United Nations Security Council finally voted Dec. 22 to impose sanctions against Iran because of that country's refusal to suspend its controversial uranium enrichment program that is suspected to be capable of producing nuclear weapons. The UN resolution orders all countries to stop supplying Iran with materials and technology that could contribute to its nuclear and missile programs.

Iran remained defiant, however, and said it will begin installing 3,000 centrifuges for use in its uranium enrichment program. Meanwhile, Iranian Oil Minister Kazem Vaziri Hamaneh said Dec. 26 that Iran's oil industry and crude exports would not be disrupted by UN sanctions.

"This move, although expected, should be viewed as an escalation in the confrontation between the Islamic Republic and Western nations," said analysts in the Houston office of Raymond James & Associates Inc.

"The resulting document has been watered down significantly at the behest of Russia and China; both have significant economic ties to Iran," said Raymond James analysts. "From an oil market perspective, this resolution does not have any direct impact on Tehran's ability to pump crude oil into the international markets; the sanctions are targeted purely at the country's ability to acquire materials necessary to develop nuclear technology.

"However, this stern decision by the international community highlights the geopolitical risks that continue to haunt the ever-tightening energy markets. Going forward, threats by Iran to pull out of the Nonproliferation Treaty and expel UN nuclear inspectors may further aggravate the current situation and inflate the risk premium in oil prices," they said.

"Iran is the Organization of Oil Exporting Countries' second-largest oil producer (pumping nearly 4 million b/d), and therefore the oil market watches the Iranian nuclear standoff extremely closely. Now diplomacy has moved from the 'carrot' stage into the 'stick' stage," said Raymond James analysts, paraphrasing Winston Churchill's famous remark early in World War II. "Maybe it's not the beginning of the end, but it certainly looks like the end of the beginning."

Nigerian violence
Violence escalated in Nigeria's Niger Delta with reports last week of armed attacks by militants on two oil production facilities. "The largest African crude producer has lost anywhere between 200,000-600,000 b/d in hydrocarbon production in the past year," Raymond James reported. "As a precautionary measure, one oil firm has already started to evacuate dependents of foreign employees from the turbulent region. Nigeria continues to be a stark example of the very real geopolitical risk to oil supply, and one that may not be fully recognized by the commodity markets."

Some 260 people, including women and children, were reported to have died from a pipeline fire Dec. 26 in a suburb of Lagos, Nigeria's major commercial city. An eyewitness said the fire occurred as local residents illegally tapped into a pipeline to steal fuel. A gasoline shortage in Nigeria has boosted that country's black market, where prices have risen more than 300%. A 4 l. can of fuel on the black market reportedly sells for the equivalent of $7.84.

Venezuela production
With the recent reelection of Hugo Chavez as president of Venezuela, oil production from that country should remain below its authorized OPEC quota, said Raymond James analysts.

The loss of more than 30% of Venezuela's former crude production level since 2001 "is one of the worst declines of any major oil producing country," analysts said. "The country's inability to meet its OPEC quota makes the government famously hawkish when it comes to defending an oil price floor for the group. This fact, along with a lack of foreign investment in the Venezuelan energy sector, should be seen as bullish factors for global oil prices."

Raymond James said, "The entire political map of Latin America continues to shift towards left-wing governments with generally antitrade and anti-investment policies. Resource nationalism, although also visible in places like Russia (e.g., Sakhalin-2), is especially prevalent now in Latin America. Venezuela exemplifies this trend, but countries like Bolivia and Ecuador are also becoming less attractive destinations for foreign operators. As a result, oil production from Latin America has been stagnating for years (with the exception of Brazil), and we do not foresee a return to meaningful growth over the intermediate-term."

Iraqi agreement
After months of negotiation, a tentative deal has been signed by the Iraqi federal and the Kurdish governments to split the much needed oil revenues. "The deal has yet to be ratified, but marks a significant step towards the establishment of a credible oil law and hence a viable industry in a war-torn nation," Raymond James analysts reported. Oil revenues constitute over 95% of Iraq's gross domestic product, and many view the potential oil profits as the only way to rebuild the country.

"This new law should be viewed favorably; however, the law will not mean much unless Iraq has the capacity and capability to bring tranquility to the current hostility," analysts said. "This new oil law would not be a cornerstone and is not expected to significantly increase production until a favorable and safe business environment is fostered first. As we have been saying all along, don't bet on an Iraqi oil production increase anytime soon."

Energy prices
The February contract for benchmark US light, sweet crudes dropped $1.31 to $61.10/bbl Dec. 26 on the New York Mercantile Exchange. The March contract lost $1.30 to $62.23/bbl. On the US spot market, West Texas Intermediate at Cushing, Okla., was down by 81¢ to $61.92/bbl. Heating oil for January delivery dropped 5.87¢ to $1.62/gal on NYMEX. Unleaded gasoline for the same month was down by 5.08¢ to $1.57/gal.

The January natural gas contract fell by 52.2¢ to $6.11/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., lost 23¢ to $5.76/MMbtu. "On the natural gas front, prices continue to fall due to forecasts for warmer weather across the US," said Raymond James analysts in Houston. However, they said, "We continue to believe that natural gas prices will reverse towards the end of the year where the year-over-year comparisons become easier, assuming normal weather for the rest of the withdrawal season."

In London, the February IPE contract for North Sea Brent crude lost $1.32 to $61.10/bbl. The January contract for gas oil dropped $18.50 to $519.25/tonne.

The average price for OPEC's basket of 11 benchmark crudes declined by 53¢ to $57.45/bbl on Dec. 26.

Contact Sam Fletcher at [email protected].