MARKET WATCH
Crude prices tumble as warm winter continues

Sam Fletcher
Senior Writer

HOUSTON, Jan. 5 -- Energy prices continued to tumble Jan. 4, pushed down by warm winter weather, with the front-month crude futures contract plummeting 9% to near 18-month lows in the first two trading sessions of 2007 on the New York market.

"We have to go back to early December 2004 to find a 2-day loss that was greater than the loss of this week. The sharp correction has not been limited to oil or energy but has been a widespread commodity move," said Olivier Jakob, managing director of Petromatrix GMBH, Zug, Switzerland.

"El Niño is taking a toll on the energy complex as it brings a warm northern hemisphere winter. We believe this fact has already been reflected in natural gas markets and is now showing up in oil," said Adam Sieminski of Deutsche Bank AG, New York. "Although the oil price could have further downside, we believe the drop so far combined with dollar weakness will prompt the Organization of Petroleum Exporting Countries into further action to defend the oil price which, in an environment of still robust world growth, we believe will eventually push the oil price back up above $60/bbl in 2007," Sieminski said.

Demand elasticity estimates from the US Energy Information Administration indicate a 10% warmer winter in the US this year that would require a 17% drop in gas prices and 21% drop in oil prices to balance out demand losses.

"At $6.16/MMbtu, natural gas is already down over 20% from its $8[/MMbtu] November average price. At $55.50/bbl, oil prices are down about 11% from the December average of $62/bbl. With OPEC already cutting output and poised to cut more, we believe that oil prices are not likely to rest at the $50/bbl level implied by the elasticity model, even if prices do 'test' that level," Sieminski said.

Moreover, he said, when adjusted for the rise in the value of the euro against the US dollar, a $55/bbl price for benchmark US crude is the equivalent of just $42/bbl for that crude and $38/bbl for the OPEC basket. That fact is "not lost on the OPEC ministers," who paid for their oil in dollars while trading with Europe in euros, Sieminski noted.

"Warmer-than-normal weather across the US has helped keep inventories of heating oil at healthy levels this season. Also, predictions of a slowing US economy in 2007 could curb the demand for oil in the world's largest consumer of crude and its products," said analysts in the Houston office of Raymond James & Associates Inc. Fears that non-OPEC supply coming online will drown the energy markets with crude in 2007 are another factor undercutting crude prices, they said.

On the other hand, they said, "The previously announced OPEC cut of 1.2 million b/d is still being implemented; we expect to see a curtailment in production when December numbers are reported. A second OPEC cut is lined up for February, which should further sweep more crude off the international markets. We believe OPEC is determined and has the resolve to further decrease output defending its $60/bbl benchmark.

"Furthermore, the bloated crude inventories in the US have evaporated and the double-digit surplus beyond 5-year highs has dissipated in just a few weeks. Another factor is the lack of comfortable OPEC excess capacity that might be insufficient to fill the void in the event of a supply disruption."

Even if the US economy slows in 2007, rising economic activity in Europe and Asia may easily make up for the lost US demand, Raymond James analysts said. "Finally, the real and existing threat of geopolitical wildcards such as Iran, Iraq, Nigeria, and Venezuela continue to hang over the oil markets, and they most likely won't disappear anytime soon," they said. "Clearly there are more fundamental and concrete reasons to support the bulls over the bears."

Energy prices
On Jan. 4, the February contract for benchmark US light, sweet crudes dropped $2.73—the same amount as its Jan. 3 loss—to $55.59/bbl on the New York Mercantile Exchange. The March contract lost $2.77 to $56.64/bbl. That market was closed Jan. 1 for the New Year's holiday and Jan. 2 in a day of mourning for former President Gerald Ford.

Heating oil for February delivery fell 4.5¢ to $1.54/gal on NYMEX. The February contract for reformulated blendstock for oxygenate blending, which replaced the previous unleaded reformulated gasoline futures contract on NYMEX, dropped 6.19¢ to $1.49/gal.

The February gas contract slipped by 0.1¢ to $6.16/MMbtu on NYMEX. On the US spot market, however, gas at Henry Hub, La., gained 10.5¢ to $5.62/MMbtu. On Jan. 5, EIA reported the withdrawal of 47 bcf of gas from US underground storage in the week ended Dec. 29. That was below the consensus of Wall Street analysts and compared with withdrawals of 46 bcf the previous week and 1 bcf during the same period the previous year. US gas storage is now slightly above 3 tcf, 433 bcf more than last year's levels and 408 bcf above the 5-year average.

"On the natural gas front, weather remains the name of the game," said Raymond James analysts. In a recent report by the National Oceanic & Atmospheric Administration, forecasts for above-normal temperatures across the US subsided, with colder-than-normal temperatures making their way across the North and Midwest. "Any signs that this front may extend to the Northeast will prove bullish and serve as a catalyst for natural gas prices," said Raymond James officials.

In London, the February IPE contract for North Sea Brent crude fell by $2.85 to $55.11/bbl. The January contract for gas oil lost $7.25 to $494.50/tonne.

The average price for OPEC's basket of 11 benchmark crudes dropped 16¢ to $53.23/bbl on Jan. 4.

Contact Sam Fletcher at samf@ogjonline.com.

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