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Higher prices threaten demand

Sam Fletcher
Senior Writer

Demand for crude may fall if prices exceed $80/bbl, said analysts in the Houston office of Raymond James & Associates Inc.

"At almost $70/bbl, oil is currently trading at the same level that it was following the spike caused by Hurricanes Katrina and Rita in 2005," Raymond James analysts reported June 22. Market fundamentals remain strong with dwindling excess production capacity of the Organization of Petroleum Exporting Countries, limited growth in non-OPEC supplies, geopolitical risks, and "the thirst of a relatively strong world economy," they said. "At this point, our main fear for oil is whether prices climb high enough to stir 'demand destruction' concerns. We believe that a price north of $80/bbl is when such fears likely become justified," Raymond James analysts said.

As labor unions in Nigeria rejected government offers to avert a nationwide strike, the July contract for benchmark US light, sweet crudes traded as high as $69.56/bbl before closing at $69.10/bbl June 19, the highest front-month finish on the New York Mercantile Exchange since Sept. 1. That contract expired June 20 at $68.19/bbl June 20 as traders switched their focus to an unexpected jump in US crude inventories to a 9-year high. The new front-month August crude contract dropped 21¢ to $68.65/bbl June 21 on NYMEX with Nigeria's oil exports still not affected by a strike that paralyzed most of that country's economy.

Attacks on oil field facilities and workers had already reduced Nigeria's production in May to its lowest level since early 2003, said the Paris-based International Energy Agency. Shut-in production averaged 800,000 b/d that month. IEA estimated Nigerian production capacity at 2.49 million b/d, excluding 545,000 b/d considered as long-term shut-in.

US inventories
US crude stocks jumped by 6.9 million bbl to 349.3 million bbl in the week ended June 15 against expectations of a 100,000 bbl draw. US gasoline stocks gained 1.8 million bbl to 203.3 million bbl, still well below average for the time of year. Distillate fuel inventories inched up 100,000 bbl to 122.7 million bbl.

US refined product output declined by 150,000 b/d as gasoline production held flat and all other product rates declined modestly. "The industry average utilization rate, surprisingly, fell from 89.2% to 87.6%, suggesting that the industry continues to contend with downtime issues," said Eitan Bernstein of Friedman, Billings, Ramsey & Co. Inc., Arlington, Va. Product imports rose by 135,000 b/d with a 125,000 b/d increase in gasoline imports.

Crude imports into the US Gulf Coast were "the largest number ever recorded" despite lower Mexican production, said Olivier Jakob, managing director of Petromatrix GMBH, Zug, Switzerland. "Crude oil stocks in the US are as high as they can be, and there has been in the first half of 2007 no evidence of reduced flows to the US despite the OPEC cuts," Jakob said. "US crude oil stocks should come down with coming higher refinery utilization rate, but the draw is needed as we are basically at peaks of recent known tank space capacity."

Paul Horsnell at Barclays Capital Inc., London, said Gulf Coast imports surged because the economics of holding floating storage in the US Gulf of Mexico collapsed. Due to the narrowing of time spreads [the selling of a nearby option and buying of a more deferred option with the same strike price specified in the contract] for benchmark US crudes, he said, "Cash-and-carry arbitrage, (i.e., buy now, sell later, lock in the prices, and store the oil), is becoming far less attractive." That means that crude held in floating storage off the US—"and there may have been as much as 20 million bbl of it," Horsnell said—must empty into either US gulf or Caribbean facilities.

"Indeed, some of the dynamics of the latest weekly US data suggest that the oil is now finding its way into the data. The most suggestive data points are the 1.4 million b/d rise in crude imports into the US gulf (while imports fell by 700,000 b/d in the rest of the US), and the 6.6 million bbl build in Gulf Coast inventories, accounting for virtually all the overall 6.7 million bbl build. Crude oil imports into the US gulf ran at 7.148 million b/d, the highest ever single week's import level. Having the highest-ever imports into the Gulf Coast at the same time as low imports elsewhere in the US, at a time of high refinery outages, does seem to very strongly suggest that some of that floating storage is now making its way into the numbers," said Horsnell.

(Online June 25, 2007; author's e-mail: samf@ogjonline.com)



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