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Fundamentals don't support $105 oil

Sam Fletcher
Senior Editor

An unexpected drop in US crude inventories made front-month crude jump $5 to a record closing of $104.52/bbl Mar. 5 on the New York Mercantile Exchange, although many of the industry's biggest participants and closest observers reported no new changes in either supply or demand to justify that fly-up.

Crude prices climbed to new heights in the next trading session, driven not by the ebb or flow of oil but by the flow of money from pension and hedge funds and speculators into energy commodities. The market hit a high of $106.54/bbl Mar. 7 before closing at $105.15/bbl, down 32¢ for the day yet up $3.21/bbl for the week, after the Labor Department reported 63,000 fewer US jobs during February, the biggest drop in 5 years.

The US dollar dropped to a new low against the euro that same day. "The weak dollar should make for a soft landing of demand erosion in non-dollar countries," said Olivier Jakob at Petromatrix, Zug, Switzerland, "but it will not create a demand booster. With record high crude oil and record high gas oil crack as well as high diesel premium, driving in Europe is not getting cheaper."

ExxonMobil Corp. Chief Executive Officer Rex Tillerson said the weak dollar, geopolitical uncertainties, and speculation were equally responsible for the run up in energy prices. Ministers of the Organization of Petroleum Exporting Countries cited essentially the same market forces Mar. 5 in voting to maintain current production levels. They said the deepening credit crisis in financial markets and a potential economic slowdown in the US economy make it likely that world demand for oil will decline in the second quarter.

Jakob said, "OPEC has proven again that the days when it was a market maker are definitely over. The oil market is about financial flows, not oil flows. The only way for OPEC to regain its previous status would be to wake up today's world and start using Futures to hedge its production."

US inventories
The Energy Information Administration said crude inventories fell 3.1 million bbl to 305.4 million bbl in the week ended Feb. 29, vs. Wall Street expectations of a 2.1 million bbl build. US gasoline stocks escalated 1.7 million bbl to 234.3 million bbl in the same period, outstripping financial analysts' consensus of a 500,000 bbl gain. Distillate fuel inventories for the same week decreased by 2.4 million bbl to 117.6 million bbl, vs. consensus of a drop of 1.9 million bbl.

Adam Sieminski, Deutsche Bank's chief energy economist in New York, said, "Price elasticity of demand is finally showing up in the data." He said, "The real price of gasoline in the US is approaching the peak last seen in March 1980. Along with higher natural gas prices, rising electricity bills and soaring expenditures for food, gasoline use in the US is starting to feel the pressure of pinched consumer spending."

Jakob said, "The fundamentals are still miles away from providing a clear justification for the current price level." He noted oil imports into the US "were suffering from fog delays" during the reported period and that 2.4 million bbl of the 3.1 million bbl crude draw occurred in the isolated Petroleum Administration for Defense District (PADD) 5, including the West Coast, Alaska, and Hawaii, "which in normal days would be discounted."

Jakob said, "The argument used to be that oil prices will rise until a top is defined by demand destruction. The [EIA] statistics are now showing US demand for the 4-week average down 1.1 million b/d from last year. Emerging countries running on state subsidies can still have some growth, but it will not translate in much oil demand growth on a worldwide basis. Given some of the fall in US oil demand is coming more from the industrial sector (fuel and 'other' oils), the demand for the main clean products (middle distillates, kerosine, gasoline) is still down 400,000 b/d for the 4-week yearly comparison."

Furthermore, Jakob said, "The dollar might be weak, but buying oil for the dollar trade is getting so amplified that even on a dollar-adjusted basis, oil is [at a] record high, which is of no relief to the nondollar consumer. WTI has gained 21% in 1 month and newcomers on the long side [of the crude futures market] need to believe that further gains are possible. Paradoxically, it is the fact that there is no compelling fundamental story that is making a further rise possible, as then $105/bbl is just a number that could as well be $120/bbl."

(Online Mar. 10, 2008; author's e-mail: samf@ogjonline.com)


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