MARKET WATCH: Energy prices rebound as Fed cuts rates

Sam Fletcher
Senior Writer

HOUSTON, Oct. 30 -- Energy prices rebounded Oct. 29, with crude surging in the highest 1-day percentage gain since June, as the Federal Open Market Committee lowered its target for overnight interest rates by a half point to 1%.

"Oil's rise was mainly the result of the US dollar's biggest 1-day fall in 23 years on news that the Fed cut the fund rate," said analysts in the Houston office of Raymond James & Associates Inc. "Oil and gas both posted solid gains yesterday of 7.6% and 4.6%, respectively, and energy stocks followed suit. While the Dow ended the day 74 points in the red, the S&P E&P 1500 Index ended up 5.3% and the Oil Service Index up 7.2%," they said.

FOMC members said they lowered the interest rate because "the pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping the prospects for US exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

Committee members expect inflation to moderate in coming quarters "to levels consistent with price stability." They said coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should in time help improve credit conditions and promote moderate economic growth.

A government report that US gasoline supplies declined for the first time in 5 weeks also helped boost energy prices. The Energy Information Administration said commercial US crude inventories increased 500,000 bbl to 311.9 million bbl in the week ended Oct. 24. Gasoline stocks for the same period fell 1.5 million bbl to 195 million bbl, while distillate fuel inventories climbed 2.3 million bbl to 126.6 million bbl (OGJ Online, Oct. 29, 2008).

OPEC and the market
At Barclays Capital Inc. in London, analyst Paul Horsnell said the market has been slow to recognize "precisely what happened" at the Oct. 24 OPEC meeting in Vienna. "Among other things, Saudi Arabia has, in effect, signaled an intention to head back towards 8.5 million b/d [production] and to unwind all of the past 20 months of steady output increases," he said. "OPEC did not just produce a consensus-sized cut with the promise of more to come; it made a first cut that appears to be greater than is strictly necessary."

OPEC's proposed reduction of 1.5 million b/d effective Nov. 1 "would, allowing for Iraq and Indonesia, take total OPEC crude output to about 30.5 million b/d." Horsnell said, "That is 2 million b/d less than current output. It is also 700,000 b/d less than the latest OPEC Secretariat forecast of the call on OPEC crude across 2009; 400,000 b/d less than the International Energy Agency's forecast of the call [on OPEC production]; and 1.5 million b/d less than the US Department of Energy forecast."

He added, "It is 1.9 million b/d less than the Barclays Capital forecast of the call on OPEC crude, as we expect non-OPEC supply to shock to the downside next year. There is then some slack built into the decision, in that it would still represent a significant market tightening after any further large downgrades in demand expectations, even if non-OPEC…performed as well as what we see as rather overblown consensus expectations. Throw in Russian supply as an additional wild card (in that it may well undershoot current projections even if Russia does not ultimately decide to pursue its current increasingly proactive alignment of objectives with OPEC members), and we remain convinced that the oil market is likely to be over-tightened."

Olivier Jakob at Petromatrix, Zug, Switzerland, said, "Our read of the OPEC meeting was that it was 'an attempt of a soft landing to force some non-OPEC support (Russia? Brazil?) at the next OPEC meeting.'" He said, "For Russia to participate as a nation has probably some legal inconvenience, but yesterday a vice-president of OAO Lukoil made a surprise statement that Russian private companies could attend the next OPEC meeting. This was followed by a Reuters [news service] analysis that export of Russian crude oil would be cut in November by at least 240,000 b/d from the initial plan. The lower Russian exports are due to the export tax being too high compared to the market price; the problem, however, is that the government needs the tax revenue to fight the credit crunch, and $50/bbl oil will not allow this."

Jakob noted the "many implications" of the credit crisis. "For now the market has mainly focused on the demand destruction side of it as the visible data available today is on that side." However, he said, "The combination of low oil prices and no credit is also having a great impact on the supply side. Organization for Economic Cooperation and Development countries have not been very [vocal] about OPEC cutting production because they also realize that too low a price will be the creation of a much greater supply problem 6 months down the road, and the political bullets need to be kept to prevent crude oil from rising above $100/bbl rather than to push it below $50/bbl."

In its latest review, Lloyds TSB Corporate Markets, a division within the UK-based Lloyds TSB Group, noted oil prices are now at year-ago levels, "wiping out the speculative bubble." Nichola James, Lloyds TSB Corporate Markets' senior economist, said crude prices are now closer to levels justified by economic fundamentals and will be priced at $80-100/bbl in the medium term. "Although global growth will slow, industrial and infrastructure development in emerging markets will underpin demand for oil and other commodities," he said. Meanwhile, non-OPEC production has been revised downwards, principally because of lower supply from the former Soviet Union, Latin America, and Asia (excluding China).

In addition, a pending report from IEA says output from the world's oil fields is declining much faster than previously thought. "That means that the oil industry will need to invest more than expected," James said. Yet he said, despite new investment, oil and gas production in the UK has declined in 7 of the last 8 years, down by 1.7% in 2007.

James said, "Global oil and gas companies have enjoyed record profits on the back of high prices in recent years, but the industry faces some difficulty going forward as production in old fields peaks and competition for untapped energy deposits intensifies. Lower output from maturing fields suggests that capital spending will need to continue rising as exploration and new field development holds the key to future sector growth."

Energy prices
Trading for the December contract for benchmark US sweet, light crudes was volatile at $63.65-69.24/bbl Oct. 29 on the New York Mercantile Exchange (NYMEX) before it closed at $67.50/bbl, up $4.77 for the day. The January contract gained $4.78 to $67.99/bbl. On the US spot market, West Texas Intermediate at Cushing, Okla., increased to $68.70/bbl from a corrected $62.73/bbl in the prior session. Heating oil for November delivery was up 8.9¢ to $2/gal on NYMEX. The November contract for reformulated blend stock for oxygenate blending (RBOB) climbed 7.75¢ to $1.53/gal.

Natural gas for the same month jumped 28.3¢ to $6.47/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., escalated 14.5¢ to $6.57/MMbtu. EIA reported the injection of 46 bcf of natural gas into US underground storage during the week ended Oct. 24. That put the inventory of working gas in storage at 3. 4 tcf. That's 97 bcf less than in the same period a year ago but 97 bcf above the 5-year average.

In London, the December IPE contract for North Sea Brent crude gained $5.18 to $65.47/bbl. The November gas oil contract jumped $35.75 to $657.75/tonne.

The average price for OPEC's basket of 13 reference crudes increased $2.23 to $58.13/bbl Oct. 29.

Contact Sam Fletcher at samf@ogjonline.com.

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