Crude prices may be bottoming

Sam Fletcher
Senior Writer

As February opened, crude prices appeared to be "in the early stages of a bottoming process" amid growing speculation that production cuts by the Organization of Petroleum Exporting Countries might finally be catching up to the demand destruction from the international financial crisis.

In New Orleans, analysts at Pritchard Capital Partners LLC said OPEC is "moving forward diligently" with reductions below its 24.8 million b/d target. The 11 participating OPEC members, aside from Iraq, are expected to produce 23.6 million b/d in the 4 weeks ending Feb. 14, down from 23.7 million b/d in the 4 weeks through Jan. 17.

Furthermore, flattening of the forward price curve as the 12-month strip contango narrowed to $11/bbl from $27/bbl was seen by Pritchard Capital Partners as "a clear signal that OPEC production cuts are having an impact on the crude oil market."

During the last week of January, the March contract for benchmark US light, sweet crudes fluctuated between $41.44-45.73/bbl before closing at $41.68/bbl Jan. 30 on the New York Mercantile Exchange. In the first trading session of 2009 on Jan. 2, the March contract closed at $50.21/bbl, while the then front-month February contract was at $46.34/bbl.

At EnVantage Inc., a Houston advisory and energy investment firm, analysts said, "It is highly probable that the March WTI contract will follow the same track as the February contact and go back into the $30/bbl range, but we continue to see WTI prices trading between $35/bbl as a bottom and $50/bbl as a ceiling."

North Sea Brent historically has traded at a 3-5% discount to US benchmark West Texas Intermediate. However, analysts in the Houston office of Raymond James & Associates Inc. reported, "Since the beginning of 2009, this trend has reversed, with Brent oil…trading 10% higher than WTI [on Jan. 30]. We believe this is largely driven by higher than average inventory levels in the US, including at Cushing, Okla., the hub from which WTI is sold. In addition, the current contango forward strip is exacerbating the situation with a contract for WTI delivery in August 2009 trading at $52.07/bbl…thereby encouraging storage. We do not expect this differential to narrow materially as long as US inventories remain high."

The two benchmark crudes were moving "in diverging trends," with the WTI contango widening and the Brent contango narrowing, said Olivier Jakob at Petromatrix, Zug, Switzerland. "But given that the widening of the WTI futures contango is immediately offset by a rise in [US Gulf market] physical cash differentials," he said, "…Brent [is] a better benchmark of the world crude oil supply and demand."

Natural gas outlook
Although Raymond James analysts refrained from trying to predict winter weather Feb. 2 on Groundhog Day, they said, "We do foresee 6 more months, not weeks, of deteriorating natural gas prices."

Pritchard Capital Partners said, "Natural gas prices have declined sharply to multi-year lows as demand destruction appears to be outpacing any slowdown in domestic supply growth." However, with the US land rig count down 28% over the last 5 months, they expect declining demand and reduced drilling activity to result in a supply-demand balance by mid-year.

Raymond James analysts expect a 60% drop in the US rig count this year, compared with a 40% decline predicted just 2 months ago. The bigger reduction will include a 65% roll-back in the number of rigs drilling for gas and a 50% cut in the number drilling for oil.

However, they said US production likely will not fall "as fast or as far" as the rig count.

"Producers will stop drilling their least productive, least economic wells first," Raymond James analysts observed. "When we account for the highly productive shale wells and consider that horizontally drilled wells (the most productive) are being dropped from drilling programs at a much slower rate, we find that gas production will probably not fall as fast or as far as the rig count (in percentage terms)."

Meanwhile, they said, "We do not think a 60% decline in the rig count is priced into the stocks for North American gas-driven companies. Likewise, we still do not believe the magnitude of the gas markets supply and demand problem is priced into US natural gas prices. While we think a late 2009 gas price and stock price rally may still be in the cards, asset utilization rates and North American service company earnings should be down year over year in both 2009 and 2010."

(Online Feb. 2, 2009; author's e-mail: samf@ogjonline.com)

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