MARKET WATCH: Oil prices continue to tumble as dollar strengthens

Sam Fletcher
OGJ Senior Writer

HOUSTON, May 24 -- The new July contract for US crude continued to tumble May 21, dropping as low as $69/bbl before closing just above $70/bbl in the New York market.

“A strengthening dollar has pushed prices back below the $70 mark despite speculation that China may delay measures to cool its economy,” said analysts in the Houston office of Raymond James & Associates Inc. Positive signs from other economic indicators later this week could “lift some of the macroeconomic pressures on crude,” they said.

Olivier Jakob at Petromatrix, Zug, Switzerland, said, “It was red across all the main stock indices during the week, and China continues to provide the lowest returns on the year with losses mounting now to slightly more than 21%.”

Jakob noted, “Spain announced a €15 billion budget cut under its austerity plan, Germany is expected to announce a €10 billion cut, the UK a £6 billion cut. The economic recovery had been sponsored by public spending (cash for clunkers, etc.), but the gear is now being put in reverse and that will necessarily bring some pressure on growth expectations. With unemployment still not resolved, we should expect to see downward revisions to the oil demand expectations for Europe. The risk is now that the lower European growth starts to dent the growth expectations of the rest of the world (US, Asia).”

Analysts at the Centre for Global Energy Studies, London, said, “A month ago the oil market was in bullish mood, focused on economic recovery and rising Asian oil demand.” Since then, the sentiment has turned bearish, with the market now “fixated” on risks of a double-dip recession. “Oil prices have fallen by 17% over the past 4weeks, with Atlantic Basin benchmarks trading close to $70/bbl,” said CGES analysts.

However, they said, “Both the global economy and the long-term health of the market for oil would benefit from a period of more modest oil prices.”

Natural gas was down in early trading May 24 after posting its fourth consecutive loss May 21, following an increase last week in the number of rigs drilling for gas. The 969 gas rigs drilling in the US last week “are likely to be sufficient to increase domestic natural gas supply,” said Raymond James (OGJ Online, May 21, 2010).

Oil price drivers
Raymond James analysts reported three key issues that seem to be driving short-term oil prices: the US dollar, the broader stock markets, and bloated crude inventories in Cushing, Okla.

“The recent dollar strength appears to be a relatively simple flight to quality,” they said. “Both Europe and Japan have bigger structural imbalances between spending, income, and debt than the US. While these issues may tend to support a stronger dollar for awhile, Washington's own fiscal state of affairs isn't exactly rosy. The Federal Reserve's (and most of the rest of the world's) printing presses should be very busy over the coming years as the budget deficits are monetized.”

Raymond James analysts pointed out, “While relatively recent history (2008 and 2009) would suggest that a downward trend for the dollar will imply rising oil prices, for most of 2010 the two have decoupled. We think this lack of oil-to-dollar correlation will increasingly hold in the future, since the underlying fundamentals of the oil market and the currency market are simply not the same. Over the long run, oil and the dollar are driven by different variables and have no lasting relationship. To be sure, we have a bullish long-term thesis on oil, but this is premised on our view of the oil market's supply-demand fundamentals rather than what we think about foreign exchange rates. In short, we think the dollar will be increasingly less relevant to oil prices.”

However, they said, “The opposite is true for the correlation between oil and Standard and Poor's 500 [index of 500 large US-based stocks]. The recent tight positive correlation between oil and the broader markets is a radical departure from past history. Usually the two are inversely linked. Our sense is that this correlation will be a significant oil price driver as long as the macroeconomic shadow of the ‘Great Recession’ dominates market discourse. This may well be the rest of 2010 and perhaps even longer. It also implies that a continuation of the current broader market pull-back could imply additional declines for oil. Conversely, a market rally should put some upward pressure on oil. In the long run (2-3 years out), the relationship should revert back to its historical norm of being an inverse one. The reality is that higher energy prices are simply not positive for the remainder of the economy, and thus for the broader market.”

The final consideration for short-term oil prices are the surplus inventories at the Cushing oil hub, the analysts said. “There have been three times over the last several years where bloated Cushing oil inventories have driven a short-term (1-3 months) disconnect between West Texas Intermediate and global oil prices. We are currently in one of those price disruption periods. The good news is that these periods tend to be short lived and should lead to a $2-4 rally in WTI relative to [North Sea] Brent in the coming months.”

Energy prices
The new July contract for benchmark US light, sweet crudes dropped 76¢ to $70.04/bbl May 21 on the New York Mercantile Exchange. The August contract declined 29¢ to $71.67/bbl. On the US spot market, WTI at Cushing was down 27¢ to $67.74/bbl. Heating oil for June delivery decreased 0.52¢, but its closing price was essentially unchanged at an average $1.90/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month slipped 0.33¢, also unchanged at $1.96/gal.

The June natural gas contract fell 7.1¢ to $4.04/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., lost 2¢ to $4.12/MMbtu.

In London, the July IPE contract for North Sea Brent crude dropped 16¢ to $71.68/bbl, still at a premium to WTI. Gas oil for June gained $8.50 to $610.25/tonne.

The Organization of Petroleum Exporting Countries offices in Vienna were closed May 24, so no price information was available.

Contact Sam Fletcher at samf@ogjonline.com.

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