High prices despite 'oversupply'

Sam Fletcher
OGJ Senior Writer

The crude price slumped as the New York Mercantile Exchange reopened Apr. 18 with Saudi Arabia Oil Minister Ali I. Al-Naimi claiming the global oil market is oversupplied. Saudi production fell by 800,000 bbl in March, “coinciding with a fall in demand from Japan after last month's devastating earthquake,” said analysts in the Houston office of Raymond James & Associates Inc.

On Apr. 15, the May contract for benchmark US light, sweet crudes climbed as high as $110.10/bbl in intraday trading before closing at $109.66/bbl, up $1.55 for the day as revolution continued to disrupt Libya’s oil production.

In London, analysts at the Centre for Global Energy Studies (CGES), observed, “Oil prices are rising to levels that are beginning to affect demand; yet the world is being told once again that markets remain ‘well-supplied’ with crude and that the upward march of prices does ‘not reflect the realities of supply and demand.’”

Members of the Organization of Petroleum Exporting Countries have not replaced oil production lost to the conflict in Libya, creating a 1 million b/d shortage last month. CGES analysts emphasized, “Oil demand cannot continue to grow over time without the supply to satisfy it. If OPEC will not raise output, then demand growth will eventually have to fall, and that will only be brought about by oil prices rising to levels high enough to begin destroying demand—exactly as happened in 2008. While the balance of fundamental factors driving oil prices upwards may differ from those in 2008, their net effect may be horribly similar.”

No demand reduction
High oil prices have yet to trigger a major reduction in oil demand and prices either in or out of the show any considerable impact on oil demand, either in or out of the Organization for Economic Cooperation and Development. Within the OECD, “especially in the US, $4/gal gasoline does represent a psychological barrier, and in the past has been associated with a significant compression in demand,” said Amrita Sen, assistant vice-president of commodities research at Barclays Capital.

“In the current backdrop,” Sen said, “the threshold for a substantial price-driven demand reaction seems to have been pushed higher somewhat. Compared to the previous cycle, the demand reaction to pushing through $3/gal US gasoline has not been replicated this time around, even with prices nearing $4/gal in many states. In fact, gasoline demand in the US has stayed around 9 million b/d and is running higher year-over-year by 1.3% in the year-to-date.

“Moreover,” Sen said, “current oil demand boasts of significantly altered global income and price elasticities. In particular, permanent changes in transportation behavior have tended to be more gradual. In terms of market impact, not only has the response of OECD demand been only one fifth of its post-1979 response in absolute quantity terms, the ability of non-OECD demand to compensate for OECD weakness is dramatically greater now than it was 30 years ago. In that context, the price levels at which global oil demand is choked off have not been truly tested yet.”

CGES analysts noted, “Oil market fundamentals have been tightening since the middle of 2010. Inventories have been declining since the end of the first quarter in 2010, falling at a rate of more than 1.4 million b/d during the second half of the year.

Although energy ministers and some investment banks claim prices were driven up by speculation, CGES disputed that cause. While speculative long positions may have set new records, the CGES’ index of speculative intensity—which measures the volume of ‘pure’ speculative activity that is not offsetting opposite positions taken by “hedgers”—is close to its lowest point since the beginning of 2007, they said.

Disruptions in the Middle East and North Africa “may take a turn for the worse providing further supply outages,” Sen said. “It is premature to weigh in on either side of those risks as the determining factor in the coming weeks.”

(Online Apr. 18, 2011; author’s e-mail: samf@ogjonline.com)

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