OGJ Senior Writer
HOUSTON, Apr. 19 -- Energy prices fell Apr. 18 when for the first time ever the Standard and Poor’s credit rating service issued a negative long-term sovereign debt rating outlook for the US, citing increased worry whether the government can handle more than $14 trillion in outstanding debt plus a spending budget larger than its income.
Although they didn’t actually cut the country's top AAA credit rating, S&P officials said the government “might not fully offset” intense credit risks “over the next 2 years.” Some analysts speculated this unusual action might build a fire under Congress and President Barack Obama’s administration to get serious about reducing debt and spending rather than continue raising the debt limit.
A drop in the US government’s credit rating would be a disaster for the US treasury, which would be forced to jack up interest rates to attract investors when it tries to sell new debt or roll over short-term credit. Moreover, investment funds prohibited from holding investments below the top AAA rating would immediately have to dispose of government bonds, driving rates even higher.
It also would have repercussions on the US economy and its currency. The value of the US dollar dropped sharply against the euro and the yen Apr. 18 as investors quickly began selling US debt. Equity and commodity markets also posted losses, while gold and silver prices escalated.
In short, the US was treated by investors as some “basket-case banana republic with a terrible balance sheet and a dysfunctional political system,” said analysts in the Houston office of Raymond James & Associates Inc. In the New York market, they said, “Crude fell 2.3% on the news, as well as reports of reduced production from Saudi Arabia due to a lack of demand. Natural gas dropped 1.6% on forecasts for warmer weather in the eastern US. Weakness across the board weighed on energy stocks.” They reported the crude price was still dropping in early trading Apr. 19 while natural gas and the broader equity market were roughly flat.
Marc Ground at Standard New York Securities Inc., the Standard Bank Group, reported, “The announcement has shaken financial markets’ confidence in the US economic recovery and sent the dollar reeling. Lingering fears that the Eurozone debt crisis is worsening and threatens the nascent economic recovery in that region is also adding to the less optimistic outlook. Meanwhile, ongoing concerns over the impact from further Chinese monetary tightening are also weighing on sentiment.”
Oil prices fell “as a darkening economic outlook raised concerns over reduced demand,” said Ground on Apr. 19. “West Texas Intermediate after ending the previous week above $109/bbl has traded below $106/bbl, with a similar move in Brent, which has moved below the $120/bbl mark.”
On the other hand, he said, “We find that Chinese monetary tightening measures have a fairly benign impact on oil prices. Currency devaluation and increasing reserve requirements appear to have no discernable impact. Although credit rationing and higher interest rates seem to have some effect, they are relatively minor when compared to their impact on other commodities, especially the base metals.”
Ground predicted, “Barring any significant developments in the Libyan situation, we expect oil prices to be dominated by the gloomy sentiment regarding the global economy. Equities and the dollar should provide a keen barometer of this sentiment, and consequently we expect crude prices to track these markets. With Asian markets having closed [overnight] in the red, and equity futures pointing to another day of losses on US stocks, the potential for upside in oil prices today [Apr. 19] looks bleak.”
Olivier Jakob at Petromatrix in Zug, Switzerland, said Apr. 18 trading “started with more noise about the likelihood of a debt restructuring in Greece, which by now seems to be inevitable, the 2-year yields on Greek [debt] starting to touch 20%; but that was easily overtaken by the news of S&P starting to downgrade the US outlook to negative.” Prices for crude and for corporate stocks listed on the S&P 500 index “started moving lower, highlighting again the lack of diversification between those two asset class.”
Jakob said, “The S&P downgrade could make the case harder to defend for QE3,” the third phase of the US Federal Reserve System’s “quantitative easing” program to stimulate the economy. He said, “A significant amount of speculative length has come into crude oil on the QE theme, and if convictions start to increase that QE3 will not be able to fly [with investors unwilling to buy Treasury bonds], then we should expect that some of the speculative positions in crude oil will be reduced. Once the weekly statistics are digested, the oil markets are likely to start positioning themselves for the Federal Open Market Committee (FOMC) meeting of next week.”
With markets to be closed Apr. 22 for Good Friday, Jakob said, “There will be a long weekend, but we already know about Libya, about shootings in Syria and in Yemen; on the other hand we are not sure that we know fully what [Ben S.] Bernanke [chairman of the Fed board of governors] will say after the FOMC meeting (for the first time, Bernanke will hold a post-FOMC press conference).”
Jakob added, “The S&P note on the US was surely a catalyst for the price movement yesterday, but we also have to acknowledge that in recent weeks oil is well bid on [Thursdays and Fridays] to price for [post-prayer] protests [on Fridays] in the Arab world, and that risk cover is then sold on Monday once traders get confirmation that there has not been another regime overthrow over the weekend. Trading volume was on the light side yesterday [a Monday].”
The May contract for benchmark US light, sweet crudes traded at $106.54-109.44/bbl on Apr. 18 in the New York Mercantile Exchange before closing at $107.12/bbl, down $2.54 for the day. The June contract dropped $2.53 to $107.69/bbl. On the US spot market, WTI at Cushing, Okla., was down $2.54 to $107.12/bbl.
Heating oil for May delivery declined 4.14¢ to $3.18/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month decreased 3.64¢ to $3.25/gal.
The May contract for natural gas lost 6.6¢ to $4.14/MMbtu on NYMEX. On the US spot market, however, gas at Henry Hub, La., increased 1.3¢ to $4.21/MMbtu.
In London, the June IPE contract for North Sea Brent retreated $1.84 to $121.61/bbl. Gas oil for May fell $19.75 to 1,004.75/tonne.
The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes was down 62¢ to $117.37/bbl.
Contact Sam Fletcher at email@example.com.
MARKET WATCH: Oil price falls as US credit rating threatened