MARKET WATCH: Crude price drops, ending 2-day rally

Sam Fletcher
OGJ Senior Writer

HOUSTON, May 27 -- The front-month crude contract fell 1% May 26, ending a 2-day rally on the New York market while an increase in US applications for unemployment benefits indicated a still weak economy.

The natural gas contract also dropped 1% on the report of a higher-than-expected increase in US underground storage, said analysts in the Houston office of Raymond James & Associates Inc.

The Energy Information Administration reported the injection of 105 bcf of natural gas into US underground storage in the week ended May 20, exceeding the Wall Street consensus for 94 bcf input. That raised working gas in storage to more than 2.02 tcf. That is 230 bcf less than last year at this time and 26 bcf below the 5-year average (OGJ Online, May 26, 2011).

“Crude is set to end in a consolidation mode for the third week in a row,” said James Zhang at Standard New York Securities Inc., the Standard Bank Group. “Yesterday front-month Brent crude traded in a very narrow range, by the recent standard.” West Texas Intermediate fell “under increasing concerns over Cushing[, Okla., crude] storage.” That “pushed the spread between front-month WTI and Brent to $14.76/bbl,” he said. “The term structure of WTI also weakened on the back of high oil inventories at Cushing, aligned with our trade recommendation to short WTI structure.”

In the financial market, Zhang said, “The euro appears to continue with its recovery, supporting oil prices.”

Meanwhile, the Standard Bank Group reassessed the impact of the war in Libya and the earthquake in Japan as more data became available.

“In the short term, global crude oil inventories have been drawn down much faster because of the supply shortfall from Libya. In addition, the decline in oil product inventories is more pronounced than those of crude due to losses in refining capacity in Japan,” Zhang said. “In the medium term, we see a further tightening in the oil market because it will take a long time for Libya’s supply to recover fully. Furthermore, military attacks on Libya’s oil fields and infrastructure might have caused considerable damage, which will take a long time to repair.”

Moreover, he said, “Oil demand is picking up, albeit at a slower pace, as the global economy grows. Therefore, we still see the risk to oil prices to the upside, although there is likelihood of limited downward corrections in the short term. In the medium term, the oil market seems heading for a structural bull market, with diminishing spare capacity and growing demand.”

Walter de Wet, another analyst at Standard Bank Group, said economic data of the past week was bearish, with the Chinese manufacturing Purchasing Managers Index (PMI) data on May 23 indicating a further slowing of growth in the manufacturing sector.

In the US, inventory levels of durable goods orders increased for the 16th consecutive month. “This could be read as a positive or negative, depending on how you judge final demand,” said De Wet. “If final demand is strong, an inventory build is positive. However, it could also signal producers cannot push inventory towards consumers because demand is weak. We favor the latter argument,” he said.

“Technically, WTI has not yet produced a convincing break [above] $100/bbl,” said Olivier Jakob at Petromatrix, Zug, Switzerland. “That level is likely to be defended as a line of support as it will converge soon with the 100-day moving average, but the open interest and volume data are not showing that there is a lot of conviction yet behind the rebound. In front of a long weekend and given the lack of investment conviction of the last few days, we expect low volume today. The test of resistance will be at the 20-day moving average ($101.30/bbl WTI) while there will be some interest like every Friday to have WTI print a price above $100/bbl for the weekend recaps.”

Brent has a momentum “a bit better defined” than WTI and will seek some momentum flows above yesterday’s high of $115.47/bbl. “The big test of resistance on Brent will be at the 50-day moving average of $118/bbl,” Jakob said. “ICE gas oil has broken the resistance of $940/tonne and needs now to break $950/tonne.”

He added, “Yesterday the euro was whacked, overnight the dollar was whacked. The only life left in the stock market is in the commodity oil sectors while oil gets its clues from the dollar; asset classes are in a circular trade that remains in our opinion a systemic risk. We expect that low trading volume will prevail today.”

The consumer spending element of the first quarter GDP in the US was downgraded from 2.7% to 2.2%. “Most of the banks are lowering their forecasts for second quarter US GDP with the obligatory comment that it is just a transitory correction lower and that the next quarters will be better,” said Jakob. “We are in front of a long weekend due to Memorial Day on May 30” with the US market closed for that day.

The extended Memorial Day weekend marks the unofficial start of the summer driving season in the US. June 1 marks the official start of the 2011 hurricane season.

Analysts at Barclays Capital Commodities Research in New York noted Egypt’s interim government indicated it will pursue a more independent external strategy and is adopting policies more in line with public opinion.

“One area in which the Egyptian government may be recalibrating its policy to be in line with public opinion is on the provision of subsidized gas to neighboring countries,” said Barclays Capital analysts. “The policy of providing subsidized gas to Israel has come under particular scrutiny. Jordan has already agreed to a revised gas price. Egypt hopes to increase its revenues by $3-4 billion as a result of gas export price renegotiations, as the country is facing a growing budget deficit. Some of the increased revenue from exports will serve to raise subsidies for domestic gas, aimed at improving the domestic standard of living.”

Adam Sieminski, chief energy economist, Deutsche Bank AG, Washington, noted commodity index returns performed strongly in the first 4 months of 2011. “However, a large portion of these gains have been wiped out in May. Since the fortunes of commodity index returns seemed to improve with the introduction of the Federal Reserve Bank's quantitative easing (QE2) program, it appears commodity markets are performing skittishly as this stimulus is removed. We expect this will prove temporary.”

He said, “Crude has become a bellwether for the broader commodities markets, reacting to anxieties about the outlook for the global economy and shifts in currency valuations. Although downside risks to global growth and upside risks to the US dollar have emerged, we believe these will prove temporary.”

This year has been tough for airlines contending with sharply higher fuel prices, civil unrest in the Middle East and North Africa, and the disaster in Japan, all of which sharply curbed air travel and demand for jet fuel.

“The latest volcanic eruption in Iceland could add further negative bias to an already weak demand picture,” said Sieminski.

Meanwhile, he said, “We believe US natural gas prices are being supported by expectations for above-average temperatures heading into June, tightening supply-demand balances in 2012, and the potential for LNG exports in 2015. From today’s prices, we believe the risks are now to the upside.”

Energy prices
The July contract for benchmark US light, sweet crudes fell $1.09 to $100.23/bbl May 26 on the New York Mercantile Exchange. The August contract dropped $1 to $100.82/bbl. On the US spot market, WTI at Cushing was down $1.09 to $100.23/bbl.

Heating oil for June delivery inched up 0.26¢, but closed virtually unchanged at a rounded $2.98/gal on NYMEX. RBOB for the same month climbed 3.21¢ to $3.05/gal.

The June contract for natural gas lost 5.3¢ to $4.33/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., declined 3.3¢, also closing at $4.33/MMbtu.

In London, the July IPE contract for North Sea Brent rose 12¢ to $115.05/bbl. Gas oil for June gained $4.75 to $941.75/tonne.

The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes was up $1.84 to $109.83/bbl.

Contact Sam Fletcher at samf@ogjonline.com

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