MARKET WATCH: Energy prices rebound on higher earnings, lower supply

Sam Fletcher
OGJ Senior Writer

HOUSTON, July 18 -- Energy prices rebound July 15 on better-than-expected earnings from bellwether companies, with crude up more than 1% in the New York market on news of lower oil supplies from Canada.

The market remains nervous over the Eurozone debt crisis, weakness of the US economy, and the quarterly earnings season, said analysts in the Houston office of Raymond James & Associates Inc.

James Zhang at Standard New York Securities Inc., the Standard Bank Group, said, “Oil rebounded after a fairly sharp fall July 14 as US economic data continued to point to a sluggish recovery.” He reported, “Oil products broadly tracked crude oil moves, which kept product cracks and refining margins broadly unchanged. The term structures for Brent and West Texas Intermediate both strengthened, following gains in flat prices.”

Zhang said, “The latest US Commodity Futures Trading Commission report shows that money managers had increased their net length in crude slightly, by 2.4% week-over-week (on futures and options combined basis). Commercial hedgers further reduced their net short positions, which declined by 3.8% [for the week], as growth in consumers’ long-hedging outstripped increases in producers’ short-hedging positions. Swap dealers increased their net short positions by 41%, albeit from a smaller, lower base. The noncommercial net long position as a percentage of open interest stood at 6.5%, a sharp decline from the record high of 9.9% set in mid-April.”

US economic data released July 15 confirmed that US economy was still soft. “US consumer confidence for July fell to 63.8, the weakest reading since March 2009. The July Empire State manufacturing survey remained negative, indicating a second month of contraction in manufacturing activity in the New York area. June US industrial production grew by 0.2% [for the month], mainly on gains from the utility sector. The impact on the auto sector from Japan’s earthquake in March still showed up in the June US industrial production data,” said Zhang.

He said, “The US Federal Reserve System opened and shut the door on a third round of quantitative easing last week, which saw many risky assets trading in a whipsaw fashion. The European Union banks’ stress test results were released later; eight banks failed the test. The market was left unconvinced by the results, since a possible sovereign debt default from Eurozone peripheral economies was not considered.”

This week, Zhang said, “We expect the market to be dominated by the Eurozone debt crisis and the US budget negotiation. This week will be light on economic data releases out of the US, with data on the housing market likely to remain weak. For the oil market specifically, the International Energy Agency will review its reserve release announced June 23, which could leave the option open for a further reserve release. For now, the oil market is likely to trade in a range-bound fashion, with more risks to the downside due to the unfavorable economic and political climate.”

Other Standard Bank Group analysts said, “Notwithstanding the improvement in net speculative length over the past two weeks, we remain wary over the medium term and consider the oil market vulnerable to further weakness.

Barclays Capital analysts reported, “The persistent dislocation in the usual relationship between WTI and other global oil price benchmarks is having a massive effect on returns to commodity investors. The Standard & Poor’s GSCI [Goldman Sachs Commodity Index published through S&P] returns since early 2010 (10%) are only half the level they would have been if more usual relationships between WTI and Brent had stayed in place. The Dow Jones-UBS Commodity Index returns at 15% are a quarter less.”

Because most index investors have little leeway in their requirement to track a particular commodity investment benchmark, Barclays analysts said, “Very few have been able to shift their exposure out of WTI and into other crudes, such as Brent, which at present are much better benchmarks of global oil market fundamentals. We estimate that the resulting lost income represents an opportunity cost to commodity index investors totaling almost $25billion over the 6 quarters.”

They said, “A combination of inflexible pipeline systems, a lack of capacity for shipping crude out of the US Midwest, and a surge in deliveries of both Canadian and US domestic crude from new shale plays means that the WTI dislocation is likely to persist for some time and could get much worse. The situation may also be exacerbated further by the need to reposition should the leading index providers decide to increase weightings in Brent at the expense of WTI.”

The best way for index investors to position for potential worsening of crude oversupply in the US Midwest—especially in Cushing, Okla., early in 2012—is by selling WTI time spreads. Barclays analysts said, “In the past when Cushing inventories have filled, prompt WTI spreads have blown out to above $9, but monthly time spreads for early 2012 are currently trading at 30-40¢. Given the potential oversupply in Cushing early next year, current values represent an attractive entry point for such a strategy, in our view.”

Analysts at the Centre for Global Energy Studies (CGES), London, said, “Oil supplies are rising, but markets remain tight and prices have returned to the levels they occupied before the Organization of Petroleum Exporting Countries and the IEA successively stunned markets in June. Although the macroeconomic outlook for the developed economies of the [member countries of] the Organization for Economic Cooperation and Development (OECD) remains far from rosy, the developing Asian and Middle Eastern economies are continuing to grow strongly and a combination of regulated end-user prices and both government and commercial stock-building are helping to maintain their thirst for crude oil.”

They reported, “Preliminary production estimates for June show Saudi Arabia, Kuwait, the UAE, and Qatar raised their collective output by more than 650,000 b/d from the previous month’s level—a much-needed boost to supplies. The IEA, too, has begun its contribution to global oil supplies, initiating the release of up to 60 million bbl of strategic stocks. The US has sold 30 million bbl of light, sweet crude from its Strategic Petroleum Reserve, but this oil cannot be exported to relieve the disruption in Europe caused by the loss of Libyan output.”

They noted, “The stock release in Europe has been less clear. Much of it has taken the form of reduced product stock-holding obligations on refiners, rather than actual sales of government-controlled stocks. With such a surge in supplies, it is pertinent to ask why oil prices, after dipping in the wake of the OPEC meeting and IEA announcement, are now back above the levels they occupied before either of these events. For a start, much of the incremental the Gulf Cooperation Council (GCC) countries production is likely to be needed to meet local demand, which is rising seasonally as temperatures soar.”

CGES analysts said, “That which is exported will take many weeks to arrive at the world’s main oil-consuming centers—one of the reasons the IEA felt it necessary to act in the first place.”

Energy prices
The August contract for benchmark US light, sweet crudes climbed $1.55 to $97.24/bbl July 15 on the New York Mercantile Exchange. The September contract advanced $1.49 to $97.60/bbl. On the US spot market, WTI at Cushing was reported unchanged at $95.69/bbl.

Heating oil for August delivery increased 3.31¢ to $3.12/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month inched up 0.45¢ to $3.13/gal.

The August natural gas contract escalated 16.8¢ to $4.55/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., was up 11.5¢ to $4.51/MMbtu.

In London, the new September front-month IPE contract for North Sea Brent crude gained $1 to $117.26/bbl. Gas oil for August was up $4.75 to $977.25/tonne.

The average price for OPEC’s basket of 12 reference crudes lost 54¢ to $112.20/bbl.

Contact Sam Fletcher at samf@ogjonline.com.

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