MARKET WATCH: Improved economy signals elevate crude oil, product prices

Sam Fletcher
OGJ Senior Writer

HOUSTON, July 8 -- Energy prices soared July 7 with West Texas Intermediate approaching $100/bbl in intraday trading in the New York market and North Sea Brent closing above $118/bbl, increasing the spread between the two key crudes to just below $20/bbl.

“Better-than-expected private-sector job data and strong retail sales lifted the broader market [with the Standard & Poor’s 500 index up 1%] and inspired hopes that the economy may be pulling out of its recent rough patch,” said analysts in the Houston office of Raymond James & Associates Inc. “The positive economic sentiment improved the demand outlook for oil, which rose a healthy 2%.” However, natural gas continued to fall, down 2% after the Energy Information Administration reported a larger-than-expected injection into US underground storage.

“Oil charged ahead yesterday as part of a broad-based market rally,” said James Zhang at Standard New York Securities Inc., the Standard Bank Group. Light products including European gasoline, European middle distillate, New York reformulated blend stock for oxygenate blending (RBOB) gasoline, and heating oil “slightly outperformed crude,” he said, “while fuel oil cracks slid, which left European refining margins broadly unchanged.” Zhang reported the term structure of Brent strengthened following flat price moves, while WTI structure remained weak at the front because of the inventory overhang at Cushing, Okla.

The ADP national employment survey for the US private sector came in at 157,000 new jobs added, much higher than the market consensus of 70,000. Also, new US unemployment claims for the week were slightly below consensus. These prompted a market rally in both commodities and equity markets.

Zhang noted WTI and Brent averaged $102.34/bbl and $116.98/bbl, respectively, in the second quarter, compared with Standard Bank’s forecasts of $105/bbl and $113/bbl. The WTI-Brent spread averaged $14.64/bbl in the second quarter, “significantly overshooting our forecast of $8/bbl,” he said. The bank increased its Brent forecast by $8 for the third and fourth quarters, leading to an average Brent price of $116/bbl for this year. The spread between the new Brent prices and unchanged WTI would average $15/bbl.

Hedging outlook
“For consumers to hedge their consumption beyond 2011, using WTI as an underlying [price standard] could leave them exposed to a further widening of the WTI-Brent spread,” Zhang said. “Consequently, if oil prices go up, consumers might have to pay significantly more for physical oil than the gains from long WTI futures.” But for producers, he said, “There could be gains from hedging using WTI, since a short paper position in WTI should benefit from further widening in the long-dated WTI-Brent spread.”

Still, he said, “The spread of WTI-Brent is likely to remain volatile, as physical arbitrage is not functioning efficiently due to a lack of infrastructure. The biggest risk for far-dated spreads is the pending US government approval for pipelines to be built that would take crude from Cushing to the US Gulf Coast. Once they are approved, the current project timelines suggest the new pipelines will not be in place before 2013.”

With Brent close to $120/bbl, Olivier Jakob at Petromatrix, Zug, Switzerland, questioned if consumers such as airlines should hedge their future consumption “when the most bullish swap dealers are only forecasting a price between $125-130/bbl in a year from now” and expecting that price level to trigger demand destruction.

“Under those price assumptions, we would argue that consumers should have a low incentive to hedge (buy) their oil consumption since prices are already close enough to the levels where demand destruction becomes [the] natural hedge,” he said. “There is always a supply event risk to consider, but going into the 2012 election year, we think that this risk is offset by the interventionist risk to control prices as getting elected with $4/gal gasoline is ‘mission impossible.’”

Jacques Rousseau, managing director of equity research, RBC Capital Markets, Reston, Va., reported, “We have raised our Brent outlook to $110/bbl from $106/bbl in 2011 and to $114/bbl from $112/bbl in 2012. Our WTI outlook has changed slightly in 2011 to $97/bbl from $96/bbl and is unchanged at $102/bbl in 2012. Our WTI outlook would map to $13/bbl and $12/bbl discounts to Brent prices, which reflect physical constraints at Cushing. Our price outlook reflects several factors, including explicit global oil demand growth, eroding usable spare capacity [in the Organization of Petroleum Exporting Countries], the US trade weighted exchange rate, US crude and product inventories, a geopolitical risk premium, and long-dated prices as a proxy for marginal costs. We have left our equilibrium WTI price unchanged at $100/bbl.”

On the other hand, Rousseau said, “US natural gas prices should remain weak: We are lowering our US natural gas price expectations to $4.38/Mcf from $4.50/Mcf and to $5/Mcf from $5.50/Mcf in 2012. We expect US natural gas fundamentals to remain challenged throughout 2011 and into early 2012 as we project natural gas production outstripping demand growth, creating a near-term overhang.”

Refining margins
The current glut of oil in the Midwest “should last until 2013,” said Rousseau. “Refining margins in the Midwest remain near record levels because of the crude oil supply glut in the region that has caused WTI oil prices to trade at large discounts to other global light, sweet oils like Brent and Light Louisiana Sweet (LLS). Over the last 18 months, the WTI discount to LLS has widened from $2.05/bbl in January 2010 to $13.60/bbl at the end of [last month]. Integrated oils have little incentive to ‘solve the problem’ by reversing pipelines to send more oil to the Gulf Coast since their refining businesses are benefiting.”

For now, he said, “Refiner earnings continue to exceed most expectations, and we are raising our refining margin and earnings/share (EPS) forecasts again (we increased our second quarter estimates on May 16), and our price targets for many of the refiners in our coverage universe. However, our increases are almost entirely driven by the strength of Midwest margins, and our outlook for other regions is less optimistic as high commodity prices have softened demand, and since global refining capacity additions should increase substantially in 2012-15.

As a result of the global recession, Rousseau said, “Net refining capacity additions (new capacity minus closures) fell from an annual average of 900,000 b/d from 2000-09 to 700,000 b/d in 2010, and the International Energy Agency forecasts a net increase of only 400,000 b/d in 2011. Coupled with a high level of refinery downtime in the first half of this year, a reduced level of supply in 2011 has helped improve refining margins.”

However, he said, “With 4 million b/d of new refining capacity expected to come on line in 2012-13, supply growth should exceed demand growth, creating additional spare capacity and placing downward pressure on refining margins.”

US inventories
The Energy Information Administration said commercial inventories of benchmark US crudes declined 900,000 bbl to 358.6 million bbl in the week ended July 1, less than the Wall Street consensus for a 2.5 million bbl drop. Crude stocks remain above average for this time of year. Gasoline inventories were down 600,000 bbl to 212.5 million bbl in the same period, more than the 200,000 bbl decline analysts expected. Finished gasoline inventories increased while blending components inventories decreased last week. Distillate fuel stocks dipped 200,000 bbl to 142.1 million bbl. Traders were anticipating a 900,000 bbl increase.

EIA also reported the injection of 95 bcf of natural gas into US underground storage last week. That put working gas in storage at 2.527 tcf, down 224 bcf from the year-ago level, and 48 bcf below the 5-year average (OGJ Online, July 7, 2011).

Jakob said the EIA’s latest report showed total US petroleum stocks are flat so far this year (i.e. at the same level as at the start of the year). Moreover, he said current US stock levels of commercial crude and products are “very comfortable” ahead of the pending release of 30 million bbl of crude from the US Strategic Petroleum Reserve. Stocks of crude on the US Gulf Coast are about the same levels as in 2009 or 2010, while crude imports into the Gulf Coast “were at the second highest level for the year due to the largest weekly discharge of Saudi crude oil since November 2010,” he said.

Despite a draw from gasoline stocks last week, Jakob said, “The absolute stock levels are still in line with recent years, and demand is not increasing from a year ago. The average regular [retail] price of gasoline at the pump on the East Coast is starting to approach $3.90/gal, and we should therefore expect to see another wave of demand erosion into the second part of the gasoline season.”

Distillate stocks were marginally lower last week, and it is “the oil commodity showing the greatest divergence to the levels of the past 2 years,” said Jakob. “Overall, there is not much to read in the current US statistics, and especially so in front of the SPR release. The pricing action also shows that the greatest contributor to the price increase was the chain reaction to an exogenous input (ADP jobs).”

Energy prices
The August contract for benchmark US light, sweet crudes scrambled up $2.02 to a closing price of $98.67/bbl July 7 on the New York Mercantile Exchange. The September contract advanced by $2.01 to $99.14/bbl. On the US spot market, WTI at Cushing was up $2.02 to $98.67/bbl in tandem with the front-month NYMEX crude contract.

Heating oil for August delivery jumped 13.87¢ to $3.10/gal on NYMEX. RBOB for the same month escalated by 12.94¢ to $3.13/gal.

The August natural gas contract, however, dropped 8.4¢ to $4.13/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., fell 16¢ to $4.19/MMbtu.

In London, the August IPE contract for North Sea Brent crude shot up $4.97 to $118.59/bbl.

The average price for OPEC’s basket of 12 reference crudes gained $2.50 to $110.76/bbl.

Contact Sam Fletcher at samf@ogjonline.com.

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