MARKET WATCH: Europe's sovereign debt woes undercut energy prices

Energy prices continued falling with crude oil down 2.6% Sept. 19 to its lowest level in nearly a month on the New York market due to a stronger dollar and continued market fears that Greece soon will default on its sovereign debt, becoming perhaps the first in an economic line of falling dominoes.

James Zhang at Standard New York Securities Inc., the Standard Bank Group, said, “The Euro-zone debt crisis continues to rattle the market. For now, the market appears to have come to a consensus that Greece will default at some point. Concerns have shifted towards Italy, with the yield for Italian 10-year government bonds exceeding that of the Spanish 10-year bond.”

Overnight, Standard & Poor's Ratings Services downgraded Italy's long-term and short-term sovereign credit ratings to A/A-1 from A+/A-1+, citing political and debt issues. Italian authorities are under pressure to enact austerity measures to reduce government spending. But weaker economic growth likely will reduce effectiveness of Italy's fiscal program, said S&P.

“Natural gas did its usual oscillation routine [in the Sept. 19 trading session], ending the day flattish. Putting it all together, you can probably guess the outcome: another low volume, chalk-grinding day for energy names” in the equities market, said analysts in the Houston office of Raymond James & Associates Inc. However, S&P’s 500 index along with crude and gas prices were up in early trading Sept. 20 “on hopes that the Federal Reserve Bank will announce another round of economic stimulus,” they reported.

Today the Fed opened the 2-day meeting of its policy-making Federal Open Market Committee. “Yields for longer-dated treasury have been falling faster than shorter-dated yields in recent weeks in anticipation of ‘operation twist,’ which is designed to substitute some short-term debt for longer-term paper in order to flatten the curve,” said Zhang (OGJ Online, Sept. 19, 2011). “While the Fed’s track record suggests that it will deliver at least what the market expects, the market is likely to remain unconvinced by the actual effect of the policy move from the Fed.”

Energy, economic outlooks

In other news, US President Barack Obama submitted his deficit-reduction plan to the joint committee assigned with the job of reducing the US deficit. “Although the proposal contains some corporate tax reform elements, there is no language that specifically pertained to taxation of pass-through entities, which is a win for MLPs [master limited partners]. The tax proposal includes those already proposed in the American Jobs Act as well as some corporate tax reform proposals that target the coal industry and the oil and gas industry: 1) Repeal of last in, first out [accounting procedure]; 2) Elimination of four tax provisions used by the coal industry and E&P sector (expensing of exploration and development costs, percentage depletion, and capital gains treatment for royalties),” said Raymond James analysts.

It “is a carbon-copy of what Obama proposed in 2009 when he had a filibuster proof majority and even then it failed to pass, so the likelihood of this passing extremely unlikely if not impossible,” they said.

Zhang said, “In both the US and Europe, political struggles make it difficult to resolve the sovereign debt crisis and to revive the economy. Consequently, we see more downside risks in the near term in the financial market, which will drag down the oil market with it. One of the brighter spots in the oil market is the middle distillates market, which has been the main contributor to refining margins. The term structure of ICE gas oil has shifted into backwardation from the middle of August, and European distillate inventories have been falling. This is in sharp contrast to the seasonal pattern of inventory build during August and September.”

He warned, however, “As global manufacturing activities slow down as the [Purchasing Managers Index (PMI) manufacturing] survey suggests, the strength in middle distillate could fade, and it could prove to be the last straw for crude prices.”

For now, Zhang said, “Middle distillate and fuel oil cracks strengthened, while gasoline cracks weakened further. European refining margins edged higher by around 50¢/bbl but remained weak. The term structure for North Sea Brent crude weakened following the October contract expiry [on Sept. 15], which indicates an improved supply situation, while West Texas Intermediate structure strengthened as Cushing, Okla., inventories are expected to draw further.”

He noted, “It has been reported that three out of five Libyan oil refineries have returned to operations. However, the two refineries running at full throughput are very small ones at 10,000 b/d and 20,000 b/d respectively. The country’s biggest refinery, Ras Lanuf, with a capacity of 220,000 b/d remained shut. As far as Libya’s crude production is concerned, Libya’s officials have said that production has reached 150,000 b/d from the Sarir and Messla fields. However, any crude cargo exports from Libya have yet to be confirmed.”

Raymond James analysts cited a report on the Fuelfix.com blog that the US Department of Energy figures members of the Organization of Petroleum Exporting Countries “stand to [generate] $1 trillion in revenue this year” with the average price of the group’s basket of benchmark crudes “above $100/bbl for the longest period ever.” DOE officials expect OPEC governments to use that cash to “maintain domestic support” in the face of prodemocracy uprisings during the Arab Spring. According to the report, Raymond James analysts said, “Nine member countries have increased 2011 budgets, with the gulf nations pledging $150 billion in social investment. These reinvestment plans are a stark contrast to some choices leaders made after prior oil booms, such as Abu Dhabi's purchase of English soccer club Manchester City and Qatar buying a stake in Porsche SE.”

Energy prices

The October contract for benchmark US sweet, light crudes continued to tumble Sept. 19, losing $2.26 to $85.70/bbl on the New York Mercantile Exchange. The November contract fell $2.37 to $85.81/bbl. On the US spot market, WTI at Cushing was down $2.26 to $85.70/bbl.

Heating oil for October delivery declined 6.42¢ to $2.94/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month decreased 8.76¢ to $2.70/gal.

The October contract for natural gas gained 2¢ to $3.83/MMbtu on NYMEX. On the US spot market, however, gas at Henry Hub, La., retreated 3.08¢ to $109.14/bbl.

In London, the November IPE contract for North Sea Brent lost $3.08 to $109.14/bbl. Gas oil for October fell $19 to $931.50/tonne.

The average price for OPEC’s basket of 12 benchmark crudes dropped $2.01 to $108.68/bbl, wiping out the Sept. 16 gain.

Contact Sam Fletcher at samf@ogjonline.com.

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