MARKET WATCH: EU economic crisis holds down oil prices

Crude oil prices were down over the US Thanksgiving holiday last week but the front-month natural gas contract managed a small gain in the New York futures market, as equities continued to take a beating.

James Zhang at Standard New York Securities Inc., the Standard Bank Group, reported oil markets were quiet and “still in holiday mood” with thin trading Nov. 25. “The term structures in crude oil were firmer on fears of market disruptions over a possible European Union embargo on Iranian crude,” Zhang said.

However, Standard & Poor’s 500 Index “logged its worst Thanksgiving-week loss since 1932 as fears of contagion pushed yields up across the Euro-zone and even in stronger economies like Germany and France,” said analysts in the Houston office of Raymond James & Associates Inc.

The S&P 500 dropped 2% Nov. 23 in its sixth consecutive session of losses. Oil prices followed the equities down, despite a bullish US petroleum inventories report. The Energy Information Administration said commercial US crude fell 6.2 million bbl to 330.8 million bbl in the week ended Nov. 18, counter to a Wall Street consensus for a 500,000 bbl increase. Gasoline stocks increased 4.5 million bbl to 209.6 million bbl in the same week, outstripping market expectations of a 1 million bbl gain. Distillate fuel inventories declined 800,000 bbl to 133 million bbl, short of Wall Street expectations of a 1.3 million bbl drop (OGJ Online, Nov. 23, 2011).

Europe’s economic problems

Raymond James analysts said, “Germany's disappointing bond auction on Nov. 23 rattled the markets, as it suggested that contagion had spread from the Euro-zone's periphery to the bloc's very core. After all, if the market loses confidence in the country that brought you Porsche and Mercedes, what hope is there for anyone else in Europe?” Moreover, they said, “Portugal was downgraded to junk status, and the German chancellor again gave a firm ‘nein’ to a bailout by the European Central Bank.”

Olivier Jakob at Petromatrix in Zug, Switzerland, said, “It was a short but not a good trading week for the stock markets. The S&P 500 was down 4.7% during the week, led by losses in energy (down 6.4%) and financials (down 5.8%). For the year, the S&P 500 is down 7.9% and…20% below the target that most sell-side financial institutions were giving at the start of the year for the end-of-the-year mark.”

Still, Raymond James analysts reported Nov. 28, “European investors are responding positively to news that Germany and France are contemplating some radical measures to secure fiscal integration throughout the Euro-zone, in hopes that this will finally ease fear among investors.” They said the broader markets were expected to start this week “sharply higher” on the Euro-zone news as well as strong Black Friday results.

Jakob remains unconvinced, however. “Europe continues to not find any solutions to the crisis apart from organizing meetings,” he said. “Despite having placed a Goldman Sachs advisor as Prime Minister of Italy, the 10-year yields on Italy are back above 7%. Spain is getting very close to that level too, and all of this is happening despite the ECB intervening in the secondary market to buy Italian and Spanish bonds. Without the ECB, the Italian and Spanish yields would be much higher. The yields on Belgium are also rising fast and on Nov. 25, S&P downgraded Belgium from AA+ to AA. Based on the bond yields, the UK is now priced as great a safe-haven as Germany; at one point during the week the yields for the UK were even lower than for Germany. Issuance of sovereign bonds in Europe is facing a lot of difficulties and this is unlikely to improve soon as we expect to see further downgrades of sovereign ratings in early 2012.”

On Nov. 28, the Washington, DC, think-tank Center for Economic and Policy Research called for the US Federal Reserve to stabilize European bond markets by buying Italian and Spanish bonds, plus the sovereign bonds of other countries “as necessary”—despite the Fed’s apparent inability to stabilize the US economy so far.

The nonpartisan organization, whose advisory board includes two Nobel Laureate economists, warned that the risk of a financial meltdown in Europe is “growing each day” with a potential financial fallout that “could be bigger than that following the collapse of Lehman Brothers in 2008” and might push the US economy into another recession. They said, “European authorities are moving much too slowly to contain this risk. The ECB especially is not fulfilling its function as a central bank to act as a lender of last resort in a crisis situation.”

Zhang said, “Geopolitical risk has again become a key concern for the oil market. Recent developments in Iran and Syria and the renewed uprising in Egypt have pushed up the risk premium. We believe that the instability in the Middle East, North Africa region will keep oil heated.”

He reported, “Risk appetite is likely to stay fairly weak into yearend. We expect some relief rallies as the market shifts its focus from the Euro-zone to the US. However, the Euro-zone debt crisis is likely to cap the upside in oil prices, while geopolitical risk should provide a firm price floor. Intraday volatility is set to stay elevated, but we take our central scenario till yearend as ‘muddle along, with a range-bound bias in price action.’ In the physical crude market, low oil inventories globally are likely to keep oil in backwardation, with the risk of spikes if a European Union embargo is imposed on Iranian crude.”

The Iranian factor

Jakob said, “If France manages to push for a EU-wide ban on Iranian crude oil, Iran will be forced into pushing more oil to the Far East and to offer greater discounts (at $110/bbl, Iran can afford to offer huge discounts to India and China) while Europe will have to pay a greater premium for its crude oil requirements. An EU-wide ban on Iranian crude oil will therefore make the Indian refineries more competitive and the Mediterranean refineries less competitive and should translate in our opinion in more European refinery capacity being shut down and being replaced by more imports of petroleum products from the East of Suez (and India in particular).”

Zhang said, “The timing of such an embargo could hardly be worse, as European crude inventories are at multi-year lows. The very steep backwardation in the oil market and poor refining margins has driven European oil refiners to keep their stocks at a minimum and take a hand-to-mouth approach on crude purchases. Even relatively small disruptions could cause spikes in flat prices and term structures, as demonstrated by the market’s reactions to production problems at the Buzzard field in the North Sea and the EU embargo on Syria crude in the past few months.”

He said, “It would be wishful thinking to assume that the oil market would rebalance itself and EU countries would easily find replacement barrels without sending prices higher. Any such rebalancing would take months. As Iran is already holding substantial crude stocks on floating storage, an embargo could even force Iran to trim oil production if storage facilities fill up.”

At KBC Energy Economics, a division of KBC Advanced Technologies PLC, analysts said, “Volatility in the outright prices for crude oil has now started to be matched by volatility in the pricing differentials between the different grades of crude. The swings in these differentials in recent months are some of the largest ever seen. Earlier this year, the US marker West Texas Intermediate was trading at a discount of almost $30/bbl to Brent while the Asian benchmark, Dubai, at one point fell to around $8/bbl below Brent. In both cases, the extraordinary widening in the price spreads reflected particular upward pricing pressure on the Brent contract itself.”

They noted, “Some commentators have maintained that Brent had become over-priced at these levels. Perhaps, but it is equally apparent that there were good reasons for this to happen. There was the loss of Libyan crude exports to Europe and problems in Nexen’s Buzzard oilfield, which faced a number of outages from April until November—and since Buzzard is blended into Forties grade, which normally determines the value of Dated Brent, its absence also led to higher Brent prices.”

However, KBC reported, “November has brought some reversal of fortunes. Brent is now trading at a discount to Asian markers, Dubai and Oman, and at the time of writing is hovering around $107/bbl. The return of Libyan oil stripped out much of the support for Brent even though the North African country is unlikely to reach its full production soon, while the return of Buzzard production has further depressed North Sea light sweet grade values. Hence, Brent price is now feeling the full force of the downdraft caused by the Euro-zone crisis. If Brent was overpriced in the summer, it now appears to have become underpriced. Even Russian Urals is fetching a premium over Brent.”

Adam Sieminski, chief energy economist, Deutsche Bank AG, Washington, DC, said, “Winter is approaching in the Northern Hemisphere, and distillate inventories in the US stand at below-average levels. The global situation is similar. This could end up creating firm support for crude oil prices regardless of economic worries and the fact that US gasoline demand has been lagging.”

He noted US natural gas “is at higher storage levels and injecting [continuing] later in the year than ever before, but this week's injection was surprisingly low. Spot prices moved lower, discouraging output, and the supply-demand balance has temporarily snapped tighter. Futures prices may have to follow spot prices lower.”

In the European gas market, Sieminski said, “A trend of weakening demand in the second half of 2011 has accelerated, particularly in Germany, not only as a result of warm weather but also on a weather-adjusted basis presumably related to the economic downturn.”

Energy prices

The January contract for benchmark US light, sweet crudes dropped $1.84 on Nov. 23 but regained 60¢ Nov. 25 to close at $96.77/bbl on the New York Mercantile Exchange, which was closed Nov. 24 for the Thanksgiving holiday. The February contract fell $1.82 Nov. 23 but climbed back 54¢ to close at $96.61/bbl Nov. 25. On the US spot market, WTI at Cushing, Okla., was down $1.84 to $96.17/bbl on Nov. 23; US cash markets were closed Nov. 24-25.

Heating oil for December delivery lost 7.55¢ Nov. 23 and another 3.18¢ to $2.93/gal Nov. 25 on NYMEX. Reformulated stock for oxygenate blending for the same month retreated 4.41¢ Nov. 23 and 6.88¢ Nov. 25 to finish the week at $2.45/gal.

The December natural gas contract gained 4.5¢ Nov. 23 and 8.2¢ to $3.54/MMbtu Nov. 25 on NYMEX. On the US spot market, gas at Henry Hub, La., fell a whopping 46.5¢ to $2.56/MMbtu Nov. 23 before the 4-day Thanksgiving holiday weekend.

In London, the January IPE contract for North Sea Brent dropped $2.01 Nov. 23 and $1.38 to $106.40/bbl Nov. 25. Gas oil for December fell $6 Nov. 23 and $10.75 Nov. 25 to $938.75/tonne.

The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes was down 2¢ Nov. 23, 22¢ Nov. 24, and 37¢ to $107.73/bbl on Nov. 25. So far this year, OPEC’s basket price has averaged $107.45/bbl, exactly $30/bbl more than for all of 2010.

Contact Sam Fletcher at samf@ogjonline.com.

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