MARKET WATCH: Iran's nuclear activity boosts crude oil prices

Front-month crude oil contract prices challenged the $110/bbl barrier in a late rally Feb. 24 in the New York market after the International Atomic Energy Agency reported accelerated nuclear activity in Iran.

“The rally was boosted by traders covering their shorts ahead of the weekend due to huge uncertainty over the geopolitical situation in the Middle East despite a report that Saudi Arabia had exported a record volume of crude last week,” said James Zhang at Standard New York Securities Inc., the Standard Bank Group.

“As usual, the sharp rise in crude prices squeezed product cracks and refining margins,” he said. “More importantly, the time spread in key oil products has been weakened over the past 2 weeks, signaling that high oil prices are hurting demand.”

Front-month contracts for West Texas Intermediate and North Sea Brent made net gains last week of $6.53/bbl and $5.89/bbl, respectively, primarily from market fears of intensifying risks to Middle East crude supplies from conflict over Iran’s nuclear program. The term structure in Brent also “went up exponentially during the early half of last week before coming off sharply,” said Zhang.

However, he said, “The firm time spread in Brent was offset by weakening physical crude price differentials as refiners are staying away from chasing prompt cargos, due to deteriorating refining margins.”

In the physical market, fuel oil cracks continue to fall with the high-sulfur fuel oil crack over Brent crude hitting a 5-month low in Europe. “Consequently, margins for refineries with simple configurations, i.e. higher fuel oil yield, in both Europe and Asia, have turned negative, which will take out the incremental demand for crude oil from those refineries,” Zhang said. “As a result, the time spread in Brent is likely to weaken further, assuming no worsening in geopolitical tensions in the Middle East.”

At KBC Energy Economics, a division of KBC Advanced Technologies PLC, analysts said Middle East tensions produced a $1/bbl backwardation in crude futures prices, while in the physical market North Sea Brent “has already hit $125/bbl and is now perilously close to the peak levels reached in spring 2011 during the Libyan crisis.” Converted into euros, oil prices in Europe “are back at all-time highs reached in July 2008, and pump prices in most European countries are already well above their peak levels reached when crude oil hit $150/bbl,” they said.

The steep backwardation in crude futures resulted from oil companies rushing to replace Iranian oil, which “suggests the latest rally is not just a speculative bubble,” said KBC analysts. Although Iran claims its production has not yet affected by international sanctions, KBC estimates sales to Europe and Asia are down by 300,000 b/d. “Our suspicion is that Iranian oil is inevitably building up in storage and will have to be moved to floating storage at some point,” they said.

With gas prices deteriorating, analysts in the Houston office of Raymond James & Associates Inc. increased their estimate of coal-to-gas switching to 2.6 bcfd , replacing roughly 65 million tons of coal, “plus another 10 million tons for a weaker electric generation outlook.” Although basic economics favor switching from coal to cheaper gas, they said, structural challenges and coal contracts are likely to limit near-term gains in market share by gas utility plants.

In other news, the G-20 group representing 20 major national economies failed to agree over the weekend on boosting the International Monetary Fund's bailout funds until Europe creates a “firewall” to prevent potential debt contagion. Raymond James analysts warned, “European concerns coupled with surging oil prices could put the brakes on the market’s positive momentum, although a slew of economic data out of the US this week could provide just enough investor confidence to continue the rally.”

Energy prices

The April contract for benchmark US light, sweet crudes climbed $1.94 to $109.77/bbl Feb. 24 on the New York Mercantile Exchange. The May contract rose $1.93 to $110.18/bbl. On the US spot market, WTI at Cushing, Okla., was up $1.94 to $109.77/bbl.

Heating oil for March delivery increased 2.1¢ to $3.32/gal on NYMEX. Reformulated stock for oxygenate blending for the same month gained 3.92¢ to $3.15/gal.

The March natural gas contract fell 7.1¢ to $2.55/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., lost 7¢ to $2.60/MMbtu.

In London, the April IPE contract for North Sea Brent was up $1.85 to $125.47/bbl. Gas oil for March slipped 75¢ to $1,030.75/tonne.

The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes increased $1.16 to $122.86/bbl. So far this year, OPEC’s basket price has averaged $114.05/bbl.

Contact Sam Fletcher at samf@ogjonline.com.

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