MARKET WATCH: Prices fall as markets ignore OPEC

Dec. 18, 2008
Energy prices continued to fall Dec. 17, with front-month crude futures dropping 7.3% as traders shrugged off an in-line increase in US oil inventories and a larger-than-expected production cut of 2.2 million b/d by the Organization of Petroleum Exporting Countries.

Sam Fletcher
Senior Writer

HOUSTON, Dec. 18 -- Energy prices continued to fall Dec. 17 with front-month crude futures dropping 7.3% as traders shrugged off an in-line increase in US oil inventories and a larger-than-expected production cut of 2.2 million b/d by the Organization of Petroleum Exporting Countries.

Following a brief meeting in Oran, Algeria, OPEC members said they would bundle previously announced cuts of 500,000 b/d in September and 1.5 million b/d in October with another cut of 2.2 million b/d for a total reduction of 4.2 million b/d effective Jan. 1 (OGJ Online, Dec. 17, 2008).).

The 2.2 million cut would be the largest single reduction by OPEC, "eclipsing the 1.795 million b/d cut announced in the spring of 1999 when oil prices had touched $10/bbl," said analysts at KBC Market Services, a division of KBC Process Technology Ltd. in Surrey, UK.

OPEC's action "is certainly a dramatic gesture, although so far one that has failed to be applauded by the markets," KBC analysts said Dec. 18.

Although OPEC "almost inevitably" will fail to achieve the desired cuts, 75% compliance by its members would eliminate 3 million b/d, which "might be enough to achieve a near-balance between supply and demand," said KBC analysts. "Whether compliance of this magnitude is possible (to date compliance with the September and October cuts is running at only about 60%) remains to be seen."

In Houston, analysts at Raymond James & Associates Inc. said, "Oil fell to its lowest level in 4 years yesterday as the markets are clearly skeptical of the degree of compliance with OPEC's 'on paper' cuts. Based on our oil model, if OPEC is 50% compliant . . . and cuts production 2 million b/d in 2009, this should be enough to offset our forecasted demand decline and rebalance the oil markets."

Olivier Jakob at Petromatrix, Zug, Switzerland, said, "There is no consensus on the level of world demand growth for next year, so there will not be no consensus on the interpretation of the latest OPEC decision. The level of compliance will also be a subject of debate."

At Barclays Capital Inc., London, Paul Horsnell said, "The cut appears to be based on a worst-possible-case scenario for demand, allowing it to fall by between 3 million b/d or 4 million b/d, even in the unlikely scenario that non-OPEC supply increases next year."

He said, "Continuing falls in OPEC output combined with weak and falling non-OPEC output ultimately should counteract a fall in demand that is quantifiable. That fall would not, in our view, appear to be as large as the worst case scenario that OPEC has had to make provisions for."

OPEC's reduction package apparently would require Saudi Arabia to shut in 1.4 million b/d production to "just above 8 million b/d," said KBC analysts. "It is widely believed that a further cut much below this level would be operationally difficult for the Saudis as the associated gas produced with their oil is needed in the petrochemicals sector as well as in other heavy industries."

They noted that the OPEC announcement lacked "any detail with respect to the individual country production allocations, and there is no mention as to what a desirable, fair oil price is. The lack of detail is disappointing in that it creates a perception of lack of resolve."

At Tristone Capital Inc., Calgary, Chris Theal, managing director of institutional equity research, said it was "on balance, a bold move by OPEC." However, he said, "We believe demand uncertainty and spare capacity overhang will weigh on crude prices in near-term. In particular, we see risk that further downward revisions to demand forecasts [for countries outside the Organization for Economic Cooperation and Development], not to mention issues with quota compliance, will lead to slower than anticipated inventory drawdowns."

Russia's widely touted attendance at the OPEC meeting proved a disappointment, said KBC analysts. "What appears to have happened is that the Russians have pledged to cut production by about 300,000 b/d at some unspecified time in the New Year if oil prices remain persistently low. What low means to the Russians is not clear. In fact, a Russian production cut is nothing of the sort because production has been falling in any event due to low investment," they said.

US inventories
The Energy Information Administration reported US crude inventories increased 500,000 bbl to 321.3 million bbl in the week ended Dec. 12. Gasoline stocks escalated by 1.3 million bbl to 204 million bbl, and distillate fuel inventories increased by 2.9 million bbl to 133.5 million bbl in the same period (OGJ Online, Dec. 17, 2008).

This latest weekly data "shows some healthier demand indications at both the top and the bottom of the demand barrel," Horsnell said. He noted that the average US retail price for regular gasoline has fallen 13 consecutive weeks to a 58-month low of $1.659/gal.

"Prices fell in all regions except the Midwest, with Houston remaining the lowest price location in the EIA sample at an average of $1.457/gal. This is the first average below $1.50/gal recorded in any EIA location since January 2004, Horsnell said.

"Prices rose on the West Coast for the 25th straight week, with the new average of $1.751/gal being $2.71 lower than the June peak. The US national average price of diesel fell by 9.3¢ to now stand at $2.422/gal, a year-over-year fall of 26.8%," Horsnell reported.

In other news, KBC analysts said, "The effective abolition of interest by the US Federal Reserve can be seen as a sign of desperation, and the economic climate is now clearly the main market driver with its impact on oil demand." On Dec. 16, the Federal Reserve chopped interest rates to a range of zero to 0.25% (OGJ Online, Dec. 17, 2008).

Energy prices
The soon-to-expire January contract for benchmark US hit an intraday low of $39.88/bbl in early trading Dec. 17 before closing at $40.06/bbl, down $3.54 for the day on the New York Mercantile Exchange. The February contract lost $2.09 to $44.61/bbl. On the US spot market, West Texas Intermediate at Cushing, Okla., was down $3.54.to $40.06/bbl. January heating oil declined 1.78¢ to $1.44/gal on NYMEX. The January contract for reformulated blend stock for oxygenate blending (RBOB) was down 3.45¢ to $1.01/gal.

Natural gas for the same month dropped 13.2¢ to $5.62/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., fell 17¢ to $5.57/MMbtu. EIA reported the withdrawal of 124 bcf of natural gas from US underground storage in the week ended Dec. 12, leaving 3.2 tcf in storage. That's 41 bcf less than a year ago but 114 bcf above the 5-year average.

In London, the February IPE contract for North Sea Brent crude lost $1.12 to $45.53/bbl. January gas oil gained $1.75 to $470.25/tonne.

The average price for OPEC's basket of 13 reference crudes increased 21¢ to $40.95/bbl on Dec. 17.

Contact Sam Fletcher at [email protected]