Setting the yuan free

Sam Fletcher
OGJ Senior Writer

The front-month crude futures contract continued climbing above $78/bbl, and natural gas rose in early trading June 21 after China said it will end the yuan’s 2-year peg to the US dollar and increase the flexibility of its exchange rate.

China artificially depressed its currency to give its exporters a financial advantage over US competitors. Now with an improved economy, the People’s Bank of China wants its currency to trade more freely. A stronger yuan would make dollar-based commodities cheaper, potentially increasing Chinese demand, said analysts in the Houston office of Raymond James & Associates Inc. “Despite the largely political-based motives behind the decision, markets are interpreting the news as a sign that policy makers believe the economic recovery will prove sustainable,” Raymond James analysts said.

Olivier Jakob at Petromatrix, Zug, Switzerland, said, “At first read, anything with the name China on it is seen as bullish for oil…. However, China is already the main source of oil demand growth, and we are not sure that this will change anything. The growth of Chinese crude oil demand is due to the increased refining capacity and that growth of crude oil demand will occur with or without a greater fluctuation in the yuan.”

Jakob said, “We are not yet convinced that the greater yuan fluctuation will translate into a shift in the petroleum product trade. Hence, overall we are not yet convinced that the latest announcement on the yuan fluctuation will translate into a major change for the physical oil supply and demand, the impact potential being probably more other commodities than in oil.”

Crude prices held above $75/bbl in the week ended June 18, gaining 39¢ to $77.18/bbl on that date after falling 88¢/bbl in the previous session on the New York Mercantile Exchange. “But the rally still appears vulnerable to economic news,” said analysts at KBC Market Services, a division of KBC Process Technology Ltd. in Surrey, UK.

CGES outlook
“After falling almost 25% during the first 3 weeks of May, oil prices staged a recovery in the first half of June, clawing back around half of the losses,” said analysts at the Centre for Global Energy Studies, London. The earlier fall in prices was in reaction to the Greek financial crisis and concerns about European economies, while the recovery reflected a more optimistic economic outlook for the US, which has translated into a surge in middle distillate deliveries.

“China continues to pull large volumes of crude oil eastwards, but it may once again start to face competition for that oil from the world’s largest oil consumer,” CGES analysts said. With renewal of oil demand growth, the US once more is emerging “as a major influence on oil prices,” they said.

“The surge in middle distillate deliveries, as haulage firms benefit from the rebuilding of industry’s inventories that were run down as the recession bit, is a physical reflection of the more optimistic outlook for the US economy,” the analysts said. “US refinery inputs have also staged a dramatic recovery during the second quarter and are now back at levels not seen since the summer of 2008, spurred by growing demand and improved margins that resulted from the slump in crude oil prices. In sharp contrast to the US, more than 20% of European refining capacity remains shut in.”

Oil supplies are abundant, with non-OPEC output expected to increase 600,000 b/d for the second consecutive year in 2010. “In the short term, the oil leak in the Gulf of Mexico should have little impact on oil production, although it may trigger a more cautious approach to hurricane-related shut-ins,” CGES speculated. “A prolonged drilling ban, though, could start to undermine production by the end of the year, given the rapid natural decline rates of deepwater wells.”

Recent economic developments in the US are supportive of oil prices, but global inventories remain high and may cap any price increases for some time.

“Although the volume of refined products held in floating storage has fallen steadily since December, offshore crude stocks have risen and at 90 million bbl are back at their peak levels of a year ago,” CGES analysts said. They estimate global oil inventories outside the former centrally planned economies were sufficient to cover 75 days of forward demand at the start of the second quarter—“1 day down on the same point last year, but still 5 days higher than at the start of second quarter 2008,” they said.

(Online June 21, 2010; author’s e-mail: [email protected])