Oil prices continue to show surprising strength

Oil prices continue to show surprising strength as skepticism builds over added Middle Eastern crude supplies and jitters arise over bogus reports of military tensions in that region.

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Oil prices continue to show surprising strength as skepticism builds over added Middle Eastern crude supplies and jitters arise over bogus reports of military tensions in that region.

Nymex crude jumped almost $1 yesterday, with the contract for September delivery closing at $31.34/bbl. The latest spike came in response to reports of growing tensions at the Iraq-Kuwait border, namely, that there had been a Kuwaiti military alert in response to a possible Iraqi troop buildup on the border. Those reports proved unfounded. But yesterday's spike capped a week-long rally, with the upward price pressure coming from reports the week before of a much stronger than expected draw on US crude stocks and reports in the US of increasingly tight gasoline and heating oil supplies.

US crude stocks at the end of July had fallen by a whopping 9 million bbl, reflecting a steep, if temporary, dip in oil imports. The market was made to wonder: Why are stocks declining if more OPEC oil (the latest approved increase, the cheating, and the Saudis' surprise extra) is coming onto the market?

Simply put, refiners were drawing down stocks because that extra oil is still in transit and they want to take advantage of high gasoline prices before the driving season ends. Purvin & Gertz, which expects to see a global stock build of about 1.9 million b/d in the third quarter, notes of the recent declines in crude stocks: "We view this as intentional in the offseason. This is keeping the market on edge as we approach the winter season with still low distillate stocks."

In fact, high prices have already bitten into estimates of a global oil demand increase this year. Purvin & Gertz notes that first quarter demand worldwide fell by 0.5%, "due to a combination of direct and indirect effects of the massive differences in prices and market price-time structure this year vs. last."

The Houston analyst expects global oil demand to grow by 1.5 %, or about 1.1 million b/d this year and, assuming further easing of prices in 2001, "we project growth in demand at 2.4%, or about 1.8 million b/d.

At the same time, Purvin & Gertz sees non-OPEC crude, together with OPEC NGL and condensate, to increase by 1.5 million b/d in 2000 and 1.1 million b/d in 2001.

This does not leave a whole lot of room for OPEC to expand its crude oil production this year and next beyond current levels without spurring another round of excessive stockbuilding that would weaken markets again. Bear in mind, however, that the "current levels" referred to represent OPEC output in excess of agreed production levels by about 600,000 b/d (mostly from Saudi Arabia, Kuwait, and the UAE, just about the only OPEC members with any significant surplus capacity).

If anything, much of the recent market skittishness has been attributed to doubts over whether the Saudis have the resolve to follow through on a promise to further raise production—unilaterally, if necessary, in order to jawbone prices back down to a more-comfortable $25/bbl. The skittishness is a response to the fact that the Saudis have not had anything further to say on the subject, following a rondelay of comments from other OPEC members asserting that no such agreement was forthcoming and that no OPEC member can act unilaterally with such assent. Have the Saudis backed off? Or, in hindsight, was Riyadh simply codifying verbally what it already was doing-breaking its quota to cool the market? Either way, the Saudi promise (or threat, depending on whose vantage point is being used) helped shave about $7 off the price of crude by the end of last month. This, says Purvin & Gertz, suggested that no further output increases were justified.

But will the Saudis assert themselves again now that prices have rebounded past the magic $30 mark again?

That may not be necessary, as the current rally responding to the big stock draws may be a false one.

As Purvin & Gertz puts it, "These draws should not be misconstrued as a shortage of available supply, and the upward move is really unjustified. Refiners are simply making a prudent move again to reduce buffers in the offseason as backwardation continues. Even distillate market time structure into winter does not support large stock builds. Nevertheless, these factors will keep trade sentiment strong."

So what's likely to happen at the next OPEC meeting, in September. The best guess here is that OPEC will simply codify current levels of production and wait to see what happens next, probably suggesting a continuing review of price levels under its price-band-trigger monitoring system to see whether further increases are warranted.

And then probably backing off those actual increases at the last minute, just as they did the last time, because the markets themselves turned the pronouncement of the trigger effect into a market slide that brought prices back within the price band again—thus negating the need for an increase.

Commodity markets and self-fulfilling prophecies—a match made in heaven.

OGJ Hotline Market Pulse
Latest Prices as of August 11, 2000

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Nymex unleaded

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Nymex heating oil

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IPE gas oil

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Nymex natural gas

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