Market watch: Falling futures prices ignore market fundamentals, analysts say

Energy prices continued to deteriorate in anticipation of the United Nations Security Council's approval of a resolution stipulating no military action be taken against Iraq without consulting the UN.

Sam Fletcher
OGJ Senior Writer

HOUSTON, Nov. 8 -- Energy futures prices continued to deteriorate Thursday in anticipation of the United Nations Security Council's approval Friday of a resolution stipulating no military action can be taken against Iraq without first consulting the UN.

Market perceptions of increased cheating on production quotas among members of the Organization of Petroleum Exporting Countries have coupled with reduced apprehension of any immediate threat of war in the Middle East to drive down oil futures prices in recent weeks.

But rather than losing "cohesion," as some traders suspect, "OPEC appears to be on a war footing," said Paul Horsnell, head of energy research for JP Morgan Chase & Co., London.

"Oil is being moved out of the (Persian) Gulf to fill up producer-held storage closer to market. We suspect that much of OPEC's apparent increase is not actually making its way to refiners. Some is, as oil is also being moved to Asian refiners who have a certain sense of panic that their inventories are too low for normal times, let alone for a period of Middle East uncertainty," he said.

In a condemnation of futures market speculation, Horsnell said, "Grievous bodily harm has been inflicted on oil prices over the last month. It doesn't take Sherlock Holmes to work out who and how, but why is more arguable."

Data from the Commodities and Futures Trading Commission "show the heaviest selling of crude oil futures by non-commercial traders over any 4-week period since 1998," amounting to 63.7 million bbl of crude oil futures and 93.4 million bbl of oil and petroleum products futures combined.

"Of the 21 most active US commodity contracts, speculative funds are net short in just 2, cocoa and crude oil. In other words, they are short in one commodity (that) is already being affected by a war and in another (that) is likely to be," Horsnell said. "While it is elementary that prices have buckled under the weight of selling by hedge funds and commodity trading advisors, there is still the question of motive."

In a separate report this week, Michael Rothman, first vice-president and senor energy market specialist at Merrill Lynch, Pierce, Fenner & Smith Inc., said, "We suspect that the price declines since last week were actually coincident with hedge funds increasing the size of their net short open interest position in . . . crude (futures) and would hazard a guess that their net position grew to something in the neighborhood of 35-45 million barrels, leaving them prone to short-covering pressures."

The December contract for benchmark US light, sweet crudes fell 39¢ to $25.38/bbl Thursday on the New York Mercantile Exchange, while the January contract dropped 35¢ to $24.93/bbl. Unleaded gasoline for December delivery lost 1.64¢ to 70.14¢/gal. Heating oil for the same month was down 1.17¢to 69.62¢/gal.

However, Horsnell said, "US heating oil inventories have now passed beyond critical into dangerously low. They are too low for a normal US winter, let alone the lower-than-normal temperatures of late. There will be serious price spikes unless the weather warms up significantly and inventories increase very sharply."

Moreover, he said, "Reformulated gasoline can also be added to the intensive care list, after 13 inventory falls in the last 15 weeks. The overall level of gasoline inventories is also far too low for a market where October demand showed a remarkable 4% annual growth rate."

US oil inventories have increased recently, with refinery runs still depressed as the result of extended storms along the US Gulf Coast where those facilities are concentrated. However, oil stocks "are still 16.5 million bbl below normal levels, and the extent of the recent increase still fall short of what we would have expected given the refinery slow down," Horsnell said.

"The oil market has then not slipped from tight to slack," he said. "If the supposed tide of OPEC oil fails to improve things quickly, then the fundamentals might cause a panic just as the geopolitics start to heat up and just as the speculative short-selling runs out of steam."

The December natural gas contract declined 2.3¢ to $3.83/Mcf Thursday on NYMEX, despite a report by the US Energy Information Administration of the early withdrawal last week of 27 bcf of gas from underground storage.

"Year-over-year natural gas storage comparisons should now become increasingly supportive of prices," said Robert Morris, energy market analyst with Salomon Smith Barney Inc., New York. "After eliminating what was a more than 760 bcf year-over-year surplus at the beginning of April, storage levels are now below last year's levels heading into the winter."

Moreover, he said, "Despite our assessment that industrial demand is still lagging 1 year ago by around 1.5 bcfd or more, North American natural gas production is projected to continue to decline. Consequently, with just normal temperatures in November and December, we project US storage could end this year at a year-over-year deficit of nearly 500 bcf."

In London, the December contract for North Sea Brent oil lost 22¢ to $23.48/bbl on the International Petroleum Exchange. The December natural gas contract jumped 7.2¢ to the equivalent of $3.83/Mcf on IPE.

OPEC's basket of seven benchmark crudes lost 20¢ to $23.61/bbl Thursday.

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