MARKET WATCH: Gustav's potential threat lifts energy prices

Despite continued signs of weakening demand, the advance of Hurricane Gustav toward the US sector of the Gulf of Mexico boosted crude and natural gas prices Aug. 26.

Sam Fletcher
Senior Writer

HOUSTON, Aug. 27 -- Despite continued signs of weakening demand, the advance of Hurricane Gustav toward the US sector of the Gulf of Mexico boosted crude and natural gas prices Aug. 26.

Although downgraded overnight to a tropical storm, "Gustav is viewed as the first major storm threat to US refinery operations in 3 years," said analysts at Pritchard Capital Partners LLC in New Orleans. Weakened by its passage over Haiti, the storm is expected to move out over the Caribbean on Aug. 27, reenergize into a hurricane once again, and could move into the Gulf of Mexico early this weekend, threatening the US central Gulf Coast on Labor Day, at the earliest. Storm warnings have been issued from Florida to Texas.

Olivier Jakob at Petromatrix, Zug, Switzerland, said "it would be a mistake" to discount the storm's potential to disrupt offshore and coastal oil and gas operations. "The direction Gustav takes will depend a lot on its interaction with land over Cuba, but for now computer models are still showing a track to the US gulf oil assets. Given that it should reintensify to a major hurricane once in the gulf, we would still expect to see more precautionary shut-downs of oil platforms in front of the weekend," he said.

Indeed, Shell Oil Co. began Aug. 27 evacuating nonessential personnel from production and drilling operations in the gulf. "We expect to bring in around 300 people today. These evacuations will have no impact on production," a company official reported.

Jacques H. Rousseau, an analyst at Soleil-Back Bay Research, reported refining stocks were on the rise amid fears that Gustav could potentially disrupt refining capacity in Texas or Louisiana. "However, fundamentals remain weak with demand continuing to decline and domestic production and imports rising. Absent a supply disruption we expect sector conditions to further weaken in September due to seasonally falling demand. We remain cautious on the near term outlook for refining stocks," he said.

Jakob said, "In 2005 when Katrina hit the US Gulf, US refineries were running at 97% of capacity; today they are at 87%. Fundamentally because US demand is running 1.2 million b/d lower than a year ago and results in idle refining capacity, it makes the US less structurally exposed to the destructive impact of a hurricane. However, we must also recognize that volatility and speculative sensitivity is higher today than in 2005; hence we are not ready to ignore the price impact that Gustav could have."

Prices for both oil and gas were up in premarket trading Aug. 27, "with natural gas up nearly 6%," said analysts in the Houston office of Raymond James & Associates Inc. "Expect crude and especially natural gas prices to gain support as Gustav is expected to travel through the Caribbean this week and may reach the Gulf of Mexico this weekend." Raymond James analysts said, "Despite short-term volatility, the crude market continues striving to reach an equalizing supply-demand pricing point; notably, the Energy Information Administration (EIA) reported that oil demand in June fell 5.6% from last year (OGJ Online, Aug. 26, 2008)."

Meanwhile, Jakob noted, "The daily price change yesterday was relatively modest but the high-low range remained wide, and we would expect to see continued high volatility today and tomorrow as most of the trading books will probably be squared before Friday. Low volume should continue to be a factor. Volume yesterday was better than Monday when volume on West Texas Intermediate at 237,000 lots was the smallest volume seen this year."

Energy outlooks
In its Aug. 27 edition, The Wall Street Journal reported natural gas futures are now trading at an 18-year low relative to crude. It noted that crude closed at the equivalent of $20.05/MMbtu Aug. 26 on the New York market, while natural gas settled at $8.27/MMbtu, "or 41% of the price of oil." With US gas storage just above the 5-year average, gas should be trading at the 60-70% level, it said. Furthermore, it said, the crude-gas ratio generally has averaged 9 but is now closer to 14.

Raymond James analysts said, "Increased gas supply estimates of 8% growth this year vs. 4% growth in 2007, according to the EIA, coupled with a decrease in demand growth from 6.5% to 3%, is a primary explanation for the differential. Likewise, we think increasing supply will continue to depress gas prices into next year."

EIA Administrator Guy F. Caruso said crude prices could fall below $100/bbl over the next 18 months because of slowing worldwide demand and increased oil production from the US, Brazil, Canada, Saudi Arabia, and Angola. Although not the official EIA prediction, Caruso said the chance of an oil price decline is "now closer to 50/50" if spare production capacity increases from to 3-4 million b/d from 1.5 million b/d currently. "That scenario is now more realistic than any time in the past 5 years," he said. Falling oil prices could lead to conflict in the Organization of Petroleum Exporting Countries as members try to retain market shares while reducing production. EIA earlier predicted oil prices of $120-130/bbl this year, compared with a record $147.27/bbl on July 11. Prices have fallen more than 20% since then.

Caruso reiterated that release of oil from the Strategic Petroleum Reserve would have little effect on prices and should be preserved for "real emergencies."

US inventories
EIA said Aug. 27 commercial US crude inventories dipped by 100,000 bbl to 305.8 million bbl during the week ended Aug. 22. The consensus among Wall Street analysts, however, was for a 1.1 million bbl increase. US gasoline stocks fell 1.2 million bbl to 195.4 million bbl in the same period, below average and well below analysts' expectations of a 2.3 million bbl decline. Distillate fuel inventories remained essentially unchanged at 132.1 million bbl vs. a consensus for a 400,000 bbl increase. Propane and propylene inventories increased by 1.2 million bbl to 52 million bbl in the same week.

Imports of crude into the US fell by 1 million b/d to 10 million b/d in that period. The input of crude into US refineries increased, however, by 300,000 b/d to 15.1 million b/d, with units operating at 87.3% of capacity. Gasoline production increased to 9.2 million b/d during the week while distillate fuel production decreased to 4.4 million b/d.

Energy prices
The October contract for benchmark US light, sweet crudes continued to climb in the second consecutive trading session Aug. 26, closing up by $1.16 to $116.27/bbl after trading through the day at $112.36-117.89/bbl on the New York Mercantile Exchange. The November contract gained 99¢ to $116.70/bbl. On the US spot market, WTI at Cushing, Okla., was up $1.50 to $116.77/bbl. Heating oil for September increased 5.85¢ to $3.21/gal on NYMEX. The September contract for reformulated blend stock for oxygenate blending (RBOB) climbed 8.74¢ to $2.97/gal.

The natural gas market reversed directions and began climbing Aug. 26, with the September contract up 45.3¢ to $8.28/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., gained 43¢ to $8.04/MMbtu.

In London, the October IPE contract for North Sea Brent crude increased 60¢ to $114.63/bbl. Gas oil for September turned around its previous decline and advanced $14 to $1,034.75/tonne.

The average price for OPEC's basket of 13 reference crudes dipped by 10¢ to $110.51/bbl on Aug. 26.

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