MARKET WATCH: China cuts subsidies, oil falls $4/bbl

Oil prices fell more than $4/bbl June 19 in New York as China reduced it's fuel subsidies, effectively raising its public costs by 17% for gasoline and 18% for diesel.

Sam Fletcher
Senior Writer

HOUSTON, June 20 -- Crude prices fell more than $4/bbl June 19 in New York as China reduced it's fuel subsidies, effectively raising its public costs by 17% for gasoline and 18% for diesel and setting the stage for a possible drop in world demand.

But crude prices were climbing again in early trading June 20 on reports that Israel's recent large military exercise in the eastern Mediterranean was really practice for a potential bombing attack on nuclear facilities in Iran. "More than 100 Israeli fighter planes, together with rescue helicopters, supposedly trained over the Mediterranean, replicating the flying distance (and the necessary refueling) from Israel to Iran," said Olivier Jakob at Petromatrix, Zug, Switzerland.

Jakob said, "By joining the list of emerging countries that have lowered subsidies, China is another confirmation that price-wise we are closer to the demand breaking point. Any further attempts at new record high levels or the mythical $150/bbl will be met by an increased risk of demand destruction." News of China's surprise move helped strengthen the US dollar against the euro and yen that day.

However, analysts in the Houston office of Raymond James & Associates Inc. said China's decision to cut fuel subsidies "might actually spur crude imports, at least in the short term, as domestic refineries that are now able to charge higher prices ramp up activity to reduce shortages." They said, "China, the world's second largest consumer of oil, has seen year-to-date gasoline and diesel imports rise 16% and 18%, respectively."

Jakob said, "The hard truth is that nobody has a proper estimate of Chinese oil demand due to lack of information on the Chinese stock changes, or the influence of their black market flows; in that context the easiest solution for analysts will be to say that the price hike will have little influence on demand. The International Energy Agency has already stated that they will not change their Chinese oil demand outlook on the price hike. We should, however, keep in mind that the IEA early this year was also saying that Organization for Economic Cooperation and Development [member countries'] demand would be resilient to high oil prices, and since then they had to revise down their world oil demand forecast by half."

Meanwhile, expectations generally are low for the upcoming June 22 meeting of oil producers and consumers in Jeddah, Saudi Arabia. Adam Sieminski, chief energy economist, Deutsche Bank, Washington, DC, said, "The meeting communique from Jeddah likely will offer the following: Saudi Arabia will pump more oil, US consumers will further reduce their gasoline use, regulators will put pressure on speculators, the Fed will try to stabilize the dollar, China has cut subsidies, and maybe Russia will be able to stem its first quarter oil production decline. With luck, oil prices can be capped below $140/bbl."

Jakob reported, "Most expectations are now for Saudi Arabia to increase supply by only an additional 200,000 b/d. This is starting to be priced in, but with Saudi Arabia being a master of providing surprises, the weekend risk for more supply will remain."

Sieminski said, "Oil markets are in a state of confusion, unwilling to believe that the forces that drove oil prices higher over the past year, namely lower oil production [from] the Organization of Petroleum Exporting Countries, disappointing non-OPEC supply, strong economic growth in the developing world, and a weaker US dollar may now be working in reverse or at least not working in favor of even higher prices."

Meanwhile, the US dollar declined against the euro on June 20, Nigerian oil workers said they will strike at a Chevron Corp. facility on June 23, and Venezuelan President Hugo Chavez threatened an oil boycott against the European Union after the EU parliament passed new rules deporting illegal immigrants. That might give pause to hard-liners against illegal immigrants in the US since Venezuela sends most of its oil exports to the US, not Europe.

Energy prices
The July contract for benchmark US light, sweet crudes dropped $4.75 to $131.93/bbl June 19 on the New York Mercantile Exchange. That contract expires at the close of business June 20. The August contract lost $4.57/bbl to $132.60/bbl. On the US spot market, West Texas Intermediate at Cushing, Okla., was down $4.75 to $131.93/bbl. Heating oil for July delivery dropped 14.65¢ to $3.71/gal on NYMEX. The July contract for reformulated blend stock for oxygenate blending (RBOB) declined 11.41¢ to $3.35/gal.

After hitting an intraday record price of $13.35/MMbtu, the July natural gas contract dropped to $12.84 at closing, down 34.9¢ for the day on NYMEX. That fall was triggered by the Energy Information Administration's report of the injection of 57 bcf of natural gas into US underground storage in the week ended June 13. Working gas in storage is now at 1.9 tcf, 376 bcf less than a year ago at the same time and 52 bcf below the 5-year average. Raymond James analysts said, "Current prices appear justified by the large year-over-year storage deficit, but downside remains later this year due mainly to growth in domestic supply."

On the US spot market, gas at Henry Hub, La., gained 7.5¢ to $13.01/MMbtu.

In London, the August IPE contract for North Sea Brent crude was down $4.44 to $132/bbl. However, the July gas oil contract gained $9.50 to $1,221.75/tonne.

The average price for OPEC's basket of 13 reference crudes increased 99¢ to $129.44/bbl.

Contact Sam Fletcher at samf@ogjonline.com

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