MARKET WATCH: Prices fall as market ignores OPEC

Energy prices fell Oct. 28 for the third consecutive session, with oil exploring new 17-month lows in intraday trading as markets continued to ignore OPEC's 1.5 million b/d production cut.

Sam Fletcher
Senior Writer

HOUSTON, Oct. 29 -- Energy prices fell Oct. 28 for the third consecutive session, with crude exploring new 17-month lows in intraday trading as markets continued to ignore the Organization of Petroleum Exporting Countries' 1.5 million b/d production cut effective Nov. 1.

OPEC ministers voted Oct. 24 to reduce the group's official production quota to 27.3 million b/d. However, OPEC reported its members produced 32 million b/d of crude in September. Now some ministers are talking of meeting again to consider further production cuts prior to group's scheduled Dec. 17 meeting in Oran, Algeria. Several analysts see that as a sign of the cartel's desperation to push up crude prices.

OPEC has lost its previous control of oil prices with crude trading now following the ebb and flow of the stock markets. "The broader and energy markets rallied yesterday afternoon on expectations that the Federal Reserve and other global central banks such as Japan, the European Central Bank, and Britain will lower interest rates," said analysts in the Houston office of Raymond James & Associates Inc. "The 2-day Fed meeting, which began Oct. 28, is expected to result in another interest rate reduction of 50 basis points to 1%, the lowest since June 2004."

They said, "Since OPEC's production cut announcement last Friday, crude prices have been responding contrary to expectations. Will demand destruction exceed OPEC cuts? Possibly." Raymond James analysts observed crude prices were up more than 5% in premarket trading Oct. 29. "Is the market finally responding to OPEC, or are interest rate cuts just making investors trigger happy?" they wondered.

Olivier Jakob at Petromatrix, Zug, Switzerland, said, "The global supply and demand continues to readjust to the economic slowdown but with most of the industry shaving [capital spending] and holding as much cash as possible, we foresee a trend for a greater move to minimum of inventory into next year."

Nobuo Tanaka, executive director of the International Energy Agency in Paris, and others say low energy prices could cause infrastructure underinvestment. Some say lower oil prices are not "favorable" to climate change as higher priced alternative energy technologies become "luxuries" when competing against low-cost fossil fuels. OPEC Sec. Gen. Abdalla Salem El Badri has said further price declines would result in infrastructure project delays or cancellations and that OPEC countries would postpone capacity expansion projects before cutting domestic programs.

'The iron laws' of economics
In its October report, the Centre for Global Energy Studies said OPEC's proposed production cut challenges "the iron laws of economics." CGES analysts said, "This is not the time for the world's residual suppliers to constrain oil supplies. The world is almost certainly sliding into a recession that everyone hopes will be shallow and short but could be deep and long lasting. The savage oil price rises of the last 5 years, which have taken the OPEC basket price from an average $28/bbl in 2003 to an expected $100/bbl for this year, were instrumental in cutting back the rate of growth of oil demand from a peak of 3.9% in 2004 to 1% in 2007 and a projected 0.2% this year. The impending recession will add a further downward thrust to oil consumption, despite the heavy fall in the price of oil from its peak above $140/bbl in July, making any attempt to push the oil price back up again—perhaps above $100/bbl, as many in OPEC seem to want—a special kind of madness."

Although the global credit crunch cannot be ascribed directly to the escalation of oil prices, the rapid rise in the cost of crude helped create conditions that made the crisis more difficult to address deal with. "There is little doubt that the relentless rise in oil prices caused inflation everywhere to edge up at first and then accelerate. The world had enjoyed a relatively long period of stable and low consumer inflation, which had allowed central banks to drop their discount rates to historically low levels. Cheap money was prevented, though, from having its usual impact on inflation by productivity gains and low-cost imports from the Far East in a world trading system," CGES reported.

However, it said, cheap money had a deleterious effect on the financial system by encouraging the reckless pursuit of higher returns. "What started as a hillock of high-yielding, subprime debt ended up as a mountain of toxic paper that few were willing to buy—and the rest, as they say, is history that is still with us," said CGES.

US Inventories
The Energy Information Administration said Oct. 29 commercial US crude inventories increased 500,000 bbl to 311.9 million bbl in the week ended Oct. 24. That was below Wall Street's consensus for a 1 million bbl build. Gasoline stocks for the same period fell 1.5 million bbl to 195 million bbl, while Wall Street expected an increase of 1.1 million bbl. Distillate fuel inventories climbed 2.3 million bbl to 126.6 million bbl, outstripping a consensus for a 1.2 million bbl increase. Propane and propylene stocks fell 700,000 bbl to 60.4 million bbl.

Imports of crude into the US declined by 63,000 b/d to 10.3 million b/d that same week. However, the input of crude into US refineries increased 289,000 b/d to 14.9 million b/d, with units operating at 85.3% of capacity. Gasoline production dropped to 8.8 million b/d while distillate fuel production was flat at 4.4 million b/d.

Analysts at Friedman, Billings, Ramsey & Co. Inc. (FBR) in Arlington, Va., said, "Although EIA data can be 'lumpy' (a tanker can arrive a day late or a day early, for example), we would suggest that crude and product builds could easily continue given surging imports and continued low refiner utilization levels in response to declines in vehicle miles traveled." The latest MasterCard Advisors' data implied US gasoline demand of 8.897 million b/d, "a 6.4% retreat against year-ago levels," they said.

Jacques H. Rousseau, an analyst at Soleil-Back Bay Research, said refined product inventories (gasoline plus distillate plus jet fuel) were essentially unchanged vs. the previous week as refiners were able to keep supply low to match weak demand. "We expect this pattern to continue in the coming weeks since low gasoline margins do not provide enough incentive for refiners to increase production, in our view. Distillate margins remain strong ($15-25/bbl) and are the key variable to monitor to determine refiner profitability in the fourth quarter," he said.

In other news, the US Minerals Management Service said as of midday Oct. 28, crews had not yet returned to 71 of the 694 manned production platforms in the Gulf of Mexico following earlier evacuations because of Hurricanes Gustav and Ike. They said 27.8% of normal oil production and 33.5% of the usual gas production from federal leases in the gulf remain shut-in.

Energy prices
The December contract for benchmark US light, sweet crudes dropped 49¢ to $62.73.bbl Oct. 28—the lowest closing price for a front-month contract on the New York Mercantile Exchange since May 2007. The January contract fell 50¢ to $63.21/bbl. Heating oil for November dipped by 0.24¢ with the closing price virtually unchanged at $1.91/gal on NYMEX. The November contract for reformulated blend stock for oxygenate blending (RBOB) declined 2.14¢ to $1.46/gal.

Natural gas for the same month gained 6.5¢ to $6.19/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., jumped by 15.5¢ to $6.43/MMbtu.

In London, the December IPE contract for North Sea Brent crude lost $1.12 to $60.29/bbl. Gas oil for November delivery dropped $7.75 to $622/tonne.

The average price for OPEC's basket of 13 reference crudes was down 90¢ to $55.90/bbl Oct. 28.

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