MARKET WATCH: Increased supply, declining demand reduce oil prices

Crude prices dipped below $100/bbl Oct. 1 in New York as traders' attention returned to the fundamentals of increased supply and declining demand due to a dismal economy.

Sam Fletcher
Senior Writer

HOUSTON, Oct. 2 -- Crude prices dipped below $100/bbl Oct. 1 in New York as traders' attention returned to the fundamentals of increased supply and declining demand due to a dismal economy.

"Crude is again trading lower this morning following a bearish Department of Energy inventory report yesterday and building worries of demand destruction. Natural gas is trading flattish despite the slow ramp-up of Gulf of Mexico production. In our view, production lost due to the hurricanes will not be nearly enough to save gas prices in 2009," said analysts in the Houston office of Raymond James & Associates Inc.

DOE's Energy Information Administration reported commercial US crude inventories gained 4.3 million bbl to 294.5 million bbl in the week ended Sept. 26. Gasoline stocks increased by 900,000 bbl to 179.6 million bbl. Distillate fuel inventories fell 2.3 million bbl to 123.1 million bbl (OGJ Online, Oct. 1, 2008).

Analysts at Barclays Capital Inc. said, "The long awaited rise in crude oil inventories appears to have started, with the brutal mathematics of cumulative refinery run reductions having exceeded cumulative crude output losses, now working its way through the data." They said, "Our global demand projections now show just 450,000 b/d growth, indicating that 2008 is now set to rank alongside 1998 and 2002 as one of the weakest recent years for oil demand."

Jacques H. Rousseau, an analyst at Soleil-Back Bay Research, said refined product inventories (gasoline plus distillate plus jet fuel) declined by only 2.4 million bbl last week, less than expectations due to very weak demand, which was more than 5% below year-ago levels for the week. "Some of this consumption decline could have been due to the lack of product availability in some markets, especially the Southeast," he said. "We believe refining margins will remain above average until normal inventory levels are restored, which we do not expect to occur until around yearend 2008. This should positively impact second half earnings for the refiners. However, we remain concerned about weak demand."

In its latest monthly Traffic Volume Trends report for July, the Department of Transportation showed a 3.6% decline in total miles driven on US streets and highways in July 2008 versus July 2007, and a 3% decline year-to-date through July vs. year-ago levels. For June, those figures were down 4.7% and 2.8% respectively.

Olivier Jakob at Petromatrix, Zug, Switzerland, said, "With demand for petroleum products being well off the levels of previous years, refiners are able to manage better the disruption linked to the hurricanes. US petroleum demand for the 4-week average is reported in the DOE weekly report to be down 1.4 million b/d (and that is before any revisions, which have averaged about 700,000 b/d so far this year). This is also about 1.2 million b/d lower than in the same period in 2005" when Hurricanes Katrina and Rita struck the Gulf Coast.

Jakob said, "While there is much political talk about the need for the US to cut its dependence on foreign oil imports, the hidden truth is that US refineries are importing crude oil only to export middle distillates. When the US does not export middle distillates (as in times of hurricanes disruptions) it is then able to easily switch yields back to gasoline and resupply the domestic market. But with low demand it can not do that for too long a time before recreating a glut. As a result, the gasoline November and December cracks are starting to flirt with even levels to crude oil."

Meanwhile, Gulf Coast imports of crude are rebounding as storm-delayed cargoes are being discharged. "But the draw in Cushing [,Okla., spot market] stocks has triggered short covering on the front timespreads, which are moving into a deeper backwardation," Jakob said.

The US House of Representatives is expected to vote Oct. 3 on the new economic rescue package that the Senate approved Oct. 1. The Senate vote "was closely watched by renewable energy companies, because among the new 'sweeteners' included in the bill were the tax credit extensions that have been in limbo for much of the past year—notably the investment tax credit for solar power and the production tax credit for wind power," Raymond James analysts said. "While viewed as a step in the right direction, do not expect the champagne to be opened just yet. There remains the uncertainty of the House vote."

Storm update
The US Minerals Management Service said both the evacuation and shut-in production figures that it released Sept. 29-30 were inaccurate because some offshore operators failed to report. "Steps have been taken to ensure full compliance with the prescribed deadlines in the future," said MMS officials. Updated as of midday Oct. 1, MMS reported 123 of the 694 manned production platforms and 1 of the 116 mobile rigs operating in the US sector of the Gulf of Mexico were still without crews. The corrected number of evacuated platforms was up from the 111 reported earlier. MMS said 58.8 % of oil and 47.7% of natural gas usually produced from offshore federal leases are still shut in, up from earlier reports of 57.1 % and 47.7%, respectively.

DOE said 1 refinery with a capacity of 348,500 b/d remained offline and another 13 refineries with total capacity of 3.2 million b/d of capacity were operating at reduced runs. Additionally, gas processing plants with total capacity of 3. 2 bcfd are still shut down while12 natural gas processing plants with total capacity of 7.2 bcfd are restarting or operating at reduced runs. Officials said 35,000 Texas customers are still without electrical power.

In reaction to a request by Georgia Gov. Sonny Perdue's (R), DOE agreed to release 900,000 bbl of crude from the Strategic Petroleum Reserve for delivery to two unidentified Georgia refineries. "In rough numbers, we estimate total hurricane-related production losses at approximately 31.26 million bbl and total SPR draws at approximately 5.8 million bbl," said analysts at Friedman, Billings, Ramsey & Co. Inc. in Arlington, Va.

FBR analysts also noted that Sen. Jim DeMint (R-SC) introduced a bill to circumvent the usual 5-year planning process for federal offshore drilling to enable lease sales next year that would offer coastal states 50% of the royalties from adjacent federal waters. "This represents the most extreme flavor of 'drill, drill, drill' language we have seen since rising natural gas prices engendered Congressional activism 6 years ago, making it the least tenable in a divided Congress. The current 5-year plan expires in 2012; even though the Interior Department has completed its preliminary work to offer coastal leases on the Atlantic and Pacific OCS, lease sales for this acreage are not feasible before 2010."

Moreover, the analysts reiterated, "Democrats have not necessarily 'lost' on the drilling issue. The next Congress would have more than enough time to reinstate the moratorium in appropriations law (Congress blocks drilling by "deappropriating" monies for lease sales in off-limits waters) and an Obama Administration could 'rewithdraw' coastal waters from consideration for the next 5-year plan."

Energy prices
The November contract for benchmark US sweet, light crudes traded at $95.95-102.84/bbl Oct. 1 before closing down $2.11 for the day at $98.53/bbl on the New York Mercantile Exchange. The December contract dropped $2.34 to $97.92/bbl. The new front-month November contract for heating oil lost 4.78¢ to $2.85/gal. Reformulated blend stock for oxygenate blending (RBOB) for the same month fell 9.77¢ to $2.36/gal.

The November natural gas contract escalated by 29¢ to $7.73/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., climbed 25.5¢ to $7.46/MMbtu. EIA reported the injection of 87 bcf of natural gas into US underground storage during the week ended Sept. 26. That brought total working gas in storage to 3.1 tcf, down 137 bcf from year-ago levels but 50 bcf above the 5-year average.

In London, the November IPE contract for North Sea Brent crude lost $2.84 to $95.33/bbl. Gas oil for October gained $3.25 to $917.75/tonne

The average price for the Organization of Petroleum Exporting Countries' basket of 13 reference crudes declined 33¢ to $89.99/bbl Oct. 1.

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