MARKET WATCH: Crude price falls below $70/bbl to 14-month low

Sam Fletcher
Senior Writer

HOUSTON, Oct. 17 -- Energy prices continued to tumble Oct. 16 with crude falling below $70/bbl for first time since August 2007 following a report of unexpected large builds in US inventories of crude and gasoline that indicate declining demand.

"As the US and global markets appear to slip into a recession, demand destruction remains one of the biggest concerns. In the US alone, which uses 24% of the world's oil, total petroleum demand is down 9.9% on a 4-week moving average to its lowest level since June 1999," said analysts in the Houston office of Raymond James & Associates Inc. However, crude was back above $70/bbl in premarket trading Oct. 17.

Equity markets were down most of the Oct. 17 session until a rally in the last 90 min pushed the Down Jones Industrial Average up 401.35 points at closing. Usually the trading in stock and commodities markets moves in opposite directions, making commodities a good alternative investment when the equity market is down. This month, however, the Dow Jones Industrial Average is down 17.3% while the Dow Jones-American International Group Inc. Commodity Index is down 19.3% in a parallel plunge. That might continue as the global recession deepens, stifling world demand for energy, analysts said.

In the current climate of economic fear, it is too early to look for a short-term floor for oil prices, said Paul Horsnell, Barclays Capital Inc., London. "The speed of oil price falls has come from a Venturi effect, where an attempt to price in sharply lower demand perceptions has been channeled through a narrowing funnel caused by lower risk appetite and the immediate desire for increased liquidity," he said.

Markets now are trading on a common perception of economic growth in 2009 that is "about 4% lower than it was just 7 weeks ago," Horsnell said. "That reduction, from about 3% down to about minus 1%, is of course not a forecast, nor is it consensus, nor would we necessarily agree with it; it is simply a subjective but we think reasonably accurate, measure of the perception shift that we think has occurred in the oil market," he said.

OPEC meeting
The near-month contract for benchmark US crude has plummeted to less than half of its record high of $147/bbl just 3 months ago, prompting the Organization of Petroleum Exporting Countries to reschedule an extraordinary meeting to Oct. 24 from the original Nov. 18 date (OGJ Online, Oct. 16, 2008).

That move probably means OPEC ministers have already decided on a production cut, said Olivier Jakob at Petromatrix, Zug, Switzerland. "The only question we see is to whether it will be a 500,000 b/d or 1 million b/d cut, and it seems that they rather risk the political hardship of doing it before the US elections than miss…the cut for the December nominations." The average price for OPEC's basket of 13 reference crudes fell $5.24 to $63.34/bbl on Oct. 16.

With commodity prices now at "multiyear lows" and the prospect of a reduction in OPEC production, Jakob said, "We could start to see the consumer (airlines, etc.) starting to be a bit more aggressive on the hedging programs. We do not think that the economy or politics will allow for oil to move back to the previous record highs (and by cutting production, OPEC is increasing its spare capacity)." At $60-70/bbl, he said, crude would no longer be overvalued.

At Friedman, Billings, Ramsey & Co. Inc. (FBR) in Arlington, Va., analysts noted that OPEC still plans its 151st regular meeting Dec. 18 in Oran, Algeria. "This means OPEC will get more than one chance in the next 60 days to cut its production quota from current levels of 28.8 million b/d, possibly softening the impact from a one-time blow to Saudi Arabian production," they said. "OPEC President Chakib Khelil said last week that a production cut is 'very likely;' this morning, Qatari Oil Minister Abdullah Al Attiyah told Al Jazeera television OPEC planned to cut quotas by '1 million [bbl], or more.' We believe that the opportunity for two successive cuts before year-end presents OPEC with the means to lower quotas below 28 million b/d by 2009."

Horsnell said OPEC is likely to cut more than is necessary for the medium term, if prices are to be stabilized in the short run. "A cut of 1 million b/d with the potential for more cuts to come looks like a feasible starting point for discussions," he said. "US crude inventories have now moved back slightly above their 5-year average, while the tail of the massive armada of gasoline imports into the Gulf Coast continues to push inventories sharply higher."

The Energy Information Administration said commercial US benchmark crude inventories jumped by 5.6 million bbl to 308.2 million bbl, more than twice the increase expected by Wall Street analysts, during the week ended Oct. 10. Gasoline stocks shot up 7 million bbl to 193.8 million bbl, vs. a Wall Street consensus of a 3 million bbl build. Distillate fuel inventories fell 500,000 bbl to 122.1 million bbl (OGJ Online, Oct. 16, 2008).

As of midday Oct.16, the US Minerals Management Services said workers evacuated prior to Hurricane Ike still have not returned to 77 of the 694 manned production platforms in the Gulf of Mexico. Officials said 39.4% of the oil and 36.6% of the natural gas formerly produced from federal leases in the gulf are still shut-in.

In other news, Michael Schmitz of Banc of America Securities LLC said that bank has lowered its price forecasts for oil and gas as well as earnings and cash flow estimates for the group of exploration and production companies it follows. The bank reduced its 2008 composite spot natural gas price forecast to $8.65/MMbtu from $9.50/MMbtu and for 2009 to $7.25/MMbtu from $8.25/MMbtu. Consensus estimates for 2008 and 2009 composite spot natural gas prices are currently $9.30/MMbtu and $8.70/MMbtu, respectively.

The bank lowered its 2008 spot price estimate for West Texas Intermediate $104/bbl from $108/bbl and for 2009 to $75/bbl from $90/bbl. Consensus estimates for 2008 and 2009 spot WTI are currently $108/bbl and $99/bbl, respectively. "Importantly, we are not changing our long-term (2010 and beyond) composite spot natural gas and spot WTI oil price forecasts of $7.50/MMbtu and $80/bbl," Schmitz said. "However, we are lowering our price targets by roughly 35%, on average, to account for the higher equity risk premiums in the current market." He said, "Our E&P group is currently trading at just 52% of estimated yearend 2007 proven reserve liquidation value (using long-term prices of $7.50/MMbtu and $80/bbl) compared with an average multiple of 110% since 2000, including a previous low prior to the recent sell-off of 79% in 2001."

Energy prices
The November contract for benchmark US light, sweet crudes dropped $4.69 to $69.87/bbl Oct. 16 on the New York Mercantile Exchange. The December contract fell $4.62 to $70.26/bbl. On the US spot market, WTI at Cushing, Okla., was down $4.70 to $69.85/bbl. The November contract for reformulated blend stock for oxygenate blending (RBOB) lost 16.02¢ to $1.62/gal on NYMEX. Heating oil for the same month declined 10.32¢ to $2.09/gal.

The November natural gas contract escalated by 11.1¢ to $6.70/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., lost 1¢ to $6.64/MMbtu.

In London, the November IPE contract for North Sea Brent crude dropped $4.48 to $66.32/bbl. Gas oil for that month fell $30.25 to $674.50/tonne.

Contact Sam Fletcher at [email protected].