MARKET WATCHEnergy prices continue climb amid Israeli-Lebanon conflict

July 24, 2006
Energy prices continued to climb July 21 as traders covered futures market positions prior to possible changes in market conditions over the weekend from Israel's 2-week war against Hezbollah guerillas in Lebanon.

Sam Fletcher
Senior Writer

HOUSTON, July 24 -- Energy prices continued to climb July 21 as traders covered futures market positions prior to possible changes in market conditions over the weekend from Israel's 2-week war against Hezbollah guerillas in Lebanon.

Israeli troops took a strategically important border town in Lebanon over the weekend, prior to a scheduled visit to the Middle East by US Sec. of State Condoleezza Rice on July 24. There is growing outside pressure on Israel for a ceasefire. Israeli officials have said they would accept North Atlantic Treaty Organization peacekeepers along the border with Lebanon.

Price ratios
As a result of soaring crude prices and falling natural gas prices through much of this year, gas is now selling in the US for only 1/13 as much as a barrel of oil, compared with 1/7 the price of a barrel of crude a year ago, said Paul Ziff, chief executive officer of Ziff Energy Group, Calgary. The last time the divergence between oil and gas prices was that large was in October 1996, he said.

"The current price ratio of over 13 Mcf of gas to a barrel of oil is a very unusual situation that will have very differing impacts on various sectors of the gas industry, producers, and users," Ziff Energy analysts reported July 24. "Geopolitical risk is widespread in our world today, with the uncertain war in Iraq, the new hostilities in the Middle East, and occasional headlines from Nigeria, Korea, and Venezuela. Consequently, a very large risk premium is embedded to the price of world oil, which is the main reason for the unusually high ratio."

Another contributing factor is that gas prices have been squeezed by a robust increase in North American gas storage, which "is expected to be filled 1-2 full months ahead of schedule," analysts said.

As a result, they said, "Some natural gas producers have started to cut back spending to match reduced cash flows and are examining natural gas production 'trim back' strategies. As well, some gas leveraged income trusts have reduced their distributions. By contrast, end users such as industrials and distribution companies that were clobbered by high gas prices last fall, now can buy or hedge gas at half the price.

"Meanwhile, oil leveraged producers are gearing up for a banner 2006 year end with record profits," analysts said. Other beneficiaries are oil sands and heavy oil producers that use gas to fuel their operations, and US midstream processors, who extract high-priced gas liquids.

The historic 6:10 ratio "seems more appropriate as a broad band target although it is inevitable there will surely be more spikes—both up and down," said Bill Gwozd, vice-president of gas services at Ziff Energy. "It is hard to imagine that just 5 years ago, the ratio was under 3." The change in gas to oil equivalency to 13:1 from 3:1 "is strong evidence of the extreme volatility in energy markets," Gwozd said. "Whether producers or consumers, value-based price hedging is a powerful tool, but one which is often underutilized, especially by producers," he said.

Therefore, Ziff Energy said gas vs. oil operators who did not hedge their 2006 production will face declining margins during the rest of this year and perhaps during the initial part of 2007 as well.

Contrarian outlook
But in a contrarian report 6 weeks earlier, analysts in the Houston office of Raymond James & Associates Inc. said gas prices appeared to be nearing the bottom of their fall. At that time, they said, "Most energy investors were expecting excessive natural gas storage inventories to drive natural gas prices (and the energy stocks) down to the $4/Mcf range sometime in the late summer."

Since then, Raymond James reported July 24: "US natural gas prices have bounced firmly off of the mid-$5/Mcf range, the gas supply-demand equation has continued to tighten, and the year-over-year gas storage surplus has begun to shrink. In other words, the US natural gas fundamentals have shown steady improvement over the past 6 weeks while energy investor sentiment has become increasingly bearish. After personally visiting with numerous investors over the past month, we have never seen a broader negative consensus view on natural gas and the energy stocks than we have right now."

Energy prices
The new front-month September contract for benchmark US light, sweet crudes increased by 16¢ to $74.43/bbl July 21 on the New York Mercantile Exchange. The October contract gained 18¢ to $75.35/bbl. Subsequent monthly crude contracts are in contango, with each priced higher than the previous contract through March 2007 on NYMEX.

"Contango used to be the result of weak markets, but today wide contangos appear at record-high flat price," said Olivier Jakob, managing director of Petromatrix GMBH, Zug, Switzerland. "We do believe that the recent contango is due for some part to the balanced physical supply and demand but more importantly is the result of the same thing that has been pushing the market higher no matter what: Illiquidity," he said.

Heating oil for August delivery was up by 2.4¢ to $1.96/gal on NYMEX. Regular gasoline for the same month climbed by 4.17¢ to $2.29/gal. The August natural gas contract rose by 4.8¢ to $6.14/MMbtu.

In London, the September IPE contract for North Sea Brent crude inched up by 3¢ to $73.75/bbl. Gas oil for August increased by $1.75 to $627/tonne.

The average price for the Organization of Petroleum Exporting Countries' basket of 11 benchmark crudes advanced by 1¢ to $68.46/bbl on July 21.

Contact Sam Fletcher at [email protected].