MARKET WATCH: Energy prices plunge first trading day after US credit downgrade

Aug. 9, 2011
Energy prices plunged Aug. 8 in the New York market’s first trading session since the US credit downgrade, with the current September crude contract hitting a lifetime low of $80.17/bbl intraday before climbing slightly. Nevertheless, it was down 6% to an 8-month low at closing.

Energy prices plunged Aug. 8 in the New York market’s first trading session since the US credit downgrade, with the current September crude contract hitting a lifetime low of $80.17/bbl intraday before climbing slightly. Nevertheless, it was down 6% to an 8-month low at closing.

Energy commodities followed the broad-based sell-off that swept global markets. Standard & Poor's 500 index fell 6.7%—“its worst single-day drop since December 2008,” said analysts in the Houston office of Raymond James & Associates Inc. It’s as though Wall Street was “playing Russian roulette with all six bullets,” they said, with Standard & Poor's Financial Services LLC’s first ever downgrade of US debt to AA+ from the top AAA level, mounting concern over European debt problems, and the slowdown in the US economy.

James Zhang at Standard New York Securities Inc., the Standard Bank Group, said the sell-off carried into early trading Aug. 9 but apparently at more-stable prices.

Raymond James analysts said, “Given the weakness in crude, energy was one of the hardest hit sectors, with the [SIG Oil Exploration & Production Index] EPX and the Oil Service Index each giving up 10%. All eyes are now focused on today's US Federal Reserve System meeting, where the decision will be made whether or not to implement another round of quantitative easing [QE3]” in a third attempt to stimulate the economy.

“In the current risk-off environment, market participants are looking for safety,” said Zhang. “The question becomes, however, what has to happen to attract people to take on risk again? For now, hope is resting on further stimulus measures from the Fed. The current heightened concerns have been driven by political risks in the Eurozone and the US over the sovereign debt problem. Consequently, market fundamentals are taking a back seat.”

However, Olivier Jakob at Petromatrix in Zug, Switzerland, claims the current selloff in the equity market has “basically wiped out $600 billion” of the previous QE2 stimulus spending by the Fed. He said, “The US Federal Reserve is taken more and more by market participants as the plunge protection team, but apart from directly buying exchange-traded funds of the stock market (like the Bank of Japan) the list of options for the Fed will start to shrink. The European Central Bank (ECB) buying the Italian and Spanish debt did manage to lower their bond yields, but that comes with the comment: for now.”

Zhang said, “The ECB’s decision to buy Italian and Spanish bonds has pushed these bonds sharply higher, though the exercise has failed to boost market confidence. Consequently, the Federal Reserve is coming under pressure from some quarters to act as it convenes [the meeting of its] Federal Open Market Committee [the Fed’s policy-making arm]. Further stimulus from the Fed appears to be the only possible substantial development that could halt the market collapse for now.”

Jakob said, “The irony of it all is that the market crash of 2008 was caused by S&P not doing its job, and the market crash of 2011 is caused by S&P doing its job.” He noted, “One worrying aspect of the current crash is that the banking sector is taking a very serious hit (Bank of America lost more than 20% yesterday) and with that will come increased credit default swaps on transactions and other similar worries as in 2008.”

He reported, “West Texas Intermediate went as low as $75.71/bbl in overnight trading. On any chart, WTI at $75/bbl will look to many (mainly the retail investors and the general press) as ‘cheap.’ However, we need to keep in mind that the historical price charts on WTI do not include a Brent premium to WTI of $23/bbl. On an historical basis WTI at $75/bbl needs to be compared to $100/bbl (i.e. Brent briefly traded below $100/bbl in overnight trading); a level which is of course better than $130/bbl but is still on the high side for the safe running of the world economy. Crude oil prices have not yet departed the demand destruction zone, and it is not the recent drop in crude oil prices that is going to stimulate a jump in economic growth. The latest consumer price index data for China show inflation there is not moving lower for now.”

Zhang reported term structures weakened Aug. 8 for both WTI and Brent, with the front-end of Brent shifting into a slight contango. However, the contango is not enough “to incentivize a build in inventory.” Refining margins continued to climb as light-ends and fuel oil held up slightly better than crude.

“Technically, front-month Brent broke through the 200-day moving average yesterday, which sets the ground for a further decline,” said Zhang. “However, both Brent and WTI fell into over-sold territory on many other technical signals. While we view the current oil price level as offering good value, we are wary that a market can still overshoot significantly to the downside.”

He said, “The recent sharp drop in oil prices has echoes of 2008, when Brent peaked around $147/bbl before crashing down below $40/bbl. This time however, in our view the oil market fundamentals remain in a much better shape than in 2008, judging from the market structure.”

Energy prices

The September contract for benchmark US sweet, light crudes plunged by $5.57 to $81.31/bbl Aug. 8 on the New York Mercantile Exchange. The October contract dropped $5.60 to $81.70/bbl. On the US spot market, WTI at Cushing, Okla., was down $5.57 to $81.31/bbl, still matching the front-month futures contract.

Heating oil for September delivery tumbled 14¢ to $2.80/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month gave up 11.36¢ to $2.69/gal.

The September contract for natural gas dipped 0.6¢ to $3.94/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., was unchanged at $4.03/MMbtu.

In London, the September IPE contract for North Sea Brent fell $5.63 to $103.74/bbl. Gas oil for August lost $12.25 to $900.25/tonne.

The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes declined 93¢ to $102.37/bbl.

Contact Sam Fletcher at [email protected].