MARKET WATCH: Energy prices continue to decline

Sam Fletcher
OGJ Senior Writer

HOUSTON, June 22 -- Energy prices slipped lower June 19 with front-month crude dropping below $70/bbl but natural gas holding above $4/MMbtu in the New York market.

“Oil followed gasoline lower in [June 19] trading—the front month gasoline contract fell 4.7%,” said analysts at Pritchard Capital Partners LLC, New Orleans. “The weakness in gasoline was due to concerns that gasoline imports and refinery utilization have increased while demand remains weak. Total fuel demand averaged 18.5 million bbl in the first 4 weeks of June, down 6% from 2008, yet refinery utilization was up 2% last week. Due to the weak demand numbers and growing supply, some are predicting crude will trade lower in the summer months,” they said.

Pritchard Captial Partners said natural gas continued to slide in response to the larger than expected natural gas storage injection of 114 bcf (expectations were for a 105 bcf injection) in the week ended June 12. “Also of concern is the growing inventory level; some are expecting that natural gas storage will be above 3 tcfe in July” for the first time ever, they said. The spread between the front-month contract and the 12-month contract has narrowed to 50%, down from 65% just 2 weeks ago.

“The current 1-2 bcfd gas oversupply could correct itself, if we get the 4-6 bcfed production decline in the fourth quarter some are calling for,” they said. “LNG imports only amount to 1-2 bcfed vs. the higher forecasts for 3-5 bcfed, and an increase in natural gas demand of 1-2 bcfed from power generators switching from coal to natural gas. These estimates indicate that natural gas market could move from the current oversupplied condition to one in deficit by yearend. This would explain why the natural gas rig count appears to be stabilizing as some exploration and production companies begin to put rigs back to work in anticipation of more favorable conditions developing in the natural gas market,” Pritchard Capital Partners said.

In Houston, analysts at Raymond James & Associates Inc. said equities are expected to trade lower, following comments from the Organization for Economic Cooperation and Development, the World Bank, and the European Central Bank noting rising borrowing costs and lingering unemployment will result in contracting global economies for the remainder of 2009.” Premarket, oil had fallen below $69/bbl due to a stronger dollar and weaker global economic forecasts, but continued relatively supported by attacks in Nigeria and positive data from China (oil demand up 6% year-over-year in May),” they said.

Raymond James raised its oil forecasts “as visibility begins to improve,” analysts said. “The combination of a weakening US dollar and inflation fears has led to a hefty rally in West Texas Intermediate crude. Oil prices have vastly exceeded even our bullish expectations, doubling from the mid-$30s in February to roughly $70/bbl currently. Therefore, we are increasing our 2009 oil price forecast to $56/bbl (from $48) primarily to reflect higher-than-expected actual prices that have recently evolved.”

However, they said, “The short-term direction of crude oil prices is still uncertain. On the bull side, high Organization of Petroleum Exporting Countries compliance with quotas, declining non-OPEC production, signs of a global economic recovery, and global inflation fears could continue to push oil prices higher. On the bear side, US crude inventories remain well above historical norms and oil demand still appears weak. Looking to 2010, we are still very confident that oil prices will move higher driven by substantially lower non-OPEC production and a gradual improvement in global oil demand. Therefore, we are increasing our 2010 price forecast to $80/bbl (from $65). While we are confident that 2010 crude prices will be higher, the magnitude of the improvement is still up in the air and depends largely on what happens to demand and geopolitical wildcards.”

Market outlook
Douglas-Westwood Ltd. reported, “With the ‘green shoots’ of recovery more numerous by the day, dark warnings of a new spike in oil prices are also multiplying. Saudi Oil Minister al-Naimi has warned that underinvestment in oil capacity may lead to a return to $150/bbl oil, “or even worse.”

New research by Douglas-Westwood suggests when oil consumption costs exceed 4% of US gross domestic product GDP, recession almost always occurs. And in general, a sustained rise in the oil price of 50% or more has always been followed by a recession. “In every case when oil consumption breeched 4% of GDP, the US suffered a recession and indeed, the current US recession began within 2 months of oil hitting the 4% threshold, most recently, when oil reached $80 a barrel,” said Steven Kopits, Douglas-Westwood’s LLC managing director.

Kopits added, “Another factor is the maximum rate of adjustment for the economy, which appears to be about 0.8% of GDP per year. That is, the economy cannot shed oil consumption instantaneously; society needs time to adjust. When the economy is adjusting at full speed, it will tend to struggle. Adjustment will tend to be characterized by recession, inflation or generally low GDP growth.” He said, “Our research suggests that a return to $80 oil could kill the present recovery and trigger a new recession—today’s oil prices means we are again teetering on the edge.”

Looking ahead, Kopits said, “Our own firm and others have the view that the world is likely to reach a peak of oil production capacity within the next 5 years and that will, of course, have massive implications for oil prices. He said, “Should oil return to $150/bbl, as Saudi Oil Minister al-Naimi and others have warned, the statistics are not ambiguous. Expect a recession, and a severe one at that.”

At KBC Market Services, a division of KBC Process Technology Ltd. in Surrey, UK, analysts said, “Since hitting $70/bbl just over a week ago, oil prices seem to have paused for a breather.

They noted, “A year ago the political turmoil in Iran would have sent oil prices through the roof—remember that in the summer of 2008 it only took three men in a rubber boat on the Niger Delta…waving machine guns and threatening to disrupt oil operations to send prices sharply up—but these days markets are calmer. There has been no discernible oil market reaction to Iran’s post-election trauma—so far. But this is a situation that needs to be watched closely as Iran exports about 2.2 million b/d of crude oil to some significant place—Japan and China stand out. There may be spare production capacity elsewhere, and in countries with barrels of similar quality to Iran’s typically high-sulfur crude oils, but the onset of strike action in Iranian oil installations would definitely be a signal for higher prices.”

KBC analysts see three good signs for market recovery. “First, the World Bank has improved its outlook for economic growth in China. For 2009 they expect Chinese GDP growth to be 7.2%, up from their previous estimate of 6.5%. Because of ongoing problems in the global economy China’s export industries are still doing badly, but the domestic economy has benefited from the $600 billion stimulus package unveiled earlier this year. It’s a shame the Chinese aren’t running the US economy. Or maybe they already are!”

KBC said, “The second good sign for recovery is that the latest 4-week average gasoline demand number for the US shows growth of 1.1%, up from 0.4% in the previous 4-week period. This looks good and indicates that there should be a gasoline season this year; but a word of warning is appropriate. For the week ending June 15, the US national average all-grades gasoline price was $2.72/gal; mere pennies for Europeans but part of a strong recent upward trend for hard-pressed US customers who are still worried about the economic outlook. We can’t be sure about the gasoline season.”

As for the third reason “for a little bit of joy,” they said KBC Market Services has revised its global demand outlook and now project oil demand in 2010 will be flat vs. 2009. Analysts said, “We had forecast a modest fall for 2010 following on from the 1.8 million b/d decline expected in 2009.”

They said, “Another indicator that the underlying market structure is strengthening is the narrowing of the Brent contango…. [T]he steep contango seen at the end of 2008 and continuing well into this year has encouraged stock holding, but we are now seeing the contango shrink and along with it a noticeable decline in the amount of floating inventory. A press report from one ship broker suggests that total floating storage is now 67 million bbl vs. a peak of 80 million bbl at the beginning of May with much of the reduction hitting land in the US Gulf. As tanker charters expire in the next few months against a background of what we believe will be a gradually strengthening market and a narrower contango structure, there will need to be a careful unloading of offshore barrels to avoid crashing the market.”

Energy prices
The July contract for benchmark US light, sweet crudes dropped $1.82 to $69.55/bbl June 19 on the New York Mercantile Exchange. The August contract lost $1.89 to $70.02/bbl. On the US spot market, WTI at Cushing, Okla., was down $1.82 to $68.55/bbl. Heating oil for July delivery declined 5.03¢ to $1.79/gal on NYMEX. Reformulated blend stock for oxygenate blending (RBOB) for the same month fell 10.51¢ to $1.92/gal.

The July natural gas contract lost 6.1¢ to $4.03/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., was down 12¢ to $4.02/MMbtu.

In London, the August IPE contract for North Sea Brent crude fell $1.87 to $69.19/bbl. July gas oil dropped $1.75 to $583.25/tonne.

The average price for OPEC's basket of 12 reference crudes dipped 1¢ to $70.27/bbl on June 19. So far this year, OPEC’s basket price has averaged $49.91/bbl.

Contact Sam Fletcher at samf@ogjonline.com.