MARKET WATCH: Energy prices retreat as equities market stumbles

Sam Fletcher
OGJ Senior Writer

HOUSTON, Oct. 26 -- Energy prices retreated Oct. 23 with crude dipping briefly below $80/bbl in the New York market as the equities market stumbled and the dollar strengthened from a 14-month low.

“Weakness in crude…was attributed to a stronger dollar and continued concerns about the US economic recovery,” said analysts at Pritchard Capital Partners LLC in New Orleans. “Crude has stubbornly clung to the $80 level over the last 2 trading days of last week.”

Pritchard Capital Partners reported, “Natural gas continued to sell off…as the market remains confused and divided on the long-term price picture for natural gas. Chesapeake Energy Corp. added to concerns regarding the abundance of North American natural gas by announcing it had achieved record daily natural gas production in its four major shale plays, Barnett, Fayetteville, Haynesville, and the Marcellus.” Analysts said, “The market remains skeptical that natural gas production will fall, and continued signs of a recovery in industrial demand as seen in the recent Caterpillar, Inc. earnings report last week would beneficial for natural gas.”

Olivier Jakob at Petromatrix, Zug, Switzerland, noted, “US equities are stalling around the 10,000 mark [on the Dow Jones Industrial Average] while the earning season continues.” He said, “The rally from the March low has been very impressive, but the problem as we start to make the investment approach to 2010 is that with the Dow at 10,000 and crude at $80/bbl, it will require the confirmation of real underlying consumer demand to provide positive returns on the long side for next year.”

Economic outlook
At KBC Market Services, a division of KBC Process Technology Ltd. in Surrey, UK, analysts said, “If the oil price continues to rise in the next week or two, there is a danger that economic recovery will be strangled at birth, and these fears will give rise to talk that the Organization of Petroleum Exporting Countries must act to put more oil into the market to cap prices. Today’s $80/bbl price is not firmly grounded because the fundamentals for both the economy and the oil market remain weak.”

KBC analysts explained, “The recent run-up in oil prices is concentrated very heavily at the front end of the price curve. Once the magic level of $80/bbl was achieved, a large number of call options (a financial contract between two parties: the buyer has the right, but not the obligation, to buy a specified quantity of stock or commodities at a specified time in the future) came into play. The exercise of these call options only makes sense if you believe that prices will rise. Sellers of the options then had to go into the market to buy futures to cover their positions, and this contributed to the price rise at the front end of the curve. The shrinking of the large contango, which for some time now has justified the holding of huge quantities of oil in storage, raises issues about the cost effectiveness of continuing to hold those stocks. At a ballpark number of $1/bbl/month to hold stocks (although slightly lower figures are sometimes quoted depending on location) today’s December to January Brent spread of 50¢/bbl is not very attractive. This raises the question of whether large quantities of oil held offshore will move onshore thus reinforcing the still considerable stocks overhang.”

They said, “Out there in the real world where oil is actually used, the near-term picture remains bleak. Try as hard as you like, but you will have trouble spinning good news out of middle distillate demand figures for the US that show an 11.5% fall in demand in the 4 weeks to mid-October compared with the same period last year. The rail industry used 18% less diesel in third quarter 2009 than in third quarter 2008.” Meanwhile, distillate inventories “are incredibly high in the US, and in Europe traders scramble to find tankers to store unwanted volumes,” KBC analysts said.

In Switzerland, Jakob said, “The US refining futures margins are now at or above refining operating costs and should ensure that more crude is transformed into products. But until demand is showing signs that it is really rebounding this should then start to translate into renewed pressure on products and move to a next cycle of pressure on refining economics.”

He said, “The dollar correlation might be moving the price of crude oil higher, but at these prices oil producers will want to maximize output be it in OPEC or outside OPEC, and the contango on West Texas Intermediate is starting to widen again to economics that will favor the rebuilding of stocks in Cushing, Okla.”

The China factor
Analysts in the Houston office of Raymond James & Associates Inc. pointed out, “Crude demand in China continues to strengthen, as Chinese oil imports for September increased 15% year-over-year to 17.2 million [tonnes].”

Moreover, they said, “As Chinese oil demand soars, Beijing is buying up the world’s oil.” Raymond James analysts noted China's state oil company “apparatchiks” are busy negotiating oil acquisitions and oil supply deals—“some of them on a vast scale”—in Myanmar, Iran, Sudan, and other global hot spots. “In just the past year, we estimate China has agreed to spend over $150 billion to secure long-term oil supplies from around the world,” they said.

Beijing is “fixated” on buying up overseas oil partly because “the Chinese ruling party is led by control freaks, and thus Beijing wants actual control of, as opposed to just access to, resources abroad (not just oil, but also natural gas, strategic minerals, and other extractive industries),” said Raymond James analysts.

In addition, the Chinese seem to be diversifying their massive dollar reserves into tangible assets, probably “to protect against devaluation of the dollar (and other paper currencies),” they said. “Finally, and perhaps most importantly, China is acquiring oil resources because its oil consumption is on a nonstop growth curve, so ownership of resources represents a natural long-term hedge against rising prices,” they concluded.

Separately, analysts at Pritchard Capital Partners reported, “According to Peabody Energy Corp., China imported 21 million tons of metallurgical coal used for steelmaking through August, 10 times last year's pace, and India reports it may be short as much as 200 million tons of coal per year by 2014. These comments reinforce the point that China’s demand for commodities continues to grow.”

Energy prices
The December contract for benchmark US light, sweet crudes dropped 69¢ to $80.50/bbl Oct. 23 on the New York Mercantile Exchange. The January contract lost 65¢ to $81.19/bbl. On the US spot market, WTI at Cushing was down 69¢ to $80.50/bbl. Heating oil for November delivery declined 1.9¢ to $2.08/gal on NYMEX. Reformulated blend stock for oxygenate blending (RBOB) for the same month dipped 0.04¢, but the closing price was virtually unchanged at an average $2.04/gal.

The November natural gas contract fell 16¢ to $4.79/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., was down 13¢ to $4.85/MMbtu.

In London, the December IPE contract for North Sea Brent crude lost 59¢ to $78.92/bbl. The November gas oil contract dropped $9 to $644.75/tonne.

Contact Sam Fletcher at [email protected].