'Vicious' loop in oil market

Escalating oil inventories have filled most storage at the Cushing, Okla., primary delivery point, undermining US crude prices to the point West Texas Intermediate is "about as useful as a chocolate oven-glove."

Sam Fletcher
Senior Writer

Escalating oil inventories have filled most storage at the Cushing, Okla., primary delivery point, undermining US crude prices to the point West Texas Intermediate is "about as useful as a chocolate oven-glove" in assessing world market conditions, said Paul Horsnell at Barclays Capital Inc., London.

With crude production outstripping demand, Cushing inventories were estimated in mid-January at 33 million bbl with a capacity of 47 million bbl. As a result, the oil futures market on the New York Mercantile Exchange "got stuck in a fairly vicious loop," Horsnell said, with traders competing to unload contracts rather than compete for storage.

In Paris, the International Energy Agency noted, "Crude prices rose to nearly $50/bbl in early January, supported by cold weather, the Russian-Ukrainian gas crisis, and fighting in Gaza. Subsequently, weak global refinery demand and an increasing crude overhang have pressured Brent futures to…$45/bbl, while WTI was at $35/bbl, distorted by record-high Cushing stocks."

The big story at mid-January was the price disparity between WTI and North Sea Brent. "While WTI is reflective of the price of oil in Cushing, Brent crude is more reflective of the international price of oil since it is used to price two thirds of the world's internationally traded oil," said analysts in the Houston office of Raymond James & Associates Inc.

Historically, the two crudes of similar composition have traded around the same pricing levels, with WTI usually priced a little higher. Front-month WTI closed at $36.51/bbl Jan. 16 compared with Brent at $46.57/bbl. "With inventories at record highs, oil tankers sitting idle at sea hoarding oil, and total US petroleum demand down 7% compared with last year, the price disparity between WTI and Brent could linger for months," Raymond James analysts said.

Horsnell pointed out, "The problem is that WTI prices are being used in a wider context: crude oil exporters link to them for the US market, derivatives are based on them, investment returns are affected by their time spreads, and policymakers in both consuming and producing countries use them as an indicator."

Although crude storage is at a record high in Cushing, that's "not true for the US as a whole," Horsnell said. He noted US crude inventories increased 18.4 million bbl over the past 3 months, including 18.1 million bbl at Cushing. "In other words, for the whole of the US outside of Cushing, crude inventories have risen by just 300,000 bbl over the past 3 months, (from 293.3 million bbl to 293.6 million bbl), and they currently stand almost 40 million bbl lower than as recently as mid-2007," he said.

Olivier Jakob at Petromatrix, Zug, Switzerland, said, "WTI is the most traded crude oil contract, but it would be wrong to extrapolate a Cushing supply and demand as the world's supply and demand."

Distillate fuels stocks
The US Energy Information Administration reported distillate fuels escalated 6.4 million bbl to 144.2 million bbl in the week ended Jan. 9, exceeding Wall Street's expectations of a 1 million bbl increase. Some analysts immediately questioned EIA's numbers, which included a 4.1 million bbl increase of low-sulfur diesel in Petroleum Administration Defense District (PADD) 2 in the Midwest, encompassing Cushing. That would be the largest-ever weekly change in distillate stock in that district, Jakob said.

Moreover, it "implies a 53% drop" in PADD 2 demand within 1 week—"a drop that we think is materially impossible," Jakob said. The large distillate spike likely includes undisclosed revisions to previous data, so EIA may have under-reported demand by 700,000 b/d, he said.

Meanwhile, Raymond James analysts surmised, "It looks as if 2008 global oil demand was negative on a year-over-year basis for the first time in over 20 years, which makes one wonder, 'How bad will 2009 get?'"

Paris-based IEA reduced its oil demand forecast by 1 million b/d to 85.3 million b/d for 2009, down 0.6% from 2008 levels. Its 2008 forecast was reduced by 70,000 b/d to 85.8 million b/d, down 0.3% from 2007 levels. That would be the first 2-year total contraction in global oil demand since 1982-83.

In Washington, EIA cut its 2009 oil price forecast another 15% to $43.25/bbl. But like most soothsayers, EIA has a poor record for accurate price predictions. Last July when the US driving season was at its peak and oil prices were soaring, it forecast the US spot price for WTI would average $127/bbl for 2008 and $133/bbl in 2009, up from an average $72/bbl for 2007.

(Online Jan. 19, 2009; author's e-mail: samf@ogjonline.com)

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