As we have said all week the market has been all about the hurricane, the short term fundamentals and the direction of the US dollar. These drivers have all been bearish this week. The hurricane turned out to have a minor impact on the oil & ng industry. The dollar has been mostly stronger on the week while the short term fundamentals are continuing to improve.
Although Hurricane Dolly made landfall far away from the heart of the US Gulf Coast Oil & NG producing & refining operations it did still impact it modestly as about 58,000 bpd of oil and about 608 thousand cu feet of NG have been temporarily shut in. Also Valero announced it was cutting its refinery runs at two Gulf locations due to delays in crude oil shipments. Although all of this can be categorized as a minor disturbance we may see it reflected in next week’s oil inventory report in the form of a larger than expected decline in crude oil and refined product stocks. But that is for next week’s discussions. For this week the storm is bearish.
The dollar has been a major contributor to the continued weakness in the price of oil and most commodities so far this week. For each 1% strengthening of the dollar the price of oil sheds about 7% (based on average relationships for 2008). The dollar versus the Euro has broken out of its latest downtrend and has been trading in this area for the last two sessions. This suggests the dollar could continue to strengthen further in the medium term and get back to trading levels not seen since early June. The dollar has the potential to firm another 0.5 to 2% which could ultimately translate to as much as another 3 to 14% decline in the price of WTI.
The big feature yesterday was yet another bearish short term fundamental snapshot. Although crude oil declined once again the surprisingly large refined product builds more than offset the crude oil decline. Both gasoline and distillate (HO & diesel) built much greater than any of the industry expectations. The build also occurred as refinery runs declined 2.4% on the week. The year on year crude oil deficit of over 55 million barrels is troubling, especially since crude oil inventories are normally/seasonally in a destocking mode through the end of September. However, the year on year surplus of both gasoline & distillate, especially gasoline is very comforting and indicative of a market that is very well supplied with little chance of any supply disruptions over the next several months or longer.
A major contributor to the swelling refined product inventory situation is the ongoing retracement in demand. This week we saw an across the board decline in implied demand. Total US demand is significantly lower than last year at this time with gasoline leading the way down.
This week’s report was clearly bearish.
| Oil Inventory | | 7/24/08 | | |
| Mil of Bbls | | | | |
| | Current | Change from | Change from | Change from |
| | Inv. | Last Week | Last Year | 5 Year |
| | | | | |
| Crude Oil | 295.3 | (1.6) | (55.7) | (21.1) |
| Gasoline | 217.1 | 2.8 | 13.0 | 8.6 |
| Distillate | 128.1 | 2.4 | 4.5 | 5.7 |
| Refinery % | 87.1% | -2.4% | -4.6% | -5.8% |
| Demand | | | | |
| | | | | |
| Total | 19903 | (295) | (1103) | (504) |
| Gasoline | 9342 | (2) | (346) | 3 |
| Distillate | 4077 | (49) | 34 | 154 |
| Jet Fuel | 1421 | (310) | (222) | (290) |
Further on the demand discussion the following chart shows a macro view of the elasticity of demand for oil. The chart plots the total US implied demand versus the spot Nymex WTI price from the beginning of 2007 through this week. Both the demand & price data also have a simple linear regression line show as a dotted line for each corresponding study. The blue line on the chart is the EIA weekly implied demand while the red line is the Nymex spot WTI price. As shown on the chart demand has been declining pretty much throughout the entire chart timeframe while the price of oil has been increasing. However, the turning point (green circle area) seems to be around the $100/bbl mark or the point where both the price increase and demand restraint accelerated. For interest I also performed this calculation using a weighted average price (50% gasoline, 25% distillate and 25% crude oil) and the turning point increased to about $110/bbl.
I view the turning point as a threshold where the consuming public moved into the “let’s reduce consumption and save money mode”. Reduced consumption can go a long way in helping to solve the current energy price crisis. The big question is will these changes in the consumption pattern of the US consumer become structurally permanent or will the US consumer revert back to the normal pattern seen over the last 30 years? What happens if the price of oil drops back down below the threshold of $100/bbl versus WTI or the 4100/bbl versus our weighted calculation?
The answer to the questions above are difficult to answer as they are dependent on many other factors especially the state of the US economy. For example would the threshold be a lot higher if the housing and stock markets were still booming?
Time will tell.
But in the meantime all of the political leaders in the US that are fixated on blaming the speculators for the price run-up should look and try to understand what happens when supply and demand becomes more in balance (as is the case in the short term) as a result of the market really working…high prices do in fact change consumption patterns which in turn takes the edge off of the price of the commodity. Surprise the speculators have been selling of late.
Our view remains the same as it has been all week. We expect the market to now remain in the new lower trading ranges and consolidate in this area for the next week or so and/or until the next major Geopolitical of fundamental flare-up. The spec side should continue to trade from the short side with very tight trailing stops. Buy side hedgers should begin to view the current correction as an opportunity to begin to start formulating entry targets for forward hedging. We still believe the market has more room to move to the downside but we do not see an all out collapse in prices.
Currently prices are mostly on the defensive as the dollar firms slightly versus the Euro. Today we get the latest snapshot of NG inventories which are expected to show an injection level of 80 to 85 BCF.
| Current Expected Trading Range | Expected Trading Range | |||
| | 7/24/08 | Change | Low | High End |
| | | From | End Support | Resistance |
| | 7:41 AM | Yesterday | | |
| Sep WTI | $124.24 | ($0.20) | $121.00 | $128.00 |
| Aug HO | $3.5610 | $0.0109 | $3.5200 | $3.7000 |
| Aug RBOB | $3.0265 | ($0.0079) | $3.0300 | $3.1700 |
| Aug NG | $9.665 | ($0.123) | $9.200 | $10.300 |
| | | | | |
| Euro/$ | 1.5618 | (0.0015) | 1.5550 | 1.5750 |
| Yen/$ | 0.9303 | 0.0009 | 0.9200 | 0.9470 |
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