Seasonal Cycles and Political Ambitions

Jim Brown
 
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Political posturing, rising inventories and falling markets pushed oil prices lower on Wednesday but it was all smoke and no fire.

WTI crude fell from $107.33 at yesterdays close to a low of $104.67 intraday. The contract rebounded to close at $105.49 and a loss of -$1.84. Brent lost -$1.28 to close at $124.26.

There were two reasons for the drop in prices. First the import drop from the prior week of 500,000 bpd (3.5 million barrels) was reversed with a +1,050,000 bpd (7.350 million barrels) gain. I mentioned last Wednesday the sharp drop was an abnormality and probably due to fog shutting down the ship channels and mooring stations as is common this time of year. Whatever the reason last week's, abnormal for this time of year, -1.2 million barrel decline was reversed with a +7.1 million barrel gain. It was all in the import number because refinery utilization spiked and demand rose sharply for both gasoline and distillates.

Gasoline inventories declined by -3.5 million barrels with demand rising by 330,000 bpd. Distillate inventories declined by -700,000 barrels and demand increased by 380,000 bpd.

Remember, refiners are still trying to deplete the supplies of winter gasoline blends so we should continue to see inventories decline. We are still several weeks away from the end of seasonal refinery maintenance and the ramp up in refining, which will begin to draw down crude inventories.

In the chart below we are still in the seasonal build phase for crude. There is no reason to get hysterical when a big number appears on the weekly inventory report.

Crude Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

Inventory Snapshot

Another reason the refinery utilization rose was the spike in the crack spread (profit) to $22.71 per barrel. With gasoline prices at $3.91 and diesel $4.85 the profit from refining has increased sharply over the last several weeks. Refiners need to capture profits now because the spread will narrow as oil prices continue higher. The demand destruction from gasoline prices approaching $4 means prices at the pump/futures will slow their ascent despite oil prices continuing their climb.

The second reason oil declined was yet another comment from a government official about conversations over a release of oil from the Strategic Petroleum Reserve. This time it was not from a U.S. official. French government spokesman Valerie Pecresse said France was working with the U.S. and U.K. as well as the IEA over a potential release of strategic reserves to lower prices.

Despite nearly every analyst saying a release would have limited short term impact on the markets this is an election year and apparently the strategic petroleum reserve has turned into the strategic political reserve.

My theory on this is as follows. If President Obama unilaterally announced a release from the U.S. reserves it would be immediately branded a political event by even the most reluctant reporters. However, if the president can get France and the U.K. to go along then all of a sudden it is a "coordinated" release designed to prevent fuel prices from pushing the world back into recession. The French budget minister said the U.S. had approached France about joining the U.S. in a release of reserves.

Meanwhile German officials said there would be no release of German reserves because they are specifically for a disruption in supply not for price management. German officials said there was no shortage of crude and no reason for a release.

Italy also said there would be no release on the basis of price.

Also putting a kink in the administration's plan for a coordinated release was the IEA. The head of the IEA, Maria van der Hoeven, has said on several occasions that a coordinated IEA release by multiple countries is not warranted because there is no significant supply disruption on world markets. She did say individual countries could choose to release reserves AFTER consultation with the IEA. The IEA has only approved three coordinated releases since it was founded in 1974. The last one came when Libyan production was lost in June 2011.

Saudi Arabia, the IEA and a survey by Reuters all claim there is a one million barrel per day surplus of oil on the market at present. It is hard to make a non-political case for releasing reserves.

The impact of a release would only be temporary for multiple reasons, which I discussed last week. Moving oil around from the SPR locations is difficult, expensive and time consuming. Given the surplus of oil in the market there might be a lack of bidders or at least bidders at a reasonable price. All the refineries would buy oil if they could steal it but that has never been the case in past releases. The price was only a couple dollars below the spot price at the time. That is not enough discount to prompt a long bidders list. It would be very dangerous for the president to announce a release and only have a couple bidders. The administration would need a long list of bidders to justify their action. I suspect administration officials have been doing the phone work to see if there is any interest in SPR oil.

The administration is getting the benefits of a release announcement with the twice weekly "comments" from various officials. While not exactly a release announcement the "we are in conversations with other countries concerning a coordinated release" headline is keeping oil prices from moving higher. I actually think that is a skillful move on the part of the administration. They are getting the price pressure movement without actually taking any political risk. The worst case would be some positive sentiment from voters that the president was feeling their pain at the pump and was exploring options. This softens the blow from gas prices nearing $4 although the degree of softening is minimal.

Even if a release was announced analysts believe the price of WTI would remain over $100 because of long term supply-demand fundamentals. When the coordinated release was announced over the Libyan disruption the price declined slightly for about two weeks then moved higher than the pre announcement price. That is a lot of risk for the administration to announce a political release and then have prices higher two weeks later.

The expiring natural gas futures contract closed at $2.17 today and a multiyear low. The next month contract closed about 10-cents higher at $2.27, also a contract low. The gas inventory report due out on Thursday is expected to show another net injection of gas into storage rather than the normal decline in supplies for this time of year.

The cheap gas continues to weigh on equity prices for energy stocks. Those with high exposure to gas prices are being crushed and recently that negative sentiment has moved to exploration companies with minimal gas exposure.

Continental Resources (CLR) declined -$2.72 today but there were extenuating circumstances. Continental announced it was buying 37,900 more acres in the Bakken including more than 1,000 wells for $340 million. The wells were producing 2500 bpd as of December 31st and have net proved reserves of 17 million barrels. The purchase from Wheatland Oil would be made with up to 4.25 million shares of stock. The purchase is subject to stockholder approval.

Occidental (OXY) shares declined -3.50 after the company said Q1 production in Columbia would decline from 28,000 bpd to 23,000 bpd as a result of insurgent activity. At the same time OXY reiterated its prior guidance for 8% to 10% U.S. production growth in 2012. Shares declined because it was a bad day to report any bad news regardless of how small the drop in production. Falling oil prices and bad news was a recipe for a sharp drop in the stock price.

The decline in the energy sector is purely related to the drop in natural gas prices and decline in gas exploration. The decline in active gas rigs means less service business for companies like National Oilwell (NOV), Schlumberger (SLB) and others. Business will pickup on the oilwell side but it will take several months for the conversations to be made and the rigs transported. Analysts believe active gas rigs could decline by another 10% this summer. Companies currently producing a majority of their profits from oil should continue to benefit. However, while a rising tide floats all boats a receding tide lowers all boats. We are in a period where all energy stocks are weak until after Q1 earnings where the winners and sinners will be separated.

Our biggest risk is that high gasoline prices will push the U.S. back into a recession. We will have to watch the economic numbers closely over the next 60-days to see if the trend is changing.

Jim Brown

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