Crude at 22 Year Highs

Jim Brown
 
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The EIA reported crude inventory levels on Wednesday that rose to 379.5 million barrels and the highest level since 1990. Gasoline prices fell to $3.75 per gallon and the OPIS said that could fall to $3.50 by July 4th.

This is by far the most confusing mix of economics and demand factors going into a summer driving season that I can remember. The daily deterioration of conditions in Europe is killing demand expectations and refiners in the U.S. have not yet ramped up production of gasoline and diesel even though inventories of those products have declined for more than 10 consecutive weeks in the case of gasoline.

Crude oil inventories as reported by the EIA rose by +3.7 million barrels to 379.5 million. That was the seventh consecutive week of strong gains. The API numbers Tuesday night showed a gain of +7.8 million barrels to 378.0 million. Imports hit a five week high at 8.97 mbpd and U.S. production continued to rise to 6.14 mbpd. As you can see in the chart below the current inventories have broken above the five year range.

Crude Oil Inventory Chart

Gasoline inventories fell by -2.6 million barrels and gasoline demand rose by +172,000 bpd. Imports rose +167,000 bpd to offset some of that demand increase. With gasoline prices falling and the summer driving season only three weeks away the refiners will have to boost production soon.

Gasoline Inventory Chart

Distillate demand rose sharply by +407,000 bpd. That is almost 3.0 million barrels for the week. Refiners did increase distillate production by +301,000 bpd. In theory rising distillate demand suggests business is picking up because most diesel is used by business transportation and of course jet fuel usage will also pickup starting with Memorial Day. Heating oil is now dormant until fall. Distillate inventories set another multiyear low last week and at the current pace will break below the five year range in two weeks.

Distillate Inventory Chart

Inventory at Cushing grew by +1.1 million barrels to a new record high. That is the second new high in the last two weeks. I believe this is in expectations of the opening of the Seaway pipeline on May 17th. Traders and suppliers are hoping for a price boost on WTI once Seaway starts delivering oil to the Gulf.

Inventory Snapshot

Despite the increase in crude inventories the EIA is still predicting WTI prices to average $104 for 2012 with Brent averaging $112. If the economy continues to grow at even the minimal pace of +2.0% GDP the demand for fuel will continue to rise. The current dip in gasoline prices is expected to be temporary.

Saudi Arabia went out of their way to claim an ocean of surplus oil. They continue to repeat the "we are pumping at 10.0 mbpd and have 2.5 mbpd of capacity in reserve" whenever they have a microphone. Saudi also said they have filled all their available storage to capacity at 80 million barrels in case of a sudden supply event like an attack on Iran. Much of their storage is out of the Middle East so they can deliver oil even in the event of a blockade of the Strait of Hormuz.

The situation in Europe is worsening daily. Greek party leaders are now openly defying the bailout agreement and it appears inevitable that Greece will leave the euro. Conditions in Spain are also worsening thanks to increased contamination from Greece. The citizens in Greece may want to go back to pre austerity conditions but they clearly do not understand that Greece has no money and cannot fund the social welfare programs. The country won't even be able to keep the trains running, water flowing and lights on if they void the bailout agreements. If they leave the euro and bring back the drachma it will have no value. The exchange rate will be horrendous and that is assuming somebody really wanted to accept it.

Oil prices declined for a sixth day to touch $95.17 intraday. Society Generale (SocGen) issued a buy on WTI crude at $95 and Brent at $110. They believe we have seen the lows and futures will rally again before the end of May.

$95 is a key psychological level. I know some people are probably shocked to see oil trading that "low" but we really should not be concerned. That was support for the November to January period before the Iran security premium briefly pushed WTI up to $110.

Oil at $95 is not cheap. It is simply cheaper than $105. This is temporary and even if it does decline below $95 it is still just temporary. Over the long term the price is still going higher. I read an interview with Eric Sprott of Sprott Asset Management on Wednesday. He runs the gold and silver investment funds under the same name. He was being skewered over the "big" drop in gold to $1600. He responded back with the mantra that metals go up and down but in the long run they always go up. Over the last 12 years gold has produced an annualized return of 17% per year. No other asset class can say that.

That is the way I feel about oil prices today. They go up and down as economics and supply produce gluts, shortages and expectations for both. In the long run the price will always go up because this is a depleting asset. Short of a nuclear war demand will always go up as populations rise and the purchasing power of the rising populations increases along with it. There are 2.3 billion people in India and China that do not have cars. That is one third of the world's population and still growing. Consumption will rise along with prices. Any dip along the way is a buying opportunity.

That does not mean we should just rush into every drop in price. I like oil at $95 but I like it better at $74 and it was at that level just seven months ago. Will it go back to that level? Nobody knows but it depends on Iran and Europe. Eventually Europe will begin to grow again. Eventually Iran will either cause trouble or give up. If they give up and halt enrichment we could see $85 oil.

However, cheap oil is a wonderful thing. Cheap oil propels economies to grow and eventually consume more oil. Cheap oil allows consumers to spend more money on things besides filling their tank.

I firmly believe that the high gas prices in early April were starting to weigh on the U.S. economy and that is why our economic numbers worsened. With gasoline prices declining and the summer "oil crisis" averted we should see that economic situation improve except that we now have a new challenge in Greece and the EU ramifications from a Greek eviction. There is always another problem on the horizon. The world economy has always gone from problem to problem but it always goes higher.

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