Crude Prices Proving Resilient

Jim Brown
 
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Brent prices moved over $113 intraday and settled at $112. That is two weeks of gains from $102 without a material bout of profit taking.

Crude prices are proving to be surprisingly resilient when the economic picture continues to be weak. The reasons for the gains are expectations for the ECB to launch another QE program and the increase in tensions over Iran and Syria.

The claims that Standard Chartered hid $250 billion in Iranian transactions have increased scrutiny on other banks and analysts believe there will be another slowdown in transactions handled for Iran by other banks that had also been participating. Once the cheating from one bank was found there are assumptions that others were doing it also. The crackdown on Standard Chartered should strike fear into any other banks and future transactions are likely to dry up on hopes the past can be hidden and by not doing any more they will reduce their risk.

This crackdown should increase the pressure on Iran and further shrink their crude exports. However, we learned today that South Korea, a prior ally to the U.S. and the fourth largest importer of Iranian crude prior to the sanctions, is going to restart purchases of Iranian oil. Korea said Iran has offered to deliver crude using Iranian tankers and provide up to $1 billion worth of insurance coverage for the vessels.

Seoul had been granted a waiver because they had cut shipments "significantly" but they cut them completely ahead of the July 1st embargo by the EU. The waivers have to be renewed every six months and I suspect there will be quite a few that will be cancelled at the end of the current period. Iran's crude exports were cut in half to 1.1 mbpd in July when the embargo prevented buyers from obtaining insurance on the shipments.

U.S. lawmakers including President Obama want to continue tightening the screws on the Iranian regime. They passed a new round of sanctions before lawmakers broke for their five week campaign vacation. If Iran continues to display its military capability each week with new announcements and exercises it will only accelerate the desire to limit their funds.

It was ten years ago this month that an Iranian dissident group held a news conference in Washington and told the world about two covert nuclear installations in Iran and started the current effort to prevent Iran from getting the bomb. Iran has perfected the nuclear hide and seek strategy and the talk and stall strategy to extend negotiations indefinitely while they continue to expand their programs. Iran's president called again for the destruction of Israel earlier this week. The closer Iran gets to a nuclear weapon the closer Israel gets to attacking them. Israel has already proved they will not tolerate a nuclear nation that exports terrorism by bombing nuclear sites in Syria and Iraq.

In the U.S. the EIA inventory numbers surprised again with a -3.7 million barrel decline compared to expectations for a decline of only -500,000 barrels. Over just the last two weeks inventories have declined by 10.2 million barrels. Cushing inventories declined -1.8 million to a 12-week low of 44.3 million barrels. The overall decline in crude put the total of 369.9 million barrels -0.1% below 2011 levels for August. After being well above year ago levels for most of the year this is a dramatic decline. However, inventories are still well above the five year average range.

Crude Oil Inventory Chart

The decline in crude was even more surprising because imports rose by +221,000 bpd (1.5 mb). That should have lifted inventories. Domestic production did decline by -102,000 bpd.

Gasoline inventories declined by -1.8 million barrels compared to expectations for a 500,000 barrel increase. That puts gasoline at -3.5% or -7.5 million barrels below year ago levels. Gasoline demand increases slightly by 40,000 bpd. Gasoline inventories are still near the bottom of the five year average range.

Gasoline Inventory Chart

Distillate inventories, jet fuel, heating oil and diesel, fell -700,000 barrels compared to expectations for a rise of +800,000. Distillates are the farthest below their year ago levels at -18.5% and are slightly below the five year average range.

Distillate Inventory Chart

Refinery utilization rose to 92.6% but should decline next week after the Chevron refinery fire in California. Other refiners will try to increase production to offset the loss of the Chevron plant but that facility produced 15% of the fuel used in California. Chevron said the fire lowered its gasoline capabilities by about 40% but it will continue producing at the lower levels while the damage is repaired. The plant produces 240,000 bpd under normal conditions. The fire was in the crude processing unit and that will be offline indefinitely. The plant is currently running using feedstocks stored onsite. Once those supplies of gasoil are depleted the plant will have to cease operations until the crude unit is repaired. Gasoline prices in California rose an average of 30 cents per gallon as a result of the blaze.

Inventory Snapshot

Crude prices continued their recent rally mostly on expectations for the ECB to announce a QE program soon. That may or may not happen since Draghi has to get permission from his board that is made up us representatives from the various countries in the eurozone including some hardliners from Germany.

The Fed appears to be on hold until at least mid September but probably longer unless the economy takes a nose dive in August. Is that good news? Should we be hoping for the economy to decline so the Fed prints more money? A slowing economy uses less oil so demand will decrease and inventories rise. Any QE bounce would be short lived in that scenario.

August is typically the period where crude prices begin to decline as the summer driving season ends. Tensions overseas could keep prices up but that increases the headline risk and sudden declines are possible. If Assad is suddenly removed from office in Syria or Iran goes back to the bargaining table then prices could fall suddenly.

We should not expect prices to continue higher through August. The historical trend does not support it. Oil prices decline when driving season ends unless there are geopolitical events supporting the price.

That suggests crude prices are going to remain locked into a range from $80 to $105 until the global economy begins to recover.

Jim Brown

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