Oil Hits $82.41 on Expectations for Stronger Demand

Jim Brown
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Crude prices rallied on Monday morning to $82.41 as the expectations rally continued. In theory a better than expected jobs report that showed less jobs lost than analysts had predicted, means crude demand is about to increase sharply. I think that is a stretch of the imagination but evidently there are plenty of vivid imaginations at work.

In reality crude demand in the U.S. and the world has increased over the last couple months. According to Bloomberg U.S. fuel usage over the last four weeks was +3% higher than the same period in 2009 and there were two blizzards in 2010. Fuel demand in the U.S. rose by 219,000 barrels over the prior week to 19.3 mbpd according to the EIA.

The recovery is starting to show up in other economies as well. Factory orders in Germany, the world's sixth biggest oil consumer, rose +4.3% in January over December levels. Economists had forecast a +1.3% rise. This was 19.6% increase from the same period in 2009.

The drop in oil prices in February has almost been erased. Crude oil traded below $70 on the current contract in early February after declining from the January high of $84.96. That low came on February 5th and today, March 8th it is back at $82.41. That is a pretty significant drop and recovery in a short period of time.

The real question now is what will OPEC do when they meet on March 17th to discuss production? Tanker tracker, Oil Movements, claim OPEC is already shipping less oil in March than they did in February. They claim exports by sea will decline -2.3% for the month ending on March 20th. The drop will take the daily average down to 22.87 mbpd. That data excludes Ecuador and Angola.

There is no shortage of oil with U.S. inventories rising 4.03 million barrels last week. OPEC leaders are going to be perplexed with the situation when they meet. Compliance with the existing production cuts is down to 53% to 57% depending on whose numbers you use. If OPEC forces more compliance then even less oil will be shipped and prices could eventually rise further. Most OPEC members would probably be thrilled with a higher price but Saudi Arabia could have a different view. They would rather see oil prices remain stable instead of spike over $85. Saudi views $75 as a fair price today. Once over $85 U.S. gasoline prices start moving over $3 again and that depresses demand. It is a fine line and Saudi would like to keep those prices just under $3 to avoid the psychological impact.

Retail gasoline in the U.S. rose to an average of $2.72 per gallon last week according to the AAA. At the same time the crack spread for refiners widened by 27 cents to $13.88 per barrel. The crack spread is the difference between what a refiner pays for a barrel of oil and how much they get for the refined products. This is their profit margin.

Reuters posted an article this weekend highlighting the increasing demand for oil in the Middle East. According to Reuters demand in the Middle East will rise by +5% in 2010. Countries that export a lot of oil tend to sell it cheaply to their own citizens. For the OPEC nations where the cost of oil is minimal they can afford to subsidize fuel to grow their economies. Unfortunately once they get addicted to that cheap fuel they start consuming more of it and that reduces the quantities left for export. Saudi Arabia and Iran are expected to be at the top of the list for increased country demand.

The IEA said demand growth in the region would top 320,000 bpd in 2010 to total 7.55 mbpd in consumption. That +4.5% growth is more than double the 1.8% the IEA is predicting for the rest of the world. Saudi alone is expected to consume an extra 130,000 bpd in 2010 and pushing their total consumption to 2.76 mbpd.

Saudi is expected to post GDP growth around 3.8% in 2010, up from 0.2% in 2009. The kingdom is expected to cut diesel exports by 19% to around 105,000 bpd because country demand is increasing. Iran is expected to see oil demand rise more than 6.3% to 1.86 mbpd according to the IEA. Saudi and Iran use diesel to power electric plants and more new construction produces more demand for air conditioning and therefore more demand for diesel.

If Iraq ever returns to the civilized world the fuel demand there would skyrocket. However, the constant threat of terror attacks and the lack of a normal business environment is keeping demand low.

Iran won't be increasing consumption much longer if it does not learn to keep its political mouth shut. Iran continued to paint a bulls-eye on itself with the announcement on Sunday of a new cruise missile program. Reportedly they have started production of the Nasr 1 cruise missile that can destroy targets up to 3,000 tons in size. The general making the announcement said the missile could be fired from ground-based launchers, ships and could be modified to be fired from helicopters and submarines. This sounds to me like the weekly announcement planned to irritate the West and supposedly make themselves appear more capable of defending themselves. A note at the bottom of the wire services release said "Iran frequently makes announcements about advances in military technology that cannot be independently verified." Obviously everyone else has figured out the Iranian strategy as well.

Jim Brown

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