Nov 16, 2000

Oil Markets: Watch the Thermometer!

World oil markets remain on a boil this month, partly responding to political developments, but primarily fixated on low heating oil inventories in the United States and beyond. The bulk of forecasters remain convinced that prices will weaken next year, perhaps sharply. Political developments, including the continuing Israeli-Palestinian turmoil, have kept traders nervous and made them reluctant to short the market. At the same time, there have been threats of disruptions to Iraqi supplies from two fronts, and although any physical impact would be mild, the psychological effect has been noticeable.

Earlier this month, Iraq announced that it would switch its oil sales contracts to euros, in an effort to show resistance to the United States and its currency, in which most oil transactions are carried out. (In fact, this should bolster the euro slightly, reducing the US trade deficit, to our benefit.) Fears that this changeover would meet US resistance and cause delays in Iraqi oil exports raised prices, but proved unfounded. Now, however, the market is watching the rollover to the next phase of the U.N. oil-for-food program, which is scheduled to begin in early December. This has sometimes been accompanied by procedural delays that reduced exports briefly, but in this case, Iraq appears to have pre-arranged enough sales from the previous phase to prevent that. Until they see sales proceeding smoothly, traders will undoubtedly continue to worry.

Global oil inventories continue to build, but slowly, which has left many concerned that estimates of OPEC production have been too high and that the market will remain tighter longer than expected. Prices remain near their post-Gulf War highs and continue to be backwardated, discouraging inventory building.

Heating oil inventories remain very low, particularly in the United States and Europe, but the uncertainty about the market is enormous. Weather, naturally, remains a big factor, since forecasting remains unreliable and heating oil demand is strongly driven by weather. An early cold spell has boosted heating oil prices and raised fears of tight supplies in the first quarter of next year.

However, there remains the possibility that industry inventories are low because of high consumer inventories. WEFA estimates that US consumers have approximately 100 million barrels of storage capacity. Since industry inventories are 20 million barrels below norm, this could be offset if consumers raised their average pre-season fill level by 20%. This would explain the anomaly of strong growth in middle distillate sales when other oil product consumption is flat. Combined with reported high distillate production and exports in Asia and Europe, there remains a possibility for a distillate (and crude) price collapse in the first quarter, particularly if US and European weather resembles the recent mild pattern rather than the predicted “normal.”

http://interactive.wefa.com/features/index.cfm?ID=334

-- Martin Thompson (mthom1927@aol.com), November 17, 2000