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03/03/2005 | Crude Prices Remain at US$50/b as OPEC Shies Away from March Cut

WMRC Staff

Crude prices in New York (NYMEX) and London (IPE) ended the day up over US$50/b on concerns over the current cold snap in Europe and the US, as OPEC's president said that there was 'no need for a cut at these prices'.

 

Significance
Despite the continued strength of oil prices OPEC has been widely discussing cutting production when ministers meet in Isfahan (Iran) in March, as they fear a possible oversupply problem in the second quarter.

Implications
The main short-term price driver appears to be the weather, as a cold snap on both sides of the Atlantic is homing in on the one main area of weakness in the market - distillate stocks. It also appears that hedge funds and other investors are betting on high prices at a level not seen since June 2004, and the overall net long position of the market (number of long contracts held minus short contracts) has hit similar heights. However, the price picture is rather unusual given the lack of any real fundamental data supporting US$50/b prices outside of low distillate stocks. 

Outlook
Putting crude stocks and prices together, there are essentially two conclusions to draw: either prices are being bid up in a bull run that will ultimately lead to correction and a large price fall; or there is a higher price floor to the market than had been previously thought, due to a lack of sufficient market transparency or background risk elements. The apparent detachment between data and prices makes it difficult to forecast the near term, but OPEC's apparent willingness to maintain output levels through the second quarter should ultimately lead to some softening in the crude price closer to the US$40/b mark.

The Market Certainties

One area on which there is a consensus in oil markets is the price. Yesterday crude prices on NYMEX continued to rise, though early gains could not be supported through the day, and by the close front-month WTI was up by just US$0.26/b to end the day on US$51.75/b. In London Brent crude rose by US$0.45/b on the day to end up at over US$50/b yet again, closing at US$50.06/b. The price rises were apparently spurred on by recent cold weather in Europe and the US and reports of more of the same on the way. Hedge funds also cropped up again as a possible price driver as net long positions grew to over 54,000, the highest level since June 2004. The cold weather has heightened worries over low distillate stocks in the US and Europe and looks to be the main price driver, though any upward movement is meeting a very bullish market, which is accentuating the rise. Recent comments from the US Energy Information Administration (EIA), International Energy Agency (IEA) and Saudis have all indicated a high price year is ahead, and this is providing a spur for the uptake of long contracts in the futures market. 

However, when assessing the bigger picture and comparing current prices with those of recent years, there are questions over their strength. While the latest IEA report released last month shows that overall Organisation for Economic Co-operation and Development (OECD) crude stocks are at the lower end of the seasonal range, the stock level is not by any means one that suggests a shortage. Total OECD stocks stood at 4,014.4 million barrels (or 80 days of forward supply) at the end of December 2004, up on the levels recorded in 2003 and 2002. Only in 2001 did stock levels surpass those seen in the OECD now at this time of year, and at that time crude prices were below US$25/b. 

Looking at differentials, we see that while the gap between heavy and light crudes is still present, that gap is far smaller than it was six months ago. This suggests that the imbalance between heavy and light crudes is still a factor, but not the reason for the current price levels. Looking at products, although distillate stocks are still a worry given the cold snap, the end of the winter is now nearly upon the Northern hemisphere. The attention will soon turn to petrol (gasoline) inventories, and here the picture is substantially better than it was in 2004. US petrol stocks are up by over 20 million barrels on where they were at this time in 2004, and the situation in Europe is also adequate. While ongoing tightness in the global refining industry means that there will be continued problems with ongoing supply during the high demand second and third quarters, the buffer of higher stocks should mean that there is no repeat of 2004. 

The Uncertainties

We know where the market stands, in terms of OECD stock levels and prices. What is not certain is where supply and demand goes from here. In recent weeks OPEC has been talking up the prospect of a supply cut when ministers meet in Isfahan (Iran) later this month. That has certainly made markets jittery. Both the IEA and EIA have cautioned against such a move, given what happened last year, and the EIA has tried to dispel the myth of the second-quarter demand downturn that OPEC fears (the EIA points to refinery turnarounds as creating the illusion of a demand drop - though overall crude consumption remains fairly constant when taking into account variations in the product market). These comments seem to have had little impact on OPEC, which has continued to cling to an analysis of stocks, and OPEC sees a stock build occurring in the US through the winter months. The analysis from OPEC is that supply is more than adequate, and that the risk now - if production volumes are maintained - is of a price fall at some time in the second quarter. 

While the IEA and OPEC have never seen eye to eye, it does seem that there has been a real breakdown in consensus over what is happening. In such times the only real variable worth noting is price. Even here there are analytical differences over significance. OPEC increasingly appears quite happy with a US$40-50/b price given the past six months, when there has been no apparent drop-off in demand, while the EIA and IEA would still prefer a US$30/b price. Nevertheless, OPEC does seem to accept that US$50/b cannot be a long-term price target and comments yesterday from OPEC's president, Sheikh Ahmed Fahd al-Sabah, now strongly suggest that OPEC is moving away from a production cut. Speaking to reporters in Kuwait City, Sheikh Ahmed said that the upcoming OPEC meeting may result in a production increase, but no cut. While Sheikh Ahmed is one of the more doveish OPEC ministers and his comments did not represent OPEC policy, it does show that OPEC is still constrained by prices. The organisation would have an extremely difficult time justifying a production cut with prices above US$45/b, and would certainly not be able to implement the new price band. 

Underlying all of the uncertainty in the market is still the demand picture. As happened last year, there seems to be an invisible force at work in the market that does not show up in the data, but somehow affects prices. The IEA has called for more data on both OPEC supply volumes and demand levels for the booming Asian economies, particularly China. There has not been any substantive improvement on transparency over last year, despite IEA efforts. Economic data suggests that China and other Asian economies are still growing strongly, though not as strong as 2004. Oil prices are perhaps suggesting something else.

Outlook and Implications

Oil prices have never been predictable, but usually explainable. Increasingly, even simply explaining where prices are is becoming more difficult. Distillate stocks can be pointed to, as can supply and demand estimates and the overall increase in Middle East tensions and geopolitical risk. None of this adequately seems to answer the questions that US$50/b prices pose. Retreating to traditional analysis, the situation appears to point towards a price decline. OECD stocks are not dangerously low, supplies do appear to be adequate to meet current demand and there should be more growth in supply capacity than demand in 2005. With prices now high, OPEC is less likely to restrict production and this should help to increase stocks further. Ultimately this will filter through to prices, but uncertainties mean that the scenario is far from guaranteed.

WMRC (Reino Unido)

 


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