Streetwise Professor

January 7, 2009

That Didn’t Last Long

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 2:15 pm

Oil has been up smartly since the last trading day of 2009, up around 25 percent (from around $40/bbl to $50/bbl).   But today, a record stocks build in beautiful, windswept Cushing Oklahoma (I’ve been there–don’t make a special trip) caused prices to drop precipitously:

The latest US stock data has just been released and it’s a whopper of a build at Cushing, Oklahoma- the delivery point for West Texas Intermediate physical barrels which set the WTI Nymex benchmark. The number is currently the most closely watched inventory figure because of the contango in the forward curve and the associated incentive to store crude.

Few analysts would have expected Wednesday’s build of 4.1m to 32.2 mn barrels. The total build documented by the US Energy Information Administration figures was 6.7m to 325.4m barrels. Crude has unsurprisingly come off sharply on the news – WTI down to some $44 per barrel at the last look, off some 7.6 per cent over the session. According to Dow Jones Newswires, total capacity at Cushing is some 45 mn barrels.

All in all it’s a very bearish indicator for crude with inventories across the oil complex building much more than expected:

US energy inventories as tabulated by Reuters

As a result, as of mid-day Central Time, Brent is down around 7 percent, and WTI (which is settled by Cushing delivery) is down over 10 percent.

Looking at the charts from ICE , there was a huge drop in prices exactly at the time the storage number was released, then a little dead cat bounce, then a continued decline.

This is another indication of persistent bearish fundamentals.   Another is that traders are continuing to hire VLCCs to store oil:

Frontline Ltd., the world’s biggest owner of supertankers, said oil traders want to charter as many as 10 vessels to stockpile crude to take advantage of higher prices later in the year.

About 25 supertankers were already hired for storage and there are enquiries for 5 to 10 more, Jens Martin Jensen, Singapore-based interim chief executive officer of the company’s management unit, said by phone today.

What’s going on in the oil market reminds me of the sorcerer’s apprentice in Disney’s Fantasia.   Traders are running about willy-nilly looking for any pot and pan available to hold the oil that producers are pumping but consumers ain’t buying.   Supply is very hard to adjust in the short run (operating a well being essentially an “on-off” decision, and turning off a well by capping it is an expensive, and expensive to reverse, decision that producers are loath to make.   Especially in places like Russia due to the lovely climate.)

The recent rally reflects two forces.   One is some limited optimism about economic prospects; the stock market has steadied, and indeed rallied a bit, and there has been a pretty decent rally in the credit market.   The other is geopolitical uncertainty, driven by the Gaza war and the Russian-Ukrainian gas stand off.

The whopping storage build should considerably dent this tentative optimism regarding firming fundamentals.   The geopolitical uncertainty is harder to gauge.

LaRussophobe beat me to the punch in hypothesizing (with accustomed hyperbole 😉 ) that one (of many) motives behind Russia’s hard line with Ukraine is that it benefits from political tensions that raise fears about energy–and hence raise energy prices:

Why, it was almost as if Russia wanted to disturb the gas market and drive up prices artificially due to a panic.   Why would it want to do an outrageous thing like that, bordering on terrorism?

. . . .

This makes it clear that Russia is not above destabilizing financial markets in order to turn a quick profit, belying any Russian contention that it is a “stable partner” in the energy field and therefore deserving of, for instance, a seat at the G-8 table.

What LR says about Russia goes exponentially for Iran, which is also sucking wind as oil prices plummet.   Indeed, Iran’s economic situation is far more dire than Russia’s.

Now, take into consideration the fact that Hamas is an Iranian sock puppet.   Oil prices spiked during the Israel-Hezbollah war in 2006, and are experiencing a mini-spike now as the Israelis pound the snot out of Hamas.   Although the Iran/Hamas-Israel hostilities have a long history, and the current conflict is overdetermined, the timing is indeed interesting.   Just as oil prices come down hard, Hamas declares the end of a cease fire, conflict erupts, and oil prices rebound, thereby helping patron Iran.   How very convenient.   Can’t say definitively that Iran turned Hamas loose in order to stem a rapidly deteriorating economic situation, but it is a reasonable hypothesis, and consistent with the observed time line.

The lessons from all this?   I draw several.   First, economic (as opposed to fear factor) fundamentals remain very weak.   Second, the recent rally (which was still to small to provide more than modest relief to Russia, Iran, Venezuela, etc.)   is primarily driven by geopolitical uncertainty.   Third, given the fact that myriad bad actors in the world sell oil, and benefit from ratcheting up fear and chaos, said actors have an incentive to sow said fear/chaos.   Meaning that we may be in for a spell of conflicts and standoffs in the former Warsaw Pact region, the Middle East, and perhaps, the Carribbean.

Thus, the oil market will be pushed and pulled by contrary forces–weak economic fundamentals in the industrial/developed world, and disorder in energy producing regions.   This is a recipe for high volatility, but I think that it is likely that the weak fundamentals will dominate, and that as a result, $50/bbl or thereabouts will probably represent the upside for oil for a while.

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4 Comments »

  1. Hard to imagine how, if the price of gas follows the price of oil into the basement, Russia as we know it can survive.

    Harder still to imagine what foul misdeeds the Kremlin would not be capable of as it realizes the end is nigh.

    Comment by La Russophobe — January 7, 2009 @ 6:02 pm

  2. That was really informative! But I see that compared to year ago, the storage is up only roughly 40 m barrels. 330m compared to 290m this time last year. I know that before the slump, US was consuming crude at 20m per day. So, the year on year inventory increase will only service the US consumption for extra 2 days (may be a little bit more. I am not sure how much the crude consumption has slumped recently – 15m/day ? 17m/day?). I also know that there is a strategic reserve underneath Lake Charles. I bet that would have been filled up to the brim now 😀

    Comment by Surya — January 7, 2009 @ 8:48 pm

  3. 13 percent is a pretty big deal given the normal variability in the amount of oil in storage. Also, the EIA and API are like the drunks looking for their wallet–they look under the lamppost where the light is good. The stories about all the tankers being snapped up just to store crude suggests that the true inventory build is substantially bigger than the official figures indicate. EIA and API and the IEA don’t really track that. The 8 pct decline in crude runs (per EIA) is also a big deal.

    The ProfessorComment by The Professor — January 7, 2009 @ 10:32 pm

  4. SWP, please stroll over to Investorvillage.com(http://www1.investorvillage.com/), free and easy registration, and go to the CWEI board where the very knowledgeable investors there, many of which are in the oil/gas industry, have been tracking with their own models against the EIA’s their Daily Gas Flow on a weekly basis. Look for robry 825’s posts. I’m throwing it out there because they are a great resource. They are very good at comparing discrepancies.

    Today’s numbers as an example of their work:

    ============US Gas Flow Models (US storage injections, in BCF, as of 9AM)=============
    …Week…..——————Composite.Model—————————-….–Weekly.Models–….Baseline
    _Ending__Sat___Sun__ Mon__Tue__Wed___Thr___Fri__Total__2005__2007__EIA__(Neutral)
    10/03/08…13.8….15.7…..14.9….14.5……9.8…….8.8….10.5…….88…….80…….90…….88……….75
    10/10/08…10.1….12.6…..14.3….13.6……9.3…….9.5……9.6…….79…….76…….84…….79……….68
    10/17/08…10.5….12.1…..11.6….11.9….10.4…….7.4……6.0…….70…….73…….75…….70……….76
    10/24/08…..9.0……9.1…….8.8……8.0……4.7…….2.5……4.0…….46…….30…….42…….46……….20
    10/31/08…..6.5……9.3…….6.4……2.7…..-4.0……-2.7……0.8……19……….6……18…….19…………2
    11/07/08…..7.4……7.4…….9.0……8.9……8.6…….9.2……9.4…….60…….42…….56…….60……….53
    11/14/08…..7.5……2.7…….0.4…..-1.9…..-0.1…….1.7……5.6…….16………0……11…….16………-18
    11/21/08…..4.4…..-0.8……-7.1..-11.8…-16.2….-15.9…-18.7……-66…..-62……-54……-66……..-83
    11/28/08..-19.3…-17.4…..-8.6…..-6.0…..-8.6……-3.7…..-0.3……-64…..-75……-62……-64……..-99
    12/05/08….-1.8……0.0…..-3.4…-12.2…-15.8….-15.1…-18.7……-67…..-80……-70……-67……-114
    12/12/08..-21.8…-21.6…-10.8…-28.6…-10.1….-13.0…-18.2….-124…-127….-120….-124……-156
    12/19/08..-22.9…-18.3…-15.0…-18.9…-28.9….-23.8…-19.1….-147…-156….-148….-147……-157
    12/26/08..-13.8…-22.7…-34.8…-32.4…-18.2….-11.6…..-9.6….-143…-164….-152….-143……-180
    01/02/09r….0.0……1.9…..-2.9…..-8.7…-12.3….-18.6…-17.2…….-58…..-69i…..-58……………….-99
    01/09/09r.-16.3i..-13.2i..-15.4i..-18.9i…-10.4i…..-8.4i….-5.0i……-88i..-102i…..-88i
    Estimated EIA-Weekly based storage (As of 01/08/09)…….2732 BCF
    …………………………………………………..(As of 01/08/08)…….2698 BCF…(+34 BCF YOY Surplus)

    Sadly, LR, I’m of the firm opinion that Putin will live on past this crisis in Russia. There is no viable alternative and no mechanism if there was a popular opposition figure to change places in the Kremlin. The risk adverse, passive and capitalism/civil society ignorant Russian masses would have to be herded into mass graves again and Putin isn’t that stupid. These are people that for decades waiting patiently for a good outcome with every lame Five Year plan that never came. The younger ones born after the USSR fell aren’t that angry, they seem content as long as they have access to western stuff.

    We are witnessing in the EU the demise of civil liberties as the non-elected Brussels bureaucrats run dictate the policies. Ireland’s “no” vote will be ignored. We are entering an age when compromising civil liberties which is the true face of socialism is occuring in the west too.

    I could be wrong for what it is worth.

    Comment by penny — January 8, 2009 @ 11:26 am

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