Today's Analysis: Crude Moves In Asia

Asian oil consumers are quietly forming an alliance whose goal is to reduce the price of oil being levied on them by Middle East producers.

Reports of OPEC coming together on a production cut surfaced on 12-9 and 12-10. As we pointed out here on 12-9, the cartel would like to keep prices at or above $40 in order to keep profits as high as possible for as long a period as possible. According to Reuters: "Ministers gathering for Friday's conference said there was consensus to withdraw around one million barrels daily of surplus production over an existing target and meet again in February to discuss further cuts."

What is emerging is a picture of a potential conflict between OPEC, its profit motives, and the effects of prolonged high oil prices, as the International Energy Agency has forecast a slowing in both demand for oil, and in global economic growth. Reuters reported: "World oil demand growth in 2005 will slow from a 28-year high this year in part because a squeeze on fuel supplies for Chinese power generation should ease." At the same time "the IEA shaved its estimate for 2005 demand growth by 70,000 barrels a day to 1.38 million bpd on the 83.7 million bpd world market. That would put growth in 2005 at 1.7 percent, down from 3.3 percent or 2.63 million bpd this year when China led the steepest increase in world oil demand since 1976."

The Asian Intangibles

The rate of growth in the demand for oil seems to have slowed in China. According to Reuters, quoting IEA data: "Chinese demand growth in 2005 is forecast at 360,000 bpd, 5.7 percent, down from this year's explosive 14.7 percent or 810,000 bpd, when fuel consumption raced ahead of economic growth, said the IEA, adviser on energy to industrialized nations. The report estimated Chinese third quarter oil consumption slowed as expected to 8.6 percent after gains of 19 percent and 25 percent in the first and second quarters of 2004."

Yet, even though the rate of growth has likely slowed, and may do so in the future, there is still a larger demand in Asia, than there has been in the past, setting up a potential future conflict.

According to Dow Jones Newswires: "Executives from five South Korean refiners –were- due in Beijing on Thursday for talks with counterparts from major Chinese oil companies on the possibility of jointly purchasing Middle East crude oil." And while no one expected a major deal to be struck, it was seen as an important beginning. Indeed, the article described the meeting as " more of a preliminary discussion about cooperating in purchasing, and perhaps also in oil stockpiling and oil transportation, than a negotiating session."

The initial event, seems to have been an attention getter as it sends "out a signal to Middle East crude suppliers that Asian customers aren't happy with current purchasing arrangements, and that they want to find ways of deflating ballooning oil import bills."

And why not? This region of the world is starting to get some serious energy consumption clout. According to Dow Jones: "East Asia is a key driver of global oil demand, containing the world's second-, third- and seventh-largest oil consumers. China now needs 5.98 million barrels a day to fuel its economy, Japan's demand is 5.45 million b/d and South Korea's is 2.30 million b/d, data by British oil major BP PLC (BP) show. Asia as a whole now imports more than two-thirds of its daily oil needs of some 23 million b/d, with slightly more than 12 million b/d of this coming from the Mideast."

Victims Of Their Own Success

There is a circular interdependence to this relationship, and it presents the potential for problems in the future. According to Dow Jones: "The bulk of the crude oil imported by China, Japan and South Korea is bought under annual term contracts negotiated with the supply countries' governments or national oil companies. Asian buyers have long complained that the lack of alternative suppliers and the pricing formula adopted by Saudi Arabia and other Mid-Eastern producers usually discriminates against them."

There is some inequality in the system though. "Middle East producers regularly offer larger discounts to their customers in Europe and the U.S. when setting their monthly official selling prices, than they do to customers in Asia. So Asian importers usually pay an ["Asian Premium"] of free-on-board flat prices of at least $1.50 a barrel more than their counterparts in Europe or the U.S." Dow Jones notes, that "in recent months, due in part to shifting price differentials between the various crudes that the suppliers base their pricing on, U.S. customers have been paying more than Asian buyers for their oil."

But here is the bottleneck, and the source of friction. "Asian nations' demand for crude continues to soar, outpacing local oil output. Accordingly, their reliance on Mideast crude has risen, as have the potential negative economic consequences stemming from their exposure to the Asian Premium. This has prompted them to look for alternative oil sources and also for ways to decrease their import bill."

The second part of the equation, and perhaps the most touchy, is the currency aspect. "Japan and South Korea are in the comfortable position of seeing their currencies strengthen against the dollar - the currency used to price oil imports - and their import costs are not as high as they might be as a result. But for China, the weaker dollar seen in the past few months hasn't helped to constrain its oil import bill, as it pegs the yuan to the dollar."

This, is another reason for China to feel pressured, as its currency peg is continuing to be a double edged sword. On one hand, it keeps the engines of its economy flowing, by allowing its products to undercut most others heading into the U.S. and the rest of the world. But at the same time, the yuan has lost some of its purchasing power, making the fuel of the boom more expensive.


Dow Jones concludes that little will come of this, beyond some basic arrangements based on convenience: "there is little prospect that China and its Asian neighbors will agree any time soon on joint purchasing, on a stock-sharing system to help each other in times of supply disruption, or going even further than that by building jointly-managed reserves."

Here are some overriding reasons:

1) "Officials from China and India, both of which are embarking a massive stockpiling ventures, have made it clear that their reserves will be used to offset eventual domestic oil shortages and not in some Asian pooling system."

2) "China seems very likely to lose out to Japan's financing muscle in the struggle over the routing of an export pipeline for Siberian crude oil," and is not on the most friendly of terms with Japan, as it is "locked in heated sovereignty disputes with Japan, and also with several Southeast Asian nations over offshore oil and gas reserves in the East China Sea and around the Spratly Islands."

3)" Beijing and Seoul may fail in efforts to persuade Russia to build a gas pipeline from Siberia through China and on to South Korea. Russia now seems to favor routing this alongside the crude pipeline, to its Pacific coast, from where the oil and gas can be shipped to Japan and elsewhere.

Bottom line: this is a touch and go situation fraught with significant problems, on multiple levels. But, it does point out that the oil demand from Asia, even if it eventually slows due to an economic event, or even a natural pause in the rate of expansion, is unlikely to return to levels seen prior to 9/11.

That alone, should keep oil prices from falling as far as they would have otherwise, when the eventual production glut appears somewhere down the road.

Oil Markets : OPEC Puts On United Front To Keep Crude Prices Above $40

OPEC has made a great effort over the last few days to get its public act together. In contrast with the usual bickering between members, this time around, it only took one or two days of public disagreements before the spin all focused on production cuts. Even the Saudis, who just a few days ago were talking about production increases seem to be backing a plan to take a reported 1 million barrels off the market. The net effect is that the $40 are has held.

Cold weather is forecast for a large portion of the United States this weekend, which is also supportive on a seasonal basis. But stockpiles of heating oil, although still below historical standards have been building for at least three weeks.

Crude oil futures were trading near $43 area on Friday, prior to any announcement from OPEC. There is significant overhead resistance at the $45-$46 per barrel area on the January futures contract. A sustained break below $40 would signal a likely end to the bull market.

The Philadelphia Oil Service Index (OSX) remained below 120, and between the 20 and 50 day moving averages. Volatility will likely increase here in the next few days. For more details on trading the energy sector visit our energy timing page, featuring our highly effective OIH timing model and our Top Ten Energy Stock List.

The Amex Oil Index (XOI) remained above 700, within the 686-720, pivot band, but slipped below the 50 day moving average, a potential negative for the future if not corrected. For immediate analysis, including stock picks, and the latest in technical analysis of the entire energy complex, our subscriber section has a full complement of recommendations in oil service and the rest of the energy complex.

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