The price of crude oil plummeted nearly 6% on the New York Mercantile Exchange Wednesday, settling just above $63 a barrel. While investments in the energy commodity have been spurred by hope of an economic turnaround, US inventories surged today, pointing to a decrease in demand.
In trading Wednesday, the price per barrel of crude oil dove $3.88 to settle at $63.35 a barrel on the NYMEX. This is the biggest single-day loss for the commodity since April.
Prompting the fall, the US Department of Energy reported an unexpected rise in supplies of 5.15 million barrels for the week ending on July 24.
"The rise in crude oil is quite contra-seasonal; usually you have inventories decline into mid-September," explained Bill O'Grady, the executive vice president and chief markets strategist at St. Louis-based Confluence Investment Management LLC, an investment advisory and management firm. "Really from May until mid-September, you usually see inventories fall every week; so any time you get a rise this time of year is unusual -- and this rise was huge."
While the summer driving season has not produced the level of demand that was expected, the culprit in this stockpile remains refineries.
"The gasoline numbers were about where they've been, which of all the products out there, it has got about the best demand, but that's not very good," said O'Grady. "Refinery operations have been falling because the margins are not very good, and as refining margins fall, and refineries slow production, it means that inventories of crude oil back up."
Oil Prices May Fall Lower
Because the high-demand season for crude oil is coming to a close, the price of oil may very well continue to drop this fall.
"The other thing that is starting to worry the market is that consumption still remains very lackluster, and we are rapidly approaching the end of the summer driving season that hasn’t been very strong anyway," O'Grady advised. "Typically after Labor Day, gasoline consumption falls off a cliff -- if that occurs, and we don't see any significant improvement in the other product categories, it's going to be very difficult for oil prices to hold up, even if investment flows are pretty good."
While there is still another month of the summer driving season to push up demand in the US, the potential for demand dropping in the autumn remains. The market's fear of this occurring may scare away investments.
"There are a lot of analysts out there calling for a break in oil prices into the low-$50s or high-$40s, and we might be setting up just that type of scenario," O'Grady revealed. "It may not occur real quickly because I think summer is where, especially during periods of economic weakness, you get a late surge in vacations."
O'Grady explained that American households may have held off on making a summer vacation because of the weak economy, but once the fear of a layoff has passed, a last-minute escape becomes a reality.
"Once we get past Labor Day, it's really going to be tough to see this market find its feet -- that's the bigger worry," he explained. "It's starting to appear that you're not going to get much product support, and you're going into a seasonally weak period of the year, you could see a pretty healthy decline here."
Will OPEC Prop up Prices?
Because the oil cartel has repeatedly claimed the $70-mark as a positive price for oil, the prospect of the Organization of the Petroleum Exporting Countries cutting production to achieve that price is a possibility, advised O'Grady.
"Getting those cuts out of the coalition will be pretty tough, in part because the Saudis have made the bulk of the cuts, and I don't think they necessarily want to make more, and they really haven't been able to reign in Angola much," O'Grady said.
Because OPEC does not publish production quotas, the market must make estimates of what each country is able to produce based on market history. While Angola has repeatedly claimed that the country has stayed within production numbers, doubts remain that it has.
"My hunch is both Angola and Iran are both aggressively overproducing," O'Grady revealed. "The Saudis will tolerate that as long as the key markets are not affected. Their two key markets are the United States and China, and as long as they are the biggest OPEC supplier to those to countries, they will generally tolerate cheating. If they start to lose the top OPEC supplier status, they don't take that well."
With the next OPEC meeting scheduled for September, the chance that the major oil cartel will cut production, limiting supply and, in turn, increasing demand may buoy prices moving forward.
"I don't think we're at a point yet where we're looking at market share issues, but if they cut back, that will be something we'll be watching," he said.
Natural Gas May Find Temporary Footing
Natural gas continued its decent on the NYMEX Wednesday, dropping another 15 cents to settle at $3.379 for August deliveries with the option expiring today. September deliveries fell as well, settling at $3.548 per mmBtu -- a decrease of nearly 14 cents.
Natural gas is largely a domestic product because of the way it is transported. The requirement of pipelines to transport the commodity keeps natural gas dependent on US factors. Currently, natural gas is finding support from weather predictions across the country.
"August looks like it's going to be a little hotter," O'Grady said. "That is actually a little more supportive than what we were seeing before, but industrial demand is still very weak. Past utilization is still at historic lows. Demand is still pretty soft, and you're still seeing injections running around average or higher. If oil prices fall, I expect it will take natural gas with it."
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