Caution Signs After Steep Oil Price Fall

NEW YORK Jan 08, 2007 (Dow Jones Newswires)

U.S. crude oil prices were below OPEC's unofficial target level of $60 a barrel for a third day Friday, with the first few trading days of 2007 casting a bearish light on the prospects for the full year.

The steep 8.9% loss in the year's first two trading days slashed more than $5.50 a barrel from prices and marked the most ominous start for Nymex crude oil futures prices since 1991.

Back then, front-month crude futures shed 12.4% in the first three trading days, and - eerily - for the full year averaged precisely 12.4% below the previous year's average.

A modest recovery in choppy trading Friday, of 72 cents to $56.31 a barrel, proves that the market isn't heading south on a one-way street. In fact, the road signs, while not suggesting a sharp U-turn in market direction yet, urge caution.

With the glaring exception of heating oil stocks - brimming at their highest level in eight years throughout the Northeast - U.S. oil inventories are tight and demand is strong.

Unusually warm temperatures across the Northeast - the world's largest heating oil market - has slashed demand for heating oil, but U.S. demand for widely used transportation fuels remains robust.

Weekend forecasts call for record high readings in New York City, which is expected to log temperatures higher than in Riyadh, Saudi Arabia, where consumer nations' unseasonable warmth translates into unreasonably low oil prices.

OPEC's Vienna-based Secretariat reported Friday that the value of its reference basket of crude oils plunged to $53.23, the lowest level since Dec. 29, 2005 after U.S. crude oil prices posted 18-month lows.

Saudi Oil Minister Ali Naimi, the de facto leader of the Organization of Petroleum Exporting Countries, has cited $60 for U.S. crude oil as a reasonable level, thereby making it OPEC's unofficial baseline.

Naimi, heading up the world's largest oil exporter, steered OPEC into pledging a 1.2 million barrel-a-day oil output cut beginning last November and consented to a further cut of 500,000 barrels a day to take effect Feb. 1.

OPEC Price Floor Sagging

Until this week's sell-off, OPEC had succeeded in putting a floor under prices, triggering a 6.6% rise from the announcement of the first cut on Oct. 20 through year-end, with prices averaging $60.54 over that time. The average price after three days of trading in 2007 is $56.74 a barrel, 6.3%, or $3.80 below that level.

While OPEC contended in December that compliance with its first output cut in two years is near 80%, a survey by Dow Jones Newswires suggests that output was cut by just 500,000 barrels a day, less than half of the pledged level.

OPEC ministers, anxiously watching price movements, have little room to maneuver now, as oil companies' purchases for February already have been set.

While pledges of better compliance, or hints of still further cuts may be forthcoming from OPEC if the sell-off picks up pace again, only a true clampdown on overproduction would right the market. History suggests that only a full-fledged price collapse, rather than fears of a collapse stiffens OPEC's resolve. Market suspicions abound that if OPEC fears that a sustained fall below $50 a barrel is in the cards, some members will try to sell all they can now, when prices are closer to $55 a barrel.

But well before the market can assess whether OPEC is reigning in production again in February, as promised, an inevitable cold snap - even in this El Nino-dominated winter - or a fresh flare-up in any of the oil world's hot spots - Iran, Iraq, Nigeria or elsewhere - could radically change the price trajectory.

Heavy maintenance at U.S. refineries in coming weeks may tighten stockpiles further, particularly for gasoline, which remain snug, despite a surprise 5.6-million-barrel gain in the last week of December.

US Demand, Norway Flows Eyed

Preliminary data from the U.S. Energy Information Administration shows gasoline stocks ended 2006 at 209.5 million barrels, up slightly from a year ago, and narrowly below the five-year average level. Due to stronger demand, though, stocks are actually tighter than they appear.

Despite a 13% jump in average retail prices for regular gasoline, preliminary EIA data through Dec. 29 show gasoline demand rose 1% in 2006, to a record 9.25 million barrels a day.

Demand for distillate fuel, the umbrella grouping for diesel and home-heating oil, posted a record 4.2 million barrels a day in 2006, jumping 2% from a year ago, despite dismal heating oil demand, the data show.

Overall, early data show, U.S. oil demand averaged around the 2004 level of 20.7 million barrels a day, with a notional 0.3% drop in 2006 offsetting a similar slim rise in 2005.

The full U.S. oil use tally was dragged down by a 26.3% plunge in demand for heavy, residual fuel oil, to its lowest level recorded by EIA in 70 years of data. EIA figures show resid demand plummeted to 671,000 barrels a day from an 11-year high of 919,000 barrels a day in 2005. Resid demand surged after deadly hurricanes in 2005 crippled natural gas output, but abundant supplies and a 22% decline in gas futures prices in 2006 slashed resid use by utilities and heavy industry.

Apart from the strong demand outlook in the U.S., the world's largest oil consumer, estimates of new oil supplies coming onstream in 2007 may prove overstated.

The Norwegian Petroleum Directorate said Friday that oil output in 2006 from the key non-OPEC oil exporter was at its lowest level since 1993-94 and that 40 of its 48 fields "have come off plateau production."

Norwegian crude oil output last year was near 2.3 million barrels, 2.9% below the government's estimate, and output in 2007 will be lower, at 2.2 million barrels a day. Norway said, however, that the uncertainty factor in its 2007 estimate is plus or minus 13%, "linked to the ability of the reservoirs to deliver, timing of start-up for new projects and the regularity of producing fields."

In the five years through 2011, Norway said, total oil output, including condensates and non-gas liquids, will average near levels seen in the previous five years.

Taken together, strong demand, tighter stocks, OPEC restraint and uncertainty over new supplies could detour prices from the current weak course.

In the past five years, Nymex front-month futures prices in the first quarter have averaged 11.6% above their December average. If that holds true this year, first-quarter prices would trade near $69.26 a barrel, challenging $70 for the first time since August.

Copyright (c) 2007 Dow Jones & Company, Inc.