Wild Ride May Take Crude Back Near $30 Level

NEW YORK (Dow Jones Newswires), Jan. 12, 2009

The roller-coaster ride in crude oil prices is far from over and may get wilder still in coming weeks.

Amid a growing glut in U.S. crude oil inventories and a dismal economic outlook, crude oil prices have shed more than $11 a barrel, or 22%, since Tuesday, with prices dropping early Friday to $39.38 a barrel, the weakest level so far this year.

Weak demand has caused crude oil inventories to swell, adding pressure on near-term prices. The Organization of Petroleum Exporting Countries is trimming output, but the moves aren't expected to begin impacting stockpiles for weeks, meaning no letup in selling pressure on oversupply concerns.

Crude prices haven't settled below $41.70 a barrel so far this year, helped by Mideast tensions and the dispute over a cut in Russian natural gas flows to Europe. But traders said poor fundamental forces in the U.S. - most notably weak demand - means prices are set for a challenge of $35 a barrel, last seen Dec. 19, and perhaps a move back toward $30 a barrel, similar to the lows of late 2003 and early 2004.

"Things are ugly and getting even uglier," said Nauman Barakat, senior vice president at Macquarie Futures in New York.

The December U.S. employment report on Friday revealed the latest economic woes. The Labor Department said non-farm payrolls fell by 524,000 in December. It also revised November data to show a steeper loss, of 584,000 jobs, which was the most since 1974. The U.S. economy lost 2.6 million jobs in 2008, the most since 1945, with the unemployment rate ending the year at a 16-year high of more than 7%.

Oil demand in the world's biggest consumer nation is down sharply amid the economic turmoil, down 1.45 million barrels a day, or 6.8% below a year ago, at around 19.8 million barrels a day. Full-year 2008 demand showed the biggest plunge since 1980, down 1.22 million barrels a day, or 5.9% from a year ago, to 19.46 million barrels a day.

Crude Build Most In 38 Years

In the world's biggest oil consumer, there's enough extra crude sloshing around in storage to feed the nation's refineries for 4.5 more days than last year. "We are drunk with crude," said Phil Flynn, analyst at Alaron Trading in Chicago.

Early data for December from the Energy Information Administration show U.S. crude oil stocks rose by 5 million barrels in the month - the biggest gain in the month since 1970 and a big change from the five-year average drop of nearly 10 million barrels. At 325.4 million barrels on Jan. 2, crude stocks are up 39 million barrels, or 13.6%, from a year ago, the biggest surplus at the start of the year since 1995.

Nowhere is the glut in U.S. crude oil stocks more evident than in Cushing, Okla., the delivery point for the Nymex contract, where the EIA said stocks are at record high levels and 81.5% above a year ago. As expiry of the February contract on Jan. 20 nears, the contract is already showing record weakness in relation to the second-month contract, a phenomenon known as contango.

The front-month discount to the second-month contract early Friday was $5 a barrel, the biggest front-to-second month spread this far ahead of contract expiration and twice the size of the discount ahead of the January-delivery contract.

Fireworks At Expiry Again

Jim Ritterbusch, president of Ritterbusch and Associates in Galena, Ill., sees the widening spread as "setting the table for a repeat" of the volatility when December went off the board. He said crude could drop back into the $30-a-barrel range in the near term.

Fireworks accompanied the January expiration, as the contract went off the board at $33.87 a barrel, nearly a five-year low and a record discount of $8.49 a barrel to the second month.

"The vicious circle of ever-increasing contangos feeding inventories at Cushing and deepening the contango further is still in full cry, leaving the February-March spread heading for a potentially violent expiry," analysts at Barclays Capital in London said.

Meanwhile, OPEC is pledging deep cuts in output and trying to erase the contango, thereby eliminating incentives to aggressively build stocks and taking control of the market back from consumers.

But in the near term, cheap crude will continue to find its way into company-held stockpiles and also government reserves. The EIA estimates that heavy maintenance, poor demand and weak margins will slash crude oil processing at U.S. refineries by 500,000 barrels a day to a 12-year-low of less than 14.1 million barrels a day.

Bargain prices have spurred the Energy Department to launch plans to restock the Strategic Petroleum Reserve this year, at a somewhat aggressive peak rate of 180,000 barrels a day in February through April. Such diversion of crude out of the market is essentially a boost to demand. But refinery runs are expected to be so low that, even adding in the SPR fill rate, demand for crude would still be 400,000 to 500,000 barrels a day below five-year average levels.  

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