A Rebound in Oil Prices May Presage Pick Up in Demand

NEW YORK (THE WALL STREET JOURNAL via Dow Jones Newswires), Jan. 23, 2009

The price of crude oil initially fell Thursday after the Energy Information Administration reported a larger-than-expected build-up in crude-oil and gasoline stocks. But after hitting as low as $40.41, oil rebounded to end at $43.67, up 12 cents, on the New York Mercantile Exchange.

That move, along with the recent narrowing of the difference between the prices of the nearby contract and later-dated contracts, suggests the market is seeing a change.

"When the market shrugs off inventory data like that, it often can be a beginning of a signal that things have turned," says Gene McGillian, analyst at brokerage TFS Energy in Stamford, Conn. "We need to see more of a confirmation that the market can withstand the negative signals that we saw today before we're really convinced."

In the past several weeks, the supply of oil has been building up. Stocks in Cushing, Okla., the delivery point for the Nymex crude oil contract, rose to a record 33.2 million barrels. The EIA reported Thursday that as of Jan. 16, total U.S. crude stocks were up 6.1 million barrels to 332.7 million barrels, the highest since August 2007.

As a result, the price of later-dated futures contracts has remained persistently higher than the current contract. This situation is known as contango, where oil-market participants buy physical barrels and sell them forward at a higher price.

It suggests that oil-market participants feel more confident about the prospects for future demand than about the current market, and they are willing to carry the cost of storing oil until they unload the oil for the higher future price.

This condition is nowhere near as severe as it was last week. As of Friday, the spread between the March and April contracts was as much as $4.45. That narrowed to $2.16 by Thursday. To some, that suggests the possibility that supply from the Organization of Petroleum Exporting Countries is indeed being reduced (something oil traders typically are skeptical of), and that oil-market participants are starting to see nascent signs of increased demand.

"We're starting to see those spreads weaken, which is indicating to us that we are going to start using some of that crude oil," says Darin Newsom, chief commodities analyst at DTN in Omaha, Neb.

Of course, it could be that the market is just getting ahead of itself. Mr. Newsom points out that gasoline demand usually doesn't pick up until the very end of January and into early February. Still, the action suggests that next week's inventory report is "going to show a far less bearish number," he says.  

Copyright (c) 2008 Dow Jones & Company, Inc.