Oil Glut Takes Temporary Back Seat in Setting Crude Prices

Dow Jones Newswires

NEW YORK (Dow Jones Newswires), May 7, 2009

The oil market isn't free of its historic glut just yet, even as prices near a six-month high.

Crude futures have undertaken a two-month upward march, despite a massive increase in U.S. crude stockpiles that signal a market overwhelmed with extra oil. For a time, the surplus prevented prices from breaking through $50 a barrel, but futures Wednesday surpassed $56 a barrel to hit the highest price intraday since Nov. 17, 2008, even as inventories rose to a fresh 18-year high.

Rising inventories helped send oil prices below $35 a barrel as recently as February. As the surplus loses its shock value, however, traders are less interested in whether inventories are at a multi-decade high or merely exceed the seasonal average. Guessing the bottom of the recession has become the leading driver behind oil prices, replacing the once-frantic speculation about how high stockpiles would rise in weekly Department of Energy data. Once the economy begins to rebound, the logic goes, refiners will quickly draw down that extra oil to provide fuel for the recovery.

Oil inventories did rise by less than most analysts expected last week, though demand is still down from a year ago, the Department of Energy said Wednesday.

"People want to be in commodities," despite the current surplus, said Rick Mueller, director of oil markets at Energy Security Analysis Inc. in Wakefield, Mass. "If the economy is starting to turn, they see that commodities are going to have the strongest (rebound)."

But the 375.3 million barrels of crude sitting in U.S. tanks are likely to come back to the forefront when that recovery happens. Oil refiners will have the option to meet rising demand not only with stockpiles built during the recession, but also with crude in tankers offshore and spare production capacity that has ballooned in places like Saudi Arabia. Together, these sources create a supply cushion that will postpone fears of a looming supply crunch, reducing the odds of a repeat of last year's price spike.

Race to Recovery

Analysts with Goldman Sachs Group Inc. (GS) on Tuesday described the market as in a "tight race," with the direction of oil prices hinging on whether demand can recover before storage space runs out. If the economy wins, oil prices could reach $65 a barrel in the second half of the year; if terminals hit full capacity, prices could be pushed down to $45 a barrel by July.


For now, physical traders see little evidence of a looming storage shortage.

"It doesn't feel as (full) now as it has been a few times in the last couple of years," said a physical crude trader who deals in the Rockies and Midwest markets.

Rockies oil inventories recently hit their highest point since the Energy Information Administration began breaking down stockpiles by region in 1990. Producers there last believed they were facing a major surplus in 2007, when oil production briefly exceeded space on outgoing pipelines. One local oil blend, Wyoming Sweet, traded at a $16 discount to crude futures as producers scrambled to find a home for their oil before storage capacity filled.

The same blend trades at a $4 discount today, as sellers are less desperate than they were in 2007, despite higher stock levels, the trader said.

A pipeline expansion quickly alleviated the glut in the Rockies back in 2007, but no such quick fix exists for high inventories nationwide. By the end of 2009, oil production capacity will exceed demand by almost 6.5 million barrels a day, or about 8% of global consumption, said Ruchir Kadakia, associate director of the global oil group at Cambridge Energy Research Associates, a consultancy. In 2008, when prices soared above $145 a barrel, spare capacity stood at 2.5 million barrels a day.

While Saudi Arabia and other major producers won't operate at their maximum rates to avoid flooding the market, they could increase production if conflicts or accidents interrupt production and damp the threat of a price spike. Producers would also be able to easily raise output along with global demand, removing the main worry that drove prices up during a multi-year oil price boom that ended last year.

"Spare capacity is that missing variable in the story that people don't really talk about," Kadakia said.

Copyright (c) 2009 Dow Jones & Company, Inc.


Generated by readers, the comments included herein do not reflect the views and opinions of Rigzone. All comments are subject to editorial review. Off-topic, inappropriate or insulting comments will be removed.