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Geopolitical concerns return to oil market center stage
by None
Midland Reporter-Telegram
Geopolitical concerns were front and center again last week as the conflict between Russia and Georgia seems likely to keep energy markets on high alert for a while. Though the conflict between the two countries has slowed to just a trickle of news, it is becoming readily apparent that a final resolution and withdrawal of military forces is not going to occur quickly. Last week, Georgia accused Russian military forces of destroying a key railway bridge in the town of Kaspi. The bridge was the only remaining route for transporting crude oil to the Georgian coast for transport. As a result, crude oil production in the region has slowed as new export options are considered. Production in Azerbaijan has been hardest hit with some estimates showing a production cut of more than half a million barrels per day.
Concerns were especially heightened last Thursday as speculation arose that Russia may halt all oil exports to the West. That scenario seems unlikely given Russia's dependency on oil export revenues and the lack of other buyers capable of buying the crude. Despite the unlikely nature of the scenario, the rumors added to increasing concerns throughout the world that Russia may be in the early stages of reasserting itself as a global military and economic power. If this is true and Russia continues to flex its muscles it could be bullish for energy prices.
On the domestic front this week, we received more of the same news from the Department of Energy. Wednesday's inventory report showed a huge increase in crude oil inventories and a huge decline in gasoline inventories. Both inventories changed by considerably more than analysts had expected. The same scenario that we have been discussing for a few weeks now was at play again. Refiners cut their capacity utilization ratio by an additional 2 percent this week, despite the fact that the current ratio is already far below normal for this time of year. Imports of refined products were also far below normal. In fact, gasoline imports are now a full 1 million barrels per day below the long-term average for this time of year.
Crude prices this week were very volatile. Prices rose modestly early in the week in the absence of fresh fundamental news and the continuation of the conflict between Russia and Georgia. Wednesday should have seen some sharp price movements because it was expiration day for the September crude oil contract and the energy inventory report showed such large changes in inventories. Goldman Sachs was also out on Wednesday reiterating its forecast for crude oil prices to rise to $149 by the end of the year. On the day, crude rallied just over a $1 despite the huge inventory build while gasoline rallied a little more than four cents.
Refiners were clearly hoping for a decline in crude oil prices and a sharp rally in gasoline, a scenario that the inventory numbers would seem to support, in order to widen their crack spreads and increase their profitability. Unfortunately for them, the initial sell-off in crude oil following the DOE's report was short-lived as was the initial spike in gasoline prices.
Last Thursday was the big day for energy. It was a slow news day on the fundamental side of the market, but tensions overseas coupled with a sharp reversal lower in the dollar rallied commodity markets. October crude oil surged more than $6 at one point on Thursday before closing higher by $5.62. Most traders spent the day scratching their heads and wondering if anything had changed. Clearly there was some additional bad news on the economic front last week that could explain the sharp fall in the dollar, but bad economic news should also be bad for energy prices. Some traders suggested that the $110 level in crude oil had proved to be a support that could not be broken while others suggested that the rally was just a "dead cat bounce" after energy markets suffered significant losses over the past six weeks.
Whichever argument ultimately turns out to be true, Friday's market action seemed to support the later suggestion. On Friday, the dollar rallied sharply against all of the major currencies while energy prices were sharply lower. To us, this seems to make sense given the still bearish fundamental news in the energy markets. A sustained rally for energy futures will need some fundamental shift in the data. So far, we have seen nothing to suggest that energy demand is going to recover in the U.S. or around the world anytime soon. There are some risks to the supply side of the market if geopolitical tensions continue to rise or if OPEC uses the recent price declines as an excuse to lower production levels. However, until something fundamental occurs to alter supply, the demand side of the equation should be in control of energy markets and right now, the data are bearish.
Portions of this article were produced on 8/22/08 by Nathan Golz, Futures Researcher. Its publication is a collaborative effort and the information is obtained from sources considered reliable, however accuracy is not guaranteed by A.G. Edwards. Past performance is not a guarantee of future results and additional information is available upon request (432)684-7335. A.G. Edwards is a division of Wachovia Securities, LLC.
Concerns were especially heightened last Thursday as speculation arose that Russia may halt all oil exports to the West. That scenario seems unlikely given Russia's dependency on oil export revenues and the lack of other buyers capable of buying the crude. Despite the unlikely nature of the scenario, the rumors added to increasing concerns throughout the world that Russia may be in the early stages of reasserting itself as a global military and economic power. If this is true and Russia continues to flex its muscles it could be bullish for energy prices.
On the domestic front this week, we received more of the same news from the Department of Energy. Wednesday's inventory report showed a huge increase in crude oil inventories and a huge decline in gasoline inventories. Both inventories changed by considerably more than analysts had expected. The same scenario that we have been discussing for a few weeks now was at play again. Refiners cut their capacity utilization ratio by an additional 2 percent this week, despite the fact that the current ratio is already far below normal for this time of year. Imports of refined products were also far below normal. In fact, gasoline imports are now a full 1 million barrels per day below the long-term average for this time of year.
Crude prices this week were very volatile. Prices rose modestly early in the week in the absence of fresh fundamental news and the continuation of the conflict between Russia and Georgia. Wednesday should have seen some sharp price movements because it was expiration day for the September crude oil contract and the energy inventory report showed such large changes in inventories. Goldman Sachs was also out on Wednesday reiterating its forecast for crude oil prices to rise to $149 by the end of the year. On the day, crude rallied just over a $1 despite the huge inventory build while gasoline rallied a little more than four cents.
Refiners were clearly hoping for a decline in crude oil prices and a sharp rally in gasoline, a scenario that the inventory numbers would seem to support, in order to widen their crack spreads and increase their profitability. Unfortunately for them, the initial sell-off in crude oil following the DOE's report was short-lived as was the initial spike in gasoline prices.
Last Thursday was the big day for energy. It was a slow news day on the fundamental side of the market, but tensions overseas coupled with a sharp reversal lower in the dollar rallied commodity markets. October crude oil surged more than $6 at one point on Thursday before closing higher by $5.62. Most traders spent the day scratching their heads and wondering if anything had changed. Clearly there was some additional bad news on the economic front last week that could explain the sharp fall in the dollar, but bad economic news should also be bad for energy prices. Some traders suggested that the $110 level in crude oil had proved to be a support that could not be broken while others suggested that the rally was just a "dead cat bounce" after energy markets suffered significant losses over the past six weeks.
Whichever argument ultimately turns out to be true, Friday's market action seemed to support the later suggestion. On Friday, the dollar rallied sharply against all of the major currencies while energy prices were sharply lower. To us, this seems to make sense given the still bearish fundamental news in the energy markets. A sustained rally for energy futures will need some fundamental shift in the data. So far, we have seen nothing to suggest that energy demand is going to recover in the U.S. or around the world anytime soon. There are some risks to the supply side of the market if geopolitical tensions continue to rise or if OPEC uses the recent price declines as an excuse to lower production levels. However, until something fundamental occurs to alter supply, the demand side of the equation should be in control of energy markets and right now, the data are bearish.
Portions of this article were produced on 8/22/08 by Nathan Golz, Futures Researcher. Its publication is a collaborative effort and the information is obtained from sources considered reliable, however accuracy is not guaranteed by A.G. Edwards. Past performance is not a guarantee of future results and additional information is available upon request (432)684-7335. A.G. Edwards is a division of Wachovia Securities, LLC.
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