Crude Price Breaches US$80/b Mark after EIA Reports Another Large U.S. Inventory Draw

Crude Prices Hit All-Time High

As the decision by OPEC to raise production by 500,000 b/d from 1 November sunk in yesterday, the U.S. government’s Energy Information Administration (EIA) released weekly data showing a larger-than-expected fall in U.S. commercial crude inventories (see World: 12 September 2007:Crude Hits New Record High as OPEC Agrees to Increase Output by 500,000 b/d). The EIA reported a fall of 7.1 million barrels in commercial U.S. crude inventories for the week ending 7 September. A fall was also reported in U.S. gasoline (petrol) stocks of 0.7 million barrels over the same period, although both distillate stocks and propane inventories rose, by 1.8 million and 2.278 million barrels, respectively. The effect of the news, on top of Tuesday’s announcement by OPEC, was to push crude prices higher still in New York (NYMEX) and London (ICE), with NYMEX crude touching the US$80/b mark in intraday trading. Prices did retreat marginally prior to the close, with front month NYMEX crude ending the day at a new all-time record high closing price of US$79.91/b, up by US$1.68/b on the previous close. In London ICE Brent crude ended the day on US$77.68/b, a rise of US$1.30/b on the previous close. Prices have since been steady, weakening slightly in overnight trading.

OPEC’s Quota Move Too Little Too Late

It has been a turbulent week on crude markets. This time last week there was a widespread belief that OPEC would simply roll-over quotas into the fourth quarter given the noises being made by most OPEC ministers (see World: 11 September 2007: Is OPEC Preparing to Spring a Surprise?). However, as Monday (10 September) arrived, it became clear that Saudi Arabia had accepted the need for additional crude volumes in the fourth quarter, and after a day of intense discussion with other members OPEC eventually agreed to increase production by a further 500,000 b/d (against actual production rather than the current quota) from 1 November. While some oil is better than none, most traders and analysts had factored in additional crude volumes of this scale simply to reflect expected leakage. While OPEC expressed concern about the possible economic fall-out from the sub-prime financial market turmoil, the actions were widely seen as too little too late. While additional crude volumes can be expected to creep up ahead of the 1 November start date, the tight supply/demand balance in the fourth quarter means that even this additional volume of crude will be only a drop in the ocean, and will not prevent a significantly large global crude drawdown. Yesterday’s EIA data, covering the period just after the U.S. “driving season” unofficially draws to a close, simply confirmed the looming problems in store later in the year.

While the fundamentals tell us that supply will be well short of demand for the next three-six months, market speculators are also likely to be playing a significant role in the relentless price increase. Although global inventories are not high, they are also not exceptionally low. U.S. inventories are actually at the top end of the five-year range for the time of year, although they are now over 5 million barrels below year-ago levels, and in the middle-to-low end of the range in terms of forward days’ cover. Nevertheless, the stock picture, if taken as a snapshot now, should not warrant a record crude price. Markets are projecting out to the end of the year, when global inventories are likely to see 100 million-150 million barrels taken out of inventories, but more importantly most large financial institutions have gone long on crude, and each new high tested equates to substantial profits. There is an element of a self-fulfilling prophecy at work on crude markets today.

Outlook and Implications

Looking at the fundamentals, Global Insight anticipates a slight weakening of demand through September and October as peak summer usage drops off ahead of the winter increase because of higher consumption for heating. Refinery maintenance will also help to reduce crude demand and this should help to ease the current price inflation. More bad news as a result of the sub-prime fall-out could also further lower growth expectations, although we believe the impact of financial tremors will not show up until 2008, and the impact on demand will be limited. Having reduced our U.S. growth forecast for 2008 by 0.5%, we expect the impact on crude prices is only likely to be felt next summer, when slightly weaker U.S. demand growth will reduce the price support traditionally given to crude by gasoline in the second and third quarters. There are further downside price risks if the economic impact spreads more substantially beyond U.S. borders, but at present this looks unlikely. The slight hiccup in global growth is unlikely to have a severe impact on demand growth.