Another record week in crude

China (Platts) -- April 28 - May 2, 2008

By reporters at Platts, the energy information division of the McGraw-Hill Companies. For more information about Platts' information products in China, contact Platts at china@platts.com, or call its representative office in Guangzhou at (+86) 20 2881 6588.

The market continued to defy gravity last week, with front-month WTI -- a barometer for the global energy markets -- hitting an all-time high of $119.93/barrel on Monday, April 28. Prices early last week were responding to several pieces of relatively short-term news the previous week: a Japanese tanker was damaged by a rocket off the coast of Yemen; a refinery strike in Scotland led BP to the temporary shut down of the Forties pipeline; four attacks on Niger Delta facilities led to a further cuts in Nigerian crude output; and OPEC hinted that there would be no significant increase in production soon, as the world has "adequate supplies."

In particular, news in the North Sea and Nigeria appeared to be on the forefront of traders' minds.

The previous week, Ineos had shut down its Grangemouth refinery in Scotland ahead of a planned two-day strike, forcing BP to prepare to shut in the country's biggest crude stream, the Forties Pipeline System. The two-day strike starting April 27 was called by the Unite union to protest changes by Ineos to the workers' pension plan at Grangemouth. Ineos started shutting down the site on April 20 in advance of the strike, and all of the petrochemical facilities were shut a few days later. The units have since been restarted but uncertainty remains as the union has hinted at a possible repeat strike next week.

Meanwhile, the disruptions in Nigeria last week led to a complete stoppage of trade in Nigerian crude oil has ground to a halt, as labor unrest and sabotage continued to shut in nearly half the country's oil output. Total Nigerian output now shut in could be more than 1.5 million b/d, according to Platts estimates, following a strike at Exxon-Mobil's operations and new attacks on Shell infrastructure. ExxonMobil has shut in 770,000 b/d of Yoho, Qua Iboe and Oso crudes in light of industrial action since last week, and at least 169,000 b/d of Shell's Bonny Light remains shut in after sabotage damaged a pipeline. Nigerian rebels said April 28 that attacks on Shell's pipelines had actually shut in a further 350,000 b/d of output.

High prices look sustainable

When prices broke the psychological $100 barrier four months ago, concerns were raised that demand would start to erode and the US economy would slip into a recession. But this has yet to happen, and the widespread expectation is that prices will remain above $100 for the medium term.

Although there are signs that high prices are starting to slow the rate of global demand growth, demand is in fact still growing. This has been the case even though prices have remained at record levels even when adjusted for inflation. Indeed, the previous record high in the early 1980's equates to only about $94/barrel at present, according to The Economist magazine, which quoted a study last month by Deutsche Bank. The study suggests that the sustainability of the currently high prices is not so surprising when considering factors other than inflation. Specifically, spending on oil as a share of the global economy has shrunk from 5.9% in the early 1980's to 3.5% currently, and DB estimates that crude oil prices would have top reach $150/barrel in order to return to the previous ration.

What goes up...

When prices hit almost $120/barrel early in the week, Platts Chief Economist Larry Chorn accurately predicted that prices would return to a range of $110-115/barrel within a few days, and indeed by the end of the week, prices plummeted by $9.63/b, a testament to the high volatility of today's markets. "Present disruptions, with the exception of the on-going Nigeria civil strife, are not expected to be of long duration...there are adequate inventories in place to offset temporary production shortfalls," he said.

The retreat in prices was tied to a mild recovery in the dollar, due in turn to a move by the US Federal Reserve to implement a further cut in interest rates. But other fundamental factors were also at play.

Whether a decelerating economy or high retail prices at the pump started to curtail consumption is difficult to discern at this point, but the world's largest consumer of petroleum was starting to show some signs of fatigue.

The US Energy Information Administration released its Petroleum Supply Monthly April 29 with downward revisions to oil demand, defying presumptions that the US consumer was always a sure bet. The EIA revised downward by 3.7% its monthly implied demand estimate for February 2008 to 19.782 million b/d from 20.538 million b/d. The preliminary weekly data from the EIA suggests total US petroleum demand was averaging 20.542 million b/d in February.

The revisions for the individual product categories were as follows; implied gasoline demand down 226,000 b/d at 8.842 million b/d; distillate demand down 134,000 b/d at 4.251 million b/d; jet fuel demand down 30,000 b/d at 1.537 million b/d and residual fuel oil demand at 552,000 b/d was down 65,000 b/d.

Not only was the need for winter fuels due to a mild winter, but demand for transportation fuels had clearly taken a hit. Perhaps the most interesting revision was US exports. US product exports averaged 1.318 million b/d in February based on preliminary weekly data, compared to the monthly revision of 2.072 million b/d, a whopping upwards revision of 754,000 b/d. This was proof that refined product prices outside the US were higher than within the US, particularly in Asia and Latin America.

By the middle of last week, on April 30, the US Bureau of Economic Analysis reported that US economy grew by a feeble 0.6% for the first quarter, adding further evidence that demand is in danger of being hurt by stubbornly high oil prices.

"Recent information indicates that the outlook for economic activity has weakened further," the US Federal Reserve said in its April 30. "Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters."

The Federal Reserve's remarks sent the US Dollar to its highest level in six weeks. Just two days later, the Federal Reserve expanded its swap lines with both the European central Bank and the Swiss National Bank, injecting additional liquidity into money markets. That type of move does not suggest the credit crisis is near an end.

Platts Futures Managing Editor Linda Rafield noted that "while supply issues are apt to support petroleum markets, demand may not be able to withstand punishing prices in the midst of an economic slowdown. Look for downward revisions to the March and April demand data."

Updated: May 5, 2008

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