Crude battles over traditional vs. economic fundamentals

Feeling the Heat

Despite the weak dollar and a mixed Energy Information Agency supply report, oil bulls are still feeling the heat of heavy global supply. As Mark Shenk at Bloomberg News pointed out we have record oil stockpiles in the Midwest or Padd2 and that is “reducing the premium traders will pay for later deliveries amid signs that fuel demand may be ebbing as the pace of the economic recovery slows. Bloomberg says that, “Inventories in the 15-state region that includes Illinois rose to 97.7 million barrels in the week ended July 30, the highest level recorded since the data started in 1990, according to an Energy Department report yesterday. Supplies in Cushing Oklahoma were less than 1% below the all-time high set in May, the report said. As Cushing stocks have increased, the discount on the front-month oil contract relative to that for the following month has narrowed 77% from a year ago. While crude has risen 28% since its low in May, US demand will average 18.9 million barrels a day in 2010, down 9% from the all- time high in 2005, according to Energy Department forecasts.”

The other reason that spread may have come in is the fact that the BP Staci Kill will most likely work. The beginning of the end of this story and the fact that the environmental damage may not be as bad as originally feared is increasing the odds that deep water drilling in the Gulf will make a comeback. Still the overwhelming supply is a major factor and even as oil trades above $80 on the weakness in the dollar and just when you thought it was safe to go into the water again, fears of QE 2 coming soon to a bank near you.

Even concerns over demand growth in China are becoming a major issue. Andrew Peaple from Dow Jones writes that a slowdown in China's factories may prove to be more than just a seasonal matter, if Beijing's plans to cut energy use trump its desire to keep growth motoring ahead. Peaple said that China's official purchasing manager’s index fell in July to its lowest level since February 2009. Economists were quick to attribute this to seasonal factors, such as the annual summer overhaul for China's factories: July PMI readings tend to be around 1 point lower than the previous month, Goldman Sachs says, as they were this year. Yet he says there's another factor at play. China's plan to cut energy intensity -- or the amount of energy used to produce each dollar of gross domestic product -- by 20% between 2006 and 2010. In 2007, the latest year for which comparative data is available, China's energy intensity was 4.2 times that of the OECD, U.S. Energy Information Administration data show.

Still he says that China's in danger of falling short of its goals. Energy intensity fell by 15.61% from 2006 to 2009, but actually rose in the first quarter of 2010. Heavy industry, the most energy-hungry sector, is going to have to bear the brunt of any catch-up, particularly if Beijing is eager to meet its own target for this year. Closing down inefficient plants is a quicker fix than making technological upgrades.

The trade-off is with slower overall economic growth. True, slowing property construction could lead to less heavy industry output without the need to close so many factories. Plus, there's always the chance of changes to past data to make the five-year-plan targets less challenging. Last month Beijing revised its energy-intensity reduction rates upward for each of the years 2006-9. Data revisions, though, are unlikely to get Beijing fully off the hook of a dilemma of its own making.

The pressure even seems to be getting to some OPEC members like Kuwait who complained that non- OPEC producers like Russia are not doing enough to help support oil prices. Kuwait is concerned that every barrel that OPEC holds off the market will be made up by a competitor taking away market share. If this continues OPEC will be more likely to exceed production quotas and if need be in the worst case scenario would use their “nuclear option” to flood the market with oil to teach those non-open process that are taking advantage of OPEC restraint.

The best thing the bulls have going for it at this point is the dollar and the Fed. This week’s economic data especially the jobs report could make or break this market.

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.

 

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