Once again, we are faced with the question of why crude oil prices continue to escalate in the face of seemingly adequate crude oil inventories in the U.S. There are several major issues to consider.
The US Department of Energy reports total US crude oil inventories down just over 6 million barrels, or only about 2%, from this same time last year when crude oil prices trading on the NYMEX futures market were closer to $63 per barrel. US refined product inventories of both gasoline and distillates are sharply lower than last year, with gasoline stocks 17 million barrels lower and total distillate stocks 13 million barrels lower. However, crude oil prices are almost 30% above the same period last year and refined product prices as reflected in NYMEX futures trading are also about 35% above last year. While tighter inventories might help explain the higher prices for gasoline and diesel fuel, why have crude oil prices continued to escalate to record levels?
First, the dramatic drop in the value of the US Dollar vs. other world currencies has helped to inflate crude oil prices when priced in US dollars. As an example, since December, 2006, the US Dollar has dropped almost 25% versus the Euro, the standard currency of the European Union. The net effect of this drop suggests that today's $80 per barrel crude oil is actually worth about $60 in terms of US dollars as of last year. In other words, buyers are willing to pay more dollars for the same barrel of crude oil since the buying power of the dollar has dropped.
Second, the latest jump pushing crude oil prices above $80 per barrel might be explained, in part, by the volume of crude oil production shut in due to recent tropical storm threats in the Gulf of Mexico, from Hurricane Humberto and more recently, from Tropical Depression 10 along the central US Gulf Coast. Offshore producers are much more cautious about evacuating platforms and shutting in production due to experience in recent years with significant storm damage from Hurricanes Ivan, Rita, and Katrina.
Third, though US oil demand growth has slowed this year through the combined effects of slower economic growth, a significant downturn in the US housing industry, more cautious consumer spending due to the tighter US credit markets, and perhaps some marginal reduction in discretionary driving due to higher retail prices for fuel, worldwide demand growth remains relatively robust with continued strong economic growth from rapidly developing economies such as China and India.
Fourth, there continues to be huge growth in the volume of investment dollars coming into commodity markets as a way to diversify investment portfolios and to attempt to capture better returns than more traditional investment instruments like stocks and bonds. The strength in all commodity sector prices, from energy to precious metals to a host of agricultural commodities reflects this new surge of investment dollars. This is often referred to as "speculative money" driving prices higher, but the distinction between a speculative dollar and an investment dollar is hardly clear cut. The net effect of all the new wealth created by a growing worldwide economy means there are lots of new investment dollars looking for a home and commodities are a logical place to invest if you assume the world's population and economy continue to grow with a concurrent growing demand for all types of commodities, whether oil or aluminum or wheat.
Finally, as we have suggested before, there is a very identifiable seasonal pattern to oil prices. Gasoline prices typically rally in the spring in advance of the summer driving season while heating oil prices typically rally in the fall prior to the onset of winter weather. Crude oil prices generally parallel these seasonal price patterns in refined products. Based on historical data, the magnitude of these seasonal rallies and retracements is reliably predictable as well. The fall heating oil/crude oil rally generally peaks in late September or early October, with the average peaking date over the past ten years on October 5. The five year average crude oil price decline from this fall peak is about 25% before prices bottom out in late December or early January before reversing to trade higher with the start of the spring rally in gasoline prices. Gasoline and heating oil prices also typically fall about 30% from this fall peak to a low sometime in January. If we are in fact at or near the peak of the fall price rally, a typical retracement from the seasonal peaks would suggest NYMEX heating oil targets a mid winter low in the $1.60-1.70 per gallon range, NYMEX RBOB gasoline targets a level near $1.50 per gallon, and NYMEX crude oil could fall back to $63-$65 per barrel. This would likely be accompanied by a significant bounce in the value of the US Dollar.
The near term question asks whether we have, in fact, seen the highs for the year. Hurricane season in the Atlantic Basin may be past its typical peak of September 10, but in years with developing La Nina weather patterns, late season storm development in the Gulf of Mexico is not uncommon and such late season development could give the market one last spike higher, but any such higher price levels are not likely to be sustainable. Weaker US oil demand with a softening US economy may also underscore the difficulty of sustaining current energy prices. The longer range weather picture forecasts the potential for a warmer than normal winter which may also add to downside price pressure. The bottom line from our perspective suggests lower prices are likely over the coming 3 months.
Is your business affected by the volatile prices we see in the fuels market? Call any of our regional sales offices and see how you may be able to benefit from working with a fuel supplier who understands the market and how it impacts your business. Let us help you develop solutions to manage your fuel cost during periods of volatile price changes.
About Tom Knight
Tom Knight heads the trading and supply operation for Truman Arnold Companies with responsibility for all refined product trading and hedging activities to support both wholesale marketing and terminal operations. For over six years at TAC and for more than 25 years in the industry, Tom has become an expert in the energy business including experience in domestic crude oil trading, pipeline and tanker scheduling, gasoline importing and blending, and refined products trading in both the NYMEX futures and physical markets. He is frequently quoted in Reuters, Bloomberg, and a variety of other news services and newspapers on energy-related topics and has been featured on several broadcast outlets including CNBC, the Texas State Radio Network, and numerous local television and radio programs. Reach Tom at tknight@tacfuel.com
