9/20 - - Crude oil prices smashed through all previous records today, and one can probably now make the case that even when adjusted for a weaker Dollar, crude has never been higher. Autumn officially arrives in the northern hemisphere on Sunday, and we’ll have about 100 more days of oil price chaos to deal with in this trying year.
I say “trying” because 2007 hasn’t just punished oil price bears - - those of us who try to provide temperate and measured voices have had occasion to lick psychological wounds of late. Yesterday was of course “Talk-Like-A-Pirate-Day” and it shivered me timbers. One day late, here’s my intrepid guess at what to expect between TLAP Day and New Year’s Eve:
Because most regular readers focus on gasoline, or even heating oil and diesel, I’ll comment on those finished products first. But if you want a sense of history being established or repeated, I urge you to read the crude comments before surfing to another site.
Gasoline: You can expect to see gasoline prices rise by at least a nickel in the next week or so, or if that doesn’t happen, you can expect to see some bankruptcy filings by chain retailers. Those who market gasoline but do not make it (the majority of stations fall into this category) cannot survive on currently razor thin margins. Wholesale gasoline prices have advanced by 15cts gal or more in the last three weeks, and retail prices have been as frozen in time as the hopes of Red Sox Nation.
From now on, each additional $1.00 bbl increase in the price of crude should result in a corresponding 2-2.5cts gal increase in pump prices. Crude oil prices today closed at a record $83.87 bbl. So, if crude advances further to $85-$90 bbl, gasoline prices will have to move up by 3-15cts gal for retailers to just stay even.
But even if one accounts for 5cts gal of “catch-up” moves and 15cts gal of additional increases, it still leaves the country shy of a $3.00 gal pump price average. The crude oil spike might need to take prices into the low $90’s in order to breach this level.
And beyond the next 10-40 days, there will be stiff downdrafts for gasoline. Gasoline demand (as measured by the Department of Energy) has dropped in each of four consecutive weeks, and it’s only about 0.5 percent above the same four week period a year ago.
Cheap ethanol (currently fetching 30-50cts gal less than gasoline in wholesale markets) will be an additional factor providing downdrafts this Fall. Until now, it has been impossible to make a trip from Maine to Florida and use an ethanol blend (most typically 10% ethanol) for all of the refueling stops. I’ll bet that by next Spring, it might be more difficult to find gasoline that doesn’t have an ethanol component.
However, I do not believe that we’ll see retail gasoline prices slip to the levels of last Autumn and Winter. We had two slumps last year - - one in mid-Autumn and one in mid-Winter -- that brought pump prices down to less than $2.20 gal on average and below $2.00 gal in many individual states. The next six months may present the “highest low” we’ve witnessed in our lifetimes.
Heating Oil, Diesel, and Jet Fuel: Record setting prices are in store. Retail diesel surpassed $3.01 gal today and there is momentum to take prices higher in the weeks ahead. The year-over-year difference is 20cts gal at the moment, and it very well could widen to 40-50cts gal before the oil rally recesses later this Autumn.
The data hints that the high values are slowing down the commercial economy. DOE suggests that distillate (mostly diesel, but heating oil as well) demand is down one percent from the identical four week period in 2006. Annual drops in distillate demand have been rare since 2002, with the exception of heating season when weather variations can have dramatic impact on yearly comparisons.
Heating oil and jet fuel, meanwhile, have marched in virtual lockstep with crude, and they will probably continue to do so into October. Retail prices for full service heating oil in the northeast are now in the $2.90 gal neighborhood, so sweater sales could be brisk (have you noticed the Autumn clothing catalogues clogging your mailbox of late?). Jet fuel prices in source markets (where refineries are located) are between $2.35-$2.50 gal, and that’s higher since the Katrina aftershocks.
Crude: This week brought two very different, but two equally compelling viewpoints on global oil prices. A Barrons’ article quoted the well-respected Mike Rothman, the head of integrated oil of the ISI Group in Manhattan. A Goldman Sachs research report built a case for an average year end price of $85 bbl for WTI crude, as well as reasons why prices could spike to $125 bbl or higher.
The Cliff Notes version is as follows. Rothman believes that world oil demand growth isn’t nearly at the pace that gets reported and recorded by the oil bulls. But more importantly, he notes that the action in crude oil is staggering. The level of open interest (reflecting long and short positions) on the New York Mercantile Exchange has tripled in the last three years, and Rothman estimates that the over-the-counter markets (which are not regulated) has outstanding positions that are some 20 times the size of the NYMEX exposure.
Let me translate this for the teeming masses with some numbers from this week’s commodities’ trading action. Output of WTI (the benchmark NYMEX crude oil blend) has been about 200,000 b/d recently (or 200 NYMEX contracts, each of which represents 1,000 bbl). Open interest in NYMEX WTI crude is just over 1.5-million contracts, which represents 1.5-billion barrels of WTI crude. If Rothman is right – and I suspect he is correct - - then we have banks, hedge funds, and other financial investments with exposure to the tune of about 30-billion bbl of WTI. At current rates of production, this end-Summer 2007 exposure to WTI price movements reflects more than twenty years of actual WTI production.
One can quibble with the numbers and the multiples, but there is a staggering amount of money being bet, invested, hedged, or whatever, on the price of a boutique blend of crude oil.
The Goldman Sachs research report is equally eye-opening. Goldman stresses that exploration & production companies are just not finding reserves at the rates that were promised to stakeholders. Goldman also heavily discounts the displacement of traditional fuels from the renewables sector (see my gasoline comments above for a slightly different take). It’s not that E&P companies are looking for oil with a false gusto akin to O.J.’s pursuit of the real killers - - - it’s just that a combination of resource nationalism (where companies nationalize much or all of their production capability .. e.g. Venezuela), poor results, and long lead times for projects dominates 2007 supply.
Who do I believe? I tend to side with the assessment by Mr. Rothman that suggests oil prices are overcooked. Goldman Sachs manages more money invested mostly on the long side of energy commodities than anyone, and they also downplay the risk of recession. Individuals, think tanks, and the best and the brightest researchers in investment banking do not predict what they don’t want to happen.
But crude will almost certainly go higher in the next 30 days. Probably the best known and most highly regarded technical analyst in the oil business is Walter Zimmerman of United Energy. Mr. Zimmerman charts price action much as the forward thinkers of ancient civilizations charted tidal assessments, and he’s almost always ahead of the curve because of that sense of history. (Disclosure: The Z-man is a pivotal speaker at OPIS’ 9th Annual Supply Summit that I host . . http://opisnet.com/supply/index.html)
There is an almost magnetic tendency for crude oil to reach its second half annual peak in October, he observes. The peaking date for an average of the last five years has been October 3. The peaking date for the last ten years has been October 5. The peaking day whether one calculates a 15 year average or a 25 year average is October 7. Watch out for a market peak when the baseball playoffs are under way.
So, the buyers of crude need to beware of October. Zimmerman and I share a belief that we’ll see $85 bbl or even $90 bbl before this foam comes to a head, but that might happen sooner rather than later in the next 100 days.