Saturday Oil Report -- March 17, 2012

In the two weeks since the previous report, oil prices rose slightly. Brent crude is up about two dollars per barrel at $126.40 while Nymex WTI is just about the same at $107.06. Little has changed in the markets over the past two weeks, although the Iran hysteria seems to have calmed down somewhat. In so far as we are only one small supply shock away from $140-150 oil, and prices are not declining, I am leaving the alarm level unchanged. We're still in the red.

Oil Alarm Level — Red

There's been no end of commentaries about why oil prices are so high. Speculation is a common theme, as well it should be. FYI, I use the word "speculators" to describe non-commercial dollar hedgers, physical oil hoarders, long-only paper investors betting the price will rise, and volatility traders (like the big banks). I'll quote from Have Oil Speculators Already Priced In War With Iran?

The last time the price of Brent crude closed below $100 a barrel was Oct. 6, 2011. It’s since gone up nearly 30 percent, to a high of $126.20 on March 1. Tensions over Iran’s nuclear program have people spooked that a potential attack would disrupt the country’s 2.2 million barrels of daily oil exports. And so money has been pouring into oil futures contracts, driving up the price without any significant change in the underlying supply-and-demand fundamentals. Only the threat of one.

So who’s buying?

Talk to oil analysts these days and chances are they’ll tell you that more than half the spike in the oil price is due to speculators—specifically noncommercial users. That’s jargon for investors who are buying up futures contracts not because they intend to use the oil, but because they think it’s a good investment. These aren’t airlines or refining companies; these are money managers betting that the price will go up. And so far they’ve been right, thanks to themselves.

Since October, money managers have bought the equivalent of 372 million barrels of oil through a variety of futures contracts, essentially doubling their oil exposure.

That includes contracts for West Texas Intermediate crude traded on the New York Mercantile Exchange (CME) and the Atlanta-based IntercontinentalExchange, known as ICE. It also includes contracts for Brent crude, gas and heating oil, and what’s known as RBOB gasoline: stocks of refined gasoline that are ready to be blended into the various grades of gasoline used in the U.S.

Not to put too fine a point on it, but those who think fundamentals are driving these crude prices are unredeemed fools (e.g. run-of-the-mill economists or die-hard peak oil analysts). Just yesterday I had somebody tell me that China's economy isn't going to have a hard landing because "the markets" are not pricing that in. And in so far as "the markets" are perfect predictors of the future, there's no need to worry about an economic meltdown in China. Efficient market theory! And we can also conclude that the oil price is always "right"—the oil markets are just like the game show!

Well, I've noticed (and occasionally write) that learning from experience is not our specie's strong suit, so it comes as no surprise that inflexible belief systems always trump actual experience. In short, religious views will supplant reason & experience every time. Did nobody learn anything in the last five years? A few people did, but the overwhelming majority learned nothing because for them learning from experience is not part of the cognitive equation.

Trust me, if prices are increasing because there's not enough crude oil to satisfy the world's thirst for it, I'll let you know about it

Speaking of China, I've been wondering what's really been going on with respect to their soaring crude imports. 

Reuters calculations, based on preliminary government data from the world's second largest oil consumer, showed implied demand was about 9.59 million barrels per day (bpd) in January, largely due to refinery production hitting an all-time high of 9.34 million bpd.

Real demand, however, could be weaker as stocks of refined oil products staged a third consecutive monthly gain by end-January and rose 14 percent from December, the official Xinhua news agency has said.

"China usually builds up fuel stockpiles in January and February. From March, fuel stocks begin to fall quickly as industrial and agricultural activities accelerate," said a Beijing-based oil analyst who asked not to be identified.

Implied oil demand is calculated by adding refinery throughput and net fuel imports, but not inventory changes. In December, implied demand was a record 9.71 million bpd.

So China has been building up inventories. Will this continue? I will quote from China oil demand as good as it gets.

SINGAPORE – China’s record crude imports in February are most likely as high as they will go, at least for the coming months, as rising prices, refinery maintenance and slower economic growth curb demand.

China swallowed a record 5.95 million barrels per day of crude last month from overseas, continuing a recent strong run of imports.

Since November China has racked up three of the four strongest months on record for oil imports, and at a time when economic growth is moderating, given the dual need to tackle high domestic inflation and weakness in key export markets such as Europe and the United States.

The conventional thinking is that Chinese refiners have been filling storage in recent months, a view borne out by the seeming disconnect between imports and implied oil demand.

Implied demand was 9.71 million barrels a day in February, with this figure calculated by adding net fuel imports to refinery throughput. However, if you add together crude imports, net imports of refined products and domestic oil output, you get a figure some 670,000 barrels a day north of the implied demand.

This means China has most likely been filling storage tanks, although it’s impossible to know for certain as the world’s second-largest oil user rarely publishes inventory data.

But if you assume the extra crude oil imports are going into storage, the question then becomes how likely is this to continue?

If history is any guide, it appears the Chinese buy crude for storage when they assess oil prices to be relatively cheap. This is no longer the case, with Brent having gained more than 26 percent since its low in October last year to trade around $126 a barrel.

This means that cargoes arriving in March and April would have been purchased at considerably higher prices than those bought for January and February, given the lag of up to two months between order and delivery.

This makes it less likely that the Chinese will continue to fill stockpiles, and more likely they will wait until prices moderate again.

Take away the extra demand for storage and suddenly China’s oil imports are more likely to be around 5.3 million to 5.4 million barrels a day.

So at a time when crude oil prices are high, China is helping to drive  price increases by boosting imports to fill their storage tanks. Great! Good job! And Thank You!

Where will oil prices be in two weeks? Unless something untoward happens, I expect prices to be about where they are now.

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