First Tropical Systems of the Season a Reminder of the Upcoming Post-Driving Season Vulnerabilities

August 11, 2009 8:51 AM ET

Tom Waterman of www.OilIntel.com

New York, NY


As the driving season winds down and predictions of falling demand, turnaround season and a growing surplus of crude oil worldwide, the reminder came this week that despite a period of slack demand upcoming, there are still dangers. The National Hurricane Center has tracked two systems off the west coast of Africa which may or may not eventually pose a threat to the U.S. Gulf. In all likelihood, they won’t, but it serves as a warning that the next 45 to 60 days are the peak of the hurricane season. The first system became a tropical depression while the second lacks the organization to become a threat, the NHC said this week. However, one or two systems will form each week in the far Atlantic and every one brings the potential for the next Rita or Katrina. Along with that threat is the potential for problems for oil and gas facilities in and around the Gulf of Mexico.

Forecasters have been predicting a much weaker hurricane season than in recent years, but one or two very strong hurricanes can be expected in any season.

Odds are they won’t impact GOM facilities, but the potential is always there. OPEC this week said refining margins will weaken due to surplus products supplies after Labor Day and the end to the U.S. driving season. However, I see more of a threat to crude oil prices because of the immense surplus around the world and the fact that OPEC has virtually ignored its quota system, ratcheting up output each month for the past four months. Most  analysts see between two and three million barrels per day of excess supply out of OPEC currently, and our estimate is smack in the center—an estimated 2.5 million bpd above quota.

While OPEC correctly points out that refinery maintenance season is rapidly approaching, they will meet on September 9 and congratulate each other for keeping the oil price in a “fair range,” thus allowing the world to recover from the worst economic crisis since the Great Depression, while still getting a reasonable return.

I have no argument that $70 is a perfectly acceptable level for crude oil, but I wouldn’t give OPEC any credit for keeping the markets in balance. They have contributed greatly to the excess in inventories worldwide and have once again proven that in a challenging environment, their ability to control supply and influence price has been greatly diminished. They can thank the index funds and currency traders that continue to buy and sell oil to offset other investments in equities and the world’s money, often having nothing to do with fundamentals.

This is why they will not change anything when they next meet. In a market where quotas mean nothing and in fact the fundamentals of supply and demand mean very little overall, why bother? If Saudi Arabia is content that its cartel members are not infringing on its markets, they will have no complaints.

Will this be a typical OPEC reaction to the state of the market? Not at all. If we go back to early 2008, and the market was beginning its rapid rise to an eventual peak at $147+ in July, I can recall that OPEC decided not to increase production because they said U.S. crude oil supplies remain in a surplus state, and those inventories must come down in order to balance the world’s supply and demand.

OPEC is correct in assuming that in order to control world crude oil inventories, the U.S. market must be in balance because we still use 25% of the world’s petroleum. For the week ending March 21, 2008, U.S. crude oil stocks stood at 311.8 million barrels. Less than six months later – near Labor Day – stocks were 298.0 million barrels, just a 4.4% drop in what OPEC labeled in March as “excessive supplies.”

Despite crude oil stocks in the U.S. at “excessive” levels, prices soared, thanks to Wall Street, and rendered OPEC’s analysis virtually useless.

It is especially useless when we consider that OPEC has never really singled out the excessive supplies of crude oil in the U.S. this year. At the end of July, we had 349.5 million barrels in inventory, a whopping 17.7% above a year ago, and little hope that stocks will fall very much before Labor Day, which means we could have about 18% more crude oil this Labor Day, heading into the weak shoulder period in the oil industry.

OPEC did acknowledge in its Monthly Oil Report that output from the 11 OPEC members under production quotas rose by 105,000 barrels a day last month, led by an unexpected increase from Saudi Arabia.

The increase from Saudi Arabia probably set off alarm bells in other OPEC nations as it may indicate the Kingdom was protecting marketshare – something that it does when threatened. Often Saudi Arabia overlooks non-compliance to quotas, as long as their designated markets are not impacted. However, if Venezuela or Iran or even Nigeria decides to steal a little marketshare, Saudi Arabia quickly responds.

That may or may not be the case in this instance.

But what is missing in OPEC’s report is a concern about U.S. inventories. As we outlined above, they are far beyond levels that OPEC said were “troubling” in 2008, yet hardly given a mention recently. It is because OPEC really doesn’t hold sway over the markets as it once did. In addition, their performance this summer did little to convince the market it could adhere to quotas, further reducing the cartel’s influence.

While the headlines talked about excess products at the end of the North American driving season, they are hoping Wall Street doesn’t notice the over-supply situation in world crude oil markets.

The fact is, oil should weaken after Labor Day, but so much now depends on what the index funds decide to do. If the economy continues to improve even slightly, and equities respond by moving higher, the oil markets could remain in the $60 to $70 range through year end.

However, if the dollar should strengthen, then the range drops to $50 to $60 per barrel. It’s just a different set of factors that influence oil markets in the 21st Century.

Either way, post-Labor Day could bring more problems for refiners worldwide that have experienced highly pressured refining margins. After spending much of the first half of 2009 at or below $10 per barrel, the standard crack spread has improved in July, but don’t expect it to last beyond the end of August.

All in all, the picture will be messy when OPEC meets in September, and for that reason, the cartel will probably do nothing at all, and simply hope that Wall Street can keep prices aloft through year end.

But it would be wise to keep an eye on the Tropical developments in the Atlantic, at least for the next 60 days.