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As oil emerges from recent lows, price is set to surge

Crude oil rose for a second day in New York on Tuesday, as gains in the stock market increased optimism that the global economy is recovering. “Sentiment has driven this market from its lows in the hopes of an imminent recovery,” said Toby Hassall, research analyst at Commodity Warrants Australia Pty in Sydney. “If we do see equities continue their rally, oil and a lot of other commodities are probably going to follow.”

Crude oil for June delivery climbed as much as 85 cents, or 1.4 per cent, to $59.88 a barrel on the New York Mercantile Exchange and traded at $59.83. Crude oil futures rallied back above $59 a barrel Monday, reflecting uncertainty over supply as the army battled militants in Nigeria, a heavyweight producer. Light, sweet crude for June delivery settled $2.69 higher at $59.03 a barrel on the NYME.

Prices were also supported by concerns of disruptions to African oil supplies as Nigerian militants threatened to block waterways used for energy exports and a fire at a Sunoco Inc. refinery in Delaware affected operations.

The June crude contract expires on Tuesday. The more-actively traded July contract gained 81 cents, or 1.4 per cent, to $60.40 a barrel, traders said. “$60 is still the resistance level,” said Clarence Chu, a trader with oil options dealer Hudson Capital Energy in Singapore. “Everybody is still looking at the June contract even though July is where the volume and the liquidity are.”

Crude-oil stockpiles dropped 1.75 million barrels in the week ended May 15 from 370.6 million the previous week, according to the median of eight estimates by analysts before an Energy Department report this week. Inventories may fall as oil imports to the U.S., the world’s biggest crude user, decline. Supplies brought into the country fell 12 per cent to 8.71 million barrels a day in the week ended May 8, the lowest since the week ended September 12, the Energy Department said on May 13.

Concerns magnified

The recent run up in oil prices to near $60 per barrel are both surprising and concerning to some analysts. While oil pulled back some last week, it still trades in the $55-$60 range. It is dangerous to make a near term directional call on oil prices, they said adding, doing such is more speculation than investment.

However, the latest report called the Short Term Energy Outlook (STEO) released last week by the U.S. Department of Energy (DOE) paints a picture of falling demand, stabilizing production, and building inventories. The data compellingly supports a correction in oil prices in the coming months, analysts add.

Even $55/barrel oil is high in the presence of falling demand despite all the talk of “green shoots” in the economy. However, there are a few basic arguments supporting the rise in oil prices:

U.S. deficit spending and Federal Reserve policies are flooding the world with dollars, devaluing the currency which will ultimately lead to inflation.

Low oil prices cause new drilling projects to be delayed or cancelled, ultimately shutting in capacity.

OPEC has been steadily reducing capacity to bring supply in line with demand.

Rising oil inventories were understandable in the face of falling prices and/or falling supply. However, it is not so logical in the face of increasing prices which has been the case since the beginning of 2009.

The most recent spike in inventories near this level was the fall of 2006. At that time crude oil prices corrected more than 20 per cent from their August ’06 high above $75/barrel. The summer of 2006 was the last time that global oil supply (production) and demand (consumption) was roughly in line at just over 84 million bbl/day each. The period that followed was consistent period of demand outstripping supply due to global growth. This gap in supply launched a run up in price for crude oil that lasted until July 2008, about the time supply caught up to demand.

Moreover, U.S. energy demand is still declining. U.S. consumption of oil is still declining. The same is true for most industrialized nations. The sharp drop last September was followed by a recovery in October leading to a view of stabilizing demand through December. However, the view of the first four months of 2009 paints a picture of continued decline.

A look at the supply side of the equation shows few surprises. Since the middle of last year OPEC countries (mostly Saudi Arabia) has gone from providing excess capacity in 2008 to reducing capacity this year. Going forward though, this OPEC reduction is expected to moderate. Additionally, the argument that low prices have caused producers around the world to stop producing has yet to be validated. Production in the U.S. and the former Soviet countries is on the rise. Only in Mexico and the North Sea is production presently in decline.

Sunoco (SUN:US), the largest refiner in the U.S. Northeast, closed a gasoline making unit and is operating its crude distillation plant at reduced rate at it Marcus Hook, Pennsylvania, facility after a fire at the ethylene unit.

The refinery can process 175,000 barrels a day of crude oil into fuels including gasoline and diesel. The company plans to “optimize” operations at its plants in Philadelphia and Eagle Point, New Jersey, to meet customer needs, Sunoco spokesman Thomas Golembeski said yesterday.

Valero Energy Corp., (NYSE: VLO)  the largest U.S. refiner, reported that the gasoline unit at its Delaware refinery suffered from a loss of steam pressure yesterday. Gasoline for June delivery rose as much as 1.59 cents, or 0.9 per cent, to $1.7740 a gallon. It gained 4.6 per cent to $1.7581 a gallon in New York yesterday, the highest settlement since October 15.

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