Barron's: Oil picture could darken later this year.
and the heat goes on
msnbc.com
msnbc.com
TA
=========================================
Bottom of the Barrel
The oil picture could darken later this year
interactive.wsj.com
By CHERYL STRAUSS EINHORN
JULY 10, 2000
Saudi Arabia's announcement that it wanted to boost its oil
production by a half-million barrels a day sent the energy
markets into a tailspin last week. Prices fell 8%, to
$30.28 a barrel. Oil exploration and production stocks slid
as well, losing nearly 10%, on average.
But the market overreacted.
Despite a tripling in price since 1998, the balance of risk
in oil isn't on the downside. It's still to the upside
because capacity and storage are constrained.
That doesn't mean that a clear price trend will prevail.
Indeed, Goldman Sachs' commodity economist Colin Fenton
argues, the market's dominant feature will be increased
volatility.
Result: Traders may profit by selling the current, or
active, futures contract and buying the second nearby
contract. In this way, they may capitalize on continued
immediate strong demand for crude and the market's
expectation that prices will slip in the future.
Here's why: At the end of an economic expansion, there are
often sudden shortages of goods. Volatility ensues and thus
price spreads-not price trends-change. This can be seen in
the shape of the forward curve of the futures markets.
--------------------------------------------------------------------------------
Key Commodity Indexes
CRB Group Indexes 7/07 6/30 Yr. Ago
CRB Futures 219.33 223.93 185.00
Industrials 199.77 199.39 186.50
Grain/Oils 156.11 161.43 150.00
Livestock 251.84 248.49 199.60
Energy 307.39 323.44 190.30
Precious Metals 263.43 271.44 225.10
Barron's ~ Bridge Telerate
--------------------------------------------------------------------------------
Supplies for immediate delivery become dear, while those to
be delivered later are viewed as less crucial. Thus, prices
are generally lower the farther out into the future one
goes. For instance, August crude is 95 cents more than oil
to be delivered in September. September crude is over 50
cents dearer than October petroleum, and so on.
This environment provides consumers with a good opportunity
to hedge their price risk by taking advantage of the lower
forward prices. Refiners also would profit by buying oil
in the future, given the likelihood of price spikes today.
For producers, however, there's significant longer-term
downside risk since current high prices encourage increased
drilling.
So, why won't the Saudi announcement make a difference?
For one thing, it's unlikely the Saudis will be able to
increase production soon. Even though they would like to
bring prices down to $25 per barrel, their OPEC colleagues
claim that any boost in output would need their approval.
Thus, chances for a quick increase are slim; instead,
lengthy talks are likely.
Both Iran and Venezuela, OPEC's second- and third-largest
producers after Saudi Arabia, oppose higher production.
Iran's OPEC governor, Hossein Kazemtspour Ardebili,
commented Thursday that "there is no production hike on the
agenda at the moment. We are assured that no country will
unilaterally increase" production further. OPEC agreed just
three weeks ago to boost supplies 3%, or 700,000 barrels
per day.
And even if Saudi Arabia does go its own way, it's really
the only nation with any spare capacity -- 2.5 million
barrels a day, or double the amount of the other OPEC
members' combined. "If you were to tally up all the
incremental production out there, it is a moot point," says
Fenton. "The level of demand exceeds supplies."
Furthermore, the Saudis don't produce the right type of
crude for the U.S. and Western Europe. They produce "sour"
crude. The Western world uses light or "sweet" crude,
namely West Texas Intermediate, Brent or Bonny (named for
the Sea of Bonny off Nigeria). Thus, increased supplies from the
Saudis simply would put downward pressure on sour
crude and increase the spread between the two types of
oil. And supplies from non-OPEC producers won't change the
picture.
Moreover, despite the 18-month rally in crude prices,
drilling-rig counts remain low, at the same level evident
in 1998, when oil sold for $10 per barrel. Back then,
storage tanks were so full that producers had to store
their inventories in the ground. Insufficient reinvestment
means that no significant new oil supply is expected to
come on line before 2001.
Hence, the diciest period is still ahead. As we move from
the summer driving season into the winter heating season,
we'll literally be scraping the bottom of the barrel. Then,
says Fenton, without enough crude, global growth could be
throttled and prices could breach $40. In the grain belt,
it was all about rain. Early last week, enough of it sent corn
and soybean prices to their lowest levels of the year,
then too little on Friday lifted them back up 3%. |
