A look at inventories suggests that while crude may have reached its 2004 high, the products have hardly been handed over to the bears.

The front-month New York Mercantile Crude Exchange contract had been on a bull run all year, driven by violence in the Middle-East, low crude inventories, growing Chinese demand and steamy gasoline prices. However, after peaking at an all time high of $42.38/bbl on Jun 1, prices have retraced. Front-month crude oil settled 68 cts lower at $37.57/bbl Jun 23 on the New York Mercantile Exchange.

The weekly US crude oil deficit versus the five-year average continued to erode Jun 23 as inventories reported by the Energy Information Administration rose by 2.5-mil bbl to 305.4-mil bbl. Crude inventories were 3.99-mil bbl below the five-year average. By comparison, inventories were 33.9-mil bbl below the five-year average the second week of January.

A two-week draw in Cushing, Oklahoma (the NYMEX crude delivery point) of 2.8-mil bbl did little to stop the front of the curve from moving deeper into contango Jun 23. The August September spread, which settled the previous trading session at flat, settled Wednesday at minus 7 cts, indicating the market is less concerned with the level of stocks in the Midwest and more focused on the overall build in US inventories."The Saudis are right there is no shortage of crude oil," Kyle Cooper, energy analyst at CitiGroup, said.

The extra crude has come largely from OPEC producers, notably Saudi Arabia, who have promised to increase output in order to calm high crude prices. In early June, OPEC agreed to raise its current 23.5-mil b/d output ceiling (not including Iraq) by 2.0-mil b/d from Jul 1, and another 500,000 b/d the beginning of August. OPEC production was estimated by Platts at 28.26-mil b/d (including Iraq) in May, up from 28.07-mil b/d in April.

On Jun 17, OPEC increased its demand forecast for its crude in the second half of 2004 by 580,000 b/d, but insisted it had spare production capacity to cover any disruptions this winter.

That the world is better supplied with crude can be seen not only in the lower benchmark prices, but in softer spot crude differentials, especially in Europe in West Africa. The spot crude trans-Atlantic arbitrage to the US has been closed for several weeks. In order for the arbitrage to reopen, US prices must rise, or foreign prices soften (or a combination of both).

However, US Gulf spot differentials to WTI have been stagnant, suggesting US buyers are in no rush to pick up more barrels. July differentials for sour grade Mars, for instance, have averaged $4.67-$4.65/bbl under WTI, compared with $4.45-4.43/bbl under for June delivery.

In contrast, markets across the Atlantic are glutted with spot crude, with sellers complaining about a lack of outlets, and spot differentials have been hammered as a result.

North Sea Forties was assessed at 13-17 cts over the forward Dated Brent swap Jun 23, compared with 76-80 cts over on Jun 2. Ekofisk has weakened from 14-19 cts over to 30-25 cts under the swap.

In West Africa, spot Brass River crude was assessed at even to the forward Dated Brent swaps Jun 23, compared to 55-60 cts over on Jun 2. In the Mediterranean, over the same period, Urals has slipped to $3.05-3.00/bbl under the Dated swaps, from $2.25-2.20/bbl under.

Still, buyers are hardly safe from crude supply disruptions. The Center for Global Energy Studies warned Jun 23 that persistent disruptions in Iraqi supply could help drive Dated Brent prices back above $40/bbl (Dated Brent was assessed by Platts at $34.25-34.30/bbl on Jun 23). The London-based think-tank warned that, OPEC assurances aside, it will not be easy for the cartel to fill any shortfall caused by a sustained loss of Iraqi exports, and that any other sustained supply disruptions--for example from Venezuela, Nigeria or Norway--would put pressure on consumer governments to release oil from their strategic stocks.

A series of explosions Jun 15 and 16 knocked out three major southern pipelines in Iraq, halting crude loadings from Persian Gulf ports. Iraq has since resumed loadings, although at 40,000 bbl/hour Jun 23, just over half of capacity. In the north, Kirkuk crude is again flowing to the Turkish port of Ceyhan, but at 200,000 b/d, under 450,000 b/d capacity.However, even if crude stocks continue to build, a lack of US refining capacity poses a threat to the product markets.

"Until someone produces an automobile that runs on crude oil, the impact of a build up in crude inventories is negated by the tightness in gasoline, particularly on the East Coast," Paul Horsnell and Kevin Knorrish, energy analysts at Barclays Capital, said in a report Jun 23.That view was echoed by the EIA Jun 23, which, while pleased that crude stocks have climbed by 6.5-mil bbl over the past four weeks, indicated Wednesday it is concerned about smaller-than-normal builds or outright declines in products inventories that should be stable or climbing this time of year.

EIA, in its This Week in Petroleum Report, said particularly worrisome is the state of US distillate stocks, which usually post significant builds from May through the fall. This year, however, distillates have added 3-mil bbl since end-April, far less than the 8- to 9-mil bbl in a typical year through mid-June.

Making matters worse, EIA said its monthly data for April will show that distillate stocks were actually 6-mil bbl lower at the end of that month than the agency was led to believe by its weekly data.

"Whichever way you look at it, distillate fuel stocks will need to build at a faster rate in order for there to be enough supplies on hand this upcoming winter," EIA said.The agency said higher imports will likely be needed to strengthen distillate stocks, since refineries are now operating at high rates and using most of their capacity to meet gasoline demand "possibly at the expense of additional distillate fuel production." The warnings did not seem to worry the NYMEX Jun 23. July heating oil settled 1.72 cts lower at 99.98 cts/gal.