Dealers pull the rug out from under energy rally

China (Platts) -- Mar 17-21, 2008

By reporters at Platts, the energy information division of the McGraw-Hill Companies. For more information about Platts' information products in China, contact Platts at china@platts.com, or call its representative office in Guangzhou at (+86) 20 2881 6588.

Futures traders have pulled the rug out from under a rally in energy futures that has dominated the year so far, pulling money out of the commodity markets at a prodigious rate last week amid the shocking collapse of US banking group Bear Stearns, fears that other banks could follow Bear Stearns into the black hole of the US credit crisis, and a feeling that interest rate cuts by the US Federal Reserve might not succeed in pulling the US economy away from a disastrous recession.

Oil futures suffered their single largest loss over the course of a week since November last year, as light sweet crude oil futures on the New York Mercantile Exchange slumped by 7.6% to close the week at $101.84 per barrel. Brent on London's ICE Futures fell by a similar quantum to close the week at $100.38 per barrel.

Hidden within that slump were two of the biggest single-day losses in value that crude oil futures have ever seen -- in outright dollar terms. Front-month crude oil futures took a $4.53 per barrel swan dive on Monday, March 17, and crashed by $4.94 per barrel on Wednesday, March 19, the fourth and third largest falls in dollar value seen since crude oil futures started trading in 1983.

Both of those falls are the biggest one-day swing downwards in crude oil prices seen since January 17, 1991 -- the day after bombing began on Iraqi positions in Kuwait, during the first Gulf War. But on a percentage movement basis, the falls were relatively modest -- at 4.52% down, March 19's fall was only the 150th biggest lurch lower on record, for example.

Outside the broad panic about the health of the US economy, a large part of the reason for the slide was the seasonal sell-off in classic winter fuels like gasoil, heating oil and natural gas.

All three energy futures contracts have outperformed expectations in March, generally rallying powerfully at a time when most traders expect to see prices falling.

US heating oil futures slumped by 5.4% to $2.9772 per gallon, while European gasoil -- which has led the entire complex for much of this year so far -- was hit with an 7.6% sell-off to close the week at $922 per metric ton.

Natural gas futures ended last week at $9.065 per million British thermal units, down 8.2% from the week before.

No total collapse yet, predict analysts

"I think the pull back may continue but it won't be a total collapse of prices," said Victor Shum, energy analyst with Purvin & Gertz in Singapore. "The oil pricing had been defying fundamentals for quite a while and the price bubble simply let out some air yesterday."

Others agreed that the run lower might continue. "We think crude is over-priced at these levels," said Jonathan Barratt, managing director of Commodity Broking Services in Sydney, speaking on CNBC Asia. "I hope the market will come back to some good fundamentals and that it will continue to come off."

Barratt, whose online brokerage handles precious metals, equities, and futures, said oil had been trading at levels which were not justified by supply and demand.

A massive draw reported in US middle distillates stocks overnight seems likely to do little to support the oil complex overall, as attention is already shifting to gasoline ahead of the driving season, said Shum, who dismissed the importance of a drop of 2.9 million barrels in US middle distillates inventories in the face of broader market concerns.

"One week doesn't make a trend. We are really entering into the gasoline season. The focus will be on gasoline demand in the US," said Shum. Week-over-week, distillate demand in the US jumped by 304,000 barrels per day to 4.342 million barrels per day. The entire decline in middle distillate stocks was concentrated in heating oil inventories, even as prices for heating oil futures were racing to an all-time high.

Gasoline moving back into focus at last

Gasoline was, meanwhile, was set to move back into focus in the coming week. It has underperformed the rest of the energy complex substantially since the start of the year, and now looks to be the most likely stick to poke the energy bubble, report analysts.

US gasoline stocks dropped by 3.447 million barrels to 232.52 million barrels last week, according to US Energy Information Administration data -- breaking 17 consecutive weeks of inventory-building.

But behind the stock draw was a tiny drop in US oil demand of 60,000 barrels per day to 9.071 million barrels per day week-over-week, which has market watchers on notice that US driving season could be less than impressive in 2008.

"Fundamentals are weakening as we get into the second quarter ... the bearish fundamentals have been there for every one to see," said Shum. "The collapse of Bear Stearns earlier this week was a trigger for investors to focus more clearly on the US recession.

"Fundamentally, we saw little fresh news to account for the strength in the RBOB futures," energy consultant Jim Ritterbusch said in a report. "However, the market appears to be interpreting yesterday's (US Energy Information Administration) stats that indicated a 3.5 million barrel draw in gasoline stocks and a significant drop in the refinery runs as a harbinger of lower supplies to come.

IEA exports find no single cause for higher oil prices

From a bigger picture point of view, a roundtable of oil experts at the International Energy Agency's Paris headquarters March 17 found no single reason why oil prices have risen to current levels of more than $100/barrel, the IEA said.

Indeed, the agency said, the meeting on oil price formation, which gathered experts from various sectors of the oil industry, voiced concern that the poor quality of data on both financial and fundamental factors made it difficult to understand oil price movements.

"The discussions sought to shed light on the many factors which have influenced and are currently influencing the formation of prices in oil markets. Topics which were discussed included both financial and fundamental aspects of price formation, together with issues of data transparency," the IEA said in a statement on its web site.

"Opinions on the topic were as strong as they were diverse, making clear that there is no single explanation for higher oil prices, and further that the impact of the various drivers can ebb and flow over time," the IEA added. "There was general concern at the lack of data transparency which exists, both financial and fundamental, and that this hinders the understanding of price formation."

Participants in the meeting, representing the oil industry, traders, regulators, banks, funds, governments and international organizations, noted large increases in money flows in recent years. But the statement said "the complexity of the interrelationships between market players makes it difficult to draw firm conclusions on the impact of investment flows."

Also discussed was "the short-term impact of dollar weakness and commodity prices" as well as rising exploration and production costs. "With hindsight," the statement said, "historical price rises were seen as closer to marginal costs than was generally perceived at the time."

The IEA said it would discuss further the themes debated during the March 17 meeting "to identify what work the IEA needs to carry out to improve market understanding and data transparency." Earlier in the day, the IEA said in a separate statement that the roundtable was part of ongoing work at the agency "to understand the complex process of price formation," and that arrangements to hold the meeting had begun three months earlier.

CME wraps up NYMEX take-over deal

Finally, in exchange news, the CME Group announced March 17 the signing of a final and long-awaited deal to buy NYMEX Holdings in a deal valued at about $9.4 billion. The deal would solidify the Chicago-based exchange as the largest organized derivatives exchange in the world.

The combination of the two exchanges will have an unparalleled position in financial futures and options as well as physical commodities. The CME-NYMEX merger comes as no surprise given the two exchanges' two-year-old technology-sharing arrangement whereby CME lists all NYMEX products on its electronic platform, Globex.

The value of the deal is less than the $11.1 billion it had been worth in late January, when CME and NYMEX issued a statement confirming market rumors they were in talks on a potential agreement. The share prices of the two exchanges slumped in February after the US Department of Justice spoke in favor of separating futures exchanges and their clearing houses, noting there would be "significant benefits" to splitting them up.

Updated: March 24, 2008