Thursday, September 17, 2009

Despite a drop in inventories, crude oil price still constrained by oversupply of natural gas

The WTI crude oil futures curve has flattened substantially in the past month. It's an indication that the US crude reserves in storage may be on a decline and people are becoming more comfortable taking deliveries in the spot market.

The latest government data from EIA seems to support the declines in inventory, although crude stocks continue to be above the norm for this time of the year.

In particular what got the market's attention is a decline of crude stocks in the Midwest. It's not clear how real this is, but it tends to be a leading indicator for improvements in the US manufacturing activity.

This inventory decline and the weak dollar have pushed the spot price for crude higher, but it continues to be constrained by the tight crack spread (spread between refined products and crude). That makes refining far less profitable.

The overall demand for refined product is still weak, capping any significant further rally for crude. This is in particular pronounced in distillates - heating oil and jet fuel. Distillates inventory continues to rise to unprecedented levels in the US, in part driven by the oversupply in natural gas. Heating oil in many instances can be substituted with cheap natural gas, forcing more distillates to go into storage.

Unless the dollar weakens further or there is a miracle massive recovery in the US manufacturing sector, a significant crude rally is unlikely. And part of this constraint is emanating (at least in part) from depressed natural gas prices.
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