In response to Hurricane Gustav and the oil production that was taken offline as a result, the federal government announced that 250,000 barrels of oil would be released from the Strategic Petroleum Reserve:

Oil prices drop as US opens reserve taps

LONDON (AFP) – Oil prices fell on Wednesday as the US government decided to release crude stocks from its strategic reserve after Hurricane Gustav halted energy production in the Gulf of Mexico.

“The release of the oil will prevent any shortage and that will, of course, help calm the market,” said Victor Shum, an analyst with energy consultancy Purvin and Gertz.

The United States announced late on Tuesday that it was releasing 250,000 barrels of oil from its strategic reserve to help cover lost production.

There was no oil production on Tuesday in the Gulf of Mexico region, where a quarter of US oil is normally produced, the US Department of the Interior said. Ninety-five percent of natural gas production was also offline.

The threat from Gustav had raised grim memories of the 2005 hurricanes Katrina and Rita which damaged or destroyed about 165 of around 4,000 oil platforms in the Gulf. Damage this time appeared to be much less severe.

This news is helping to put downward pressure on oil prices, already down almost 30% from the highs set just a couple of months ago.

Long-term, I certainly don’t believe the oil bull is dead, but a lot of people are learning a very hard lesson about commodities trading: You can go from rich to poor very quickly. I have heard some in the “peak oil now” camp argue that it is a no-brainer to invest in oil futures, because 5 years from now oil is going to be $400 a barrel. That may very well be true, but there will be a lot of ups and downs in the short-term that make the long-term strategy difficult to realize. Those who bought oil contracts at $147 and are still holding them now understand what I mean.

The supply situation is quickly coming to a head, and many questions will be answered in the coming weeks. Will OPEC increase oil production? Can they? Will there be any relief from rising gasoline prices? Will gasoline demand remain strong in the face of the recent price spike?

The trend at this time of the year – because some refineries are offline for maintenance – is that crude stocks are generally rising and gasoline is generally falling. (The trend for distillates is very dependent upon the weather). That has been the trend for several weeks, but this week crude oil inventories dipped slightly. This will happen as refineries start to come out of turnarounds, with the trend of falling crude inventories usually starting in mid-spring and continuing through the summer. Given that crude inventories are 12 million barrels below where they were at this time last year – and peak season is still in front of us – I expect that there will be a call for OPEC to open up the taps some before the end of summer.

Refinery utilization number crept up this week – from 86.3% to 87%. This may suggest that the majority of the turnarounds are complete, but if so that would be somewhat earlier than normal. It would not surprise me to see utilization dip again within the next couple of weeks before making a run to the upside of 90%.

Gasoline stocks fell for the 7th straight week, although by less than expected. This is because high wholesale prices in the U.S. always attract the attention of exporters, and a rash of gasoline imports did arrive this week. Gasoline imports rose above a million barrels per day for the first time since January. However, they will need to remain high else gasoline prices may continue to head higher. According to This Week in Petroleum:

To help gasoline supplies keep pace with demand increases that are likely over the next several weeks, total gasoline imports will need to remain above 1 million barrels per day most of the time.

While there are many statistics analysts can watch in monitoring gasoline market conditions, two statistics that they may want to add to their arsenal over the next several weeks are crude oil inputs to refineries and total gasoline imports. Combined with information on gasoline inventories and demand, they will provide a more enlightened picture of current market conditions and insight into which way gasoline prices might head. Until domestic gasoline production and imports both increase substantially, retail prices are not likely to experience a noticeable downturn.

Despite the higher prices, demand continues to run ahead of last year’s level:

Total products supplied over the last four-week period has averaged 21.1 million barrels per day, or 2.4 percent above the same period last year. Over the last four weeks, motor gasoline demand has averaged 9.2 million barrels per day, or
1.6 percent above the same period last year. Distillate fuel demand has averaged above 4.4 million barrels per day over the last four weeks, unchanged compared to the same period last year. Jet fuel demand is up 3.8 percent over the last four weeks compared to the same four-week period last year.

Stay tuned, as it promises to be a very interesting situation over the next few months.

2nd Update

Now, 30 minutes after the release of the report, the market is starting to react, and oil prices are falling. Are traders really that slow to react? Or is that some kind of mirage because there is a delay in getting trades executed and reported? I get the impression sometimes that I could make a small fortune trading within the first half hour after the release of the inventory report. Seriously, someone who trades, please fill me in on this. With a big surprise like this, you can probably predict the direction prices are headed short-term with a high rate of success. But the reaction seems to develop very slowly. My question: If I placed a trade at 1 minute past the release of the report, when would I expect it to execute?

Updated following the release

Surprise, surprise. I don’t know that anyone expected a big rise in crude stocks, but that’s what we got:

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) rose by 2.8 million barrels compared to the previous week. At 314.7 million barrels, U.S. crude oil inventories are in the upper half of the average range for this time of year. Total motor gasoline inventories increased by 0.7 million barrels last week, and are at the lower end of the average range.

Crude imports showed a big jump, but are still down over this time last year:

U.S. crude oil imports averaged nearly 10.5 million barrels per day last week, up 831,000 barrels per day from the previous week. Over the last four weeks, crude oil imports have averaged nearly 9.7 million barrels per day, or 387,000 barrels per day less than averaged over the same four-week period last year.

And why were gasoline inventories up? As I said before the release, if utilization goes up, gasoline inventories should go up. Utilization was up to 87.7%, a sharp rise from last week. The prediction from the analysts didn’t make much sense to me – refinery utilization up a good bit and a draw on gasoline inventories.

I didn’t expect crude inventories to head up before next week. The market hasn’t reacted much to this, which is surprising. Crude prices were down slightly before the inventory release, but typically I would expect a suprise of over 3.5 million barrels of crude to move the market more. So far, the market is barely reacting, but maybe I haven’t given it enough time. I think I would have been prone to go short 30 seconds after I saw that report.

To be updated following the release of the report

First off, the report was of course delayed by a day due to Veterans Day in the U.S. Expectations are for another crude decline, which given the storms in the North Sea and the flooding in Mexico is a pretty good bet. Here were the predictions per Reuters:

A Reuters poll shows that Thursday’s U.S. inventory data is expected to show crude stocks dropped last week by an average of 800,000 barrels, which would be the fourth consecutive weekly decline.

Analysts also expect 100,000 barrel draws in both distillate and gasoline stocks. Refinery runs were forecast to be up 0.5 percentage points.

(A poll by Dow Jones predicted a more modest 300,000 barrel crude decline). The market’s reaction to this week’s report is complicated by several factors. Oil prices rose on Wednesday, due to a combination of expectations of an inventory drop, as well as remarks from Saudi that they won’t discuss a production boost at this weekend’s OPEC meeting, but will instead delay that discussion until their December 5th meeting.

While a drop in crude inventories should typically favor a rise in price; 1). Some of that rise is already built in due to analysts’ expectations of an inventory drop; and 2). The December WTI contract expires tomorrow, and there is a significant net speculative long interest that will probably be anxious to take profits. That may limit the upside. (There is also the factor that a large draw may cause crude prices to run up a few more dollars, but that would increase the pressure on Saudi to placate the markets at this weekend’s meeting).

I do question the prediction that there will be a gasoline draw and a 0.5% increase in refinery utilization. Utilization has been lagging, but if the number ticks up this week, I would expect gasoline inventories to build. I think the recent uptick in gasoline prices will also cut into demand a bit, further improving the likelihood of a gasoline build. If utilization doesn’t improve, then I would expect that we would see a draw on gasoline.

Of course gasoline stocks remain near record-low territory, so any negative surprises there could quickly impact prices. Gasoline prices have recently started to climb, but that climb has not kept pace with the climb in oil prices. Based on where gasoline inventories stand right now, it’s going to take quite an inventory build at this point to avoid $4 gasoline in the spring.

I almost never talk about distillates, which are hydrocarbons that are heavier than gasoline and are used to make diesel and heating oil. I don’t use heating oil or diesel, so I don’t think about this market too much, but I know that a lot of people do. And for those who do, it’s shaping up to be at a minimum an expensive winter. I had seen this story earlier in the week:

Heating oil prices soar, elderly panic

A warm, summer-like day did nothing to ease the fears of the elderly women who walked into the Brockton senior center earlier this week seeking fuel assistance.

“They are panicking,” said Anne McCormack, the city’s director of elderly affairs.

And, they have reason to panic, say fuel oil dealers who are paying record-high prices and therefore charging record-high prices even before the winter cold sets in. The problem is even worse for those who rely on government fuel assistance programs, administrators say.

“Never in my lifetime,” veteran oil dealer Charlie Dyer of Raynham said about today’s prices. “It’s going to be a very difficult winter for customers, no doubt about it.”

And consumers will get no relief, as today the EIA announced a very large surprise drop in distillate inventories:

Oil rebounds to go above $80

In its weekly inventory report, the Energy Information Administration (EIA) said crude stocks gained by 1.2 million barrels last week. Analysts were looking for a decline of 400,000 barrels according to Dow Jones.

Gas inventories eased by 100,000 barrels, compared to the 400,000 gain predicted by analysts. Distillates, used to make heating oil and diesel fuel, fell by 1.2 million barrels. Analysts were looking for an increase of 700,000 barrels in distillate supplies.

In the inventory report, EIA said refineries operated at 87.5 percent capacity, falling just shy of expectations.

Some analysts predict crude is set to drop $10 to $15 a barrel over the next couple of months as the fundamentals aren’t there to support $80 oil. Others say $100 a barrel is just around the corner, especially in the event of a surprise disruption in supplies.

So, here’s the score heading into the 4th quarter: Gasoline inventories remain at record-low levels. Distillate inventories, at 134 million barrels, are 16 million barrels lower than at this time last year (but not terribly low by historical standards). But distillate prices are $0.65/gallon higher than they were a year ago, meaning fuel oil bills are going to be much higher than normal. Crude oil inventories have fallen over the past couple of months, but are still historically high. I think the big story remains gasoline, and whether we can dig our way out of this hole over the fall and winter. If not, something’s got to give next spring.