Update: Oil smashes $86 for the first time

This week’s inventory report will be very interesting. If there is a significant build, the price could unravel quickly. If there is another surprise on the downside, we may crack $90 by the end of the week. But as long as oil prices stay at these levels, Saudi is going to be under pressure to increase production by more than the already announced 500,000 bbl/day. If they truly have spare capacity, they have been playing Russian roulette with the economy. They may have let it go a little too far.

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The price of oil continues to climb:

Oil tops $85 for the first time

SINGAPORE (AP) — Oil prices kept rising Monday after closing at a new record in the previous session on worries that supplies are insufficient to meet coming winter demand and concerns over the conflict between Turkey and Kurds in northern Iraq.

Recent reports have indicated that crude inventories are falling. Last week, the U.S. Energy Department reported that U.S. oil supplies declined in the week ended Oct. 5, while the International Energy Agency said that oil inventories held by the world’s largest industrialized countries have fallen below a five-year average.

Some analysts think the supply shortfall in last week’s U.S. Energy Department inventory report is an anomaly. They doubt demand is as strong as recent forecasts by the department and the IEA suggest. These analysts expect oil prices will soon begin a seasonal decline to $70 a barrel, or lower.

Count me among those in the anomaly camp. No way would I be a buyer at these prices; I think your downside risk is great, and your upside potential is small. Longer term I think oil prices are going to stay high, and I won’t be surprised to see it crack $100 next year, but I think prices have gotten a bit ahead of themselves at the moment.

I was doing some research over the weekend on predictions that have been made by oil industry analysts. I thought this one was interesting. From September 2006:

$1.15 a Gallon? Leading Oil Industry Analyst Says Prices Could Plummet

A leading oil industry analyst, Philip Verleger, believes we are going to see continued reductions in the price of oil and at the pump, perhaps to as low as $1.15 per gallon for regular gasoline.

Philip Verleger was one of the few oil industry analysts to predict dramatic price increases in the cost of oil a few years ago, but his estimates proved accurate as the price per barrel soared to nearly $80 this year. With the increase came significant upward pressure on transportation costs, heavy fuel surcharges by carriers, rising costs for petroleum-based raw materials.

But Verleger is now predicting the current reduction in oil prices is no temporary aberration. According to a story in The Seattle Times, Verleger believes a combination of financial market twists and fundamental supply and demand forces will keep driving oil lower – much lower. Verleger said it’s not unthinkable that oil prices could return to $15 or less a barrel, at least temporarily. That could mean gasoline prices as low as $1.15 per gallon.

Oops. A year later oil prices are over 400% higher than his prediction.

Whoa! The analysts missed this one by a mile. Here were the predictions, prior to the release of the report:

Analysts surveyed by Dow Jones Newswires on average predict crude inventories rose 300,000 barrels during the week ended Oct. 19, and Vienna’s PVM Oil Associates also noted that “expectations for this week’s U.S. oil inventory data are for a rise in crude oil stocks.”

However, some analysts predict a decrease of up to 2 million barrels. Analysts also predict the EIA report will show refinery utilization rose 0.3 percentage point; gasoline supplies, still near record lows, rose 1.1 million barrels; and distillate stockpiles, which include heating oil and diesel, rose 200,000 barrels.

Here’s what they got:

U.S. commercial crude oil inventories fell by 5.3 million barrels compared to the previous week. At 316.6 million barrels, U.S. crude oil inventories are near the upper end of the average range for this time of year. Total motor gasoline inventories decreased by 2.0 million barrels last week, and are at the lower end of the average range.

Both finished gasoline inventories and gasoline blending components fell last week. Distillate fuel inventories decreased by 1.8 million barrels, and are at the upper limit of the average range for this time of year. Propane/propylene inventories increased 0.6 million barrels last week. Total commercial petroleum inventories decreased by 7.9 million barrels last week, but are in the upper half of the average range for this time of year.

I suspect crude will be off to the races again. I had called a (short-term) top on front-month WTI a week ago at $89, and in fact oil was down almost every day since then. But this inventory report will provide a lot of fuel for the bulls for another week.

Here is the rest of the report:

U.S. crude oil refinery inputs averaged 14.9 million barrels per day during the week ending October 19, down 183,000 barrels per day from the previous week’s average. Refineries operated at 87.1 percent of their operable capacity last week. Gasoline production rose compared to the previous week, averaging nearly 9.0 million barrels per day. Distillate fuel production fell last week, averaging 3.9 million barrels per day.

U.S. crude oil imports averaged 9.1 million barrels per day last week, down 1,305,000 barrels per day from the previous week. Over the last four weeks, crude oil imports have averaged 9.9 million barrels per day, or 414,000 barrels per day less than averaged over the same four-week period last year. Total motor gasoline imports (including both finished gasoline and gasoline blending components) last week averaged 838,000 barrels per day. Distillate fuel imports averaged 235,000 barrels per day last week.

Total products supplied over the last four-week period has averaged nearly 20.8 million barrels per day, up by 0.4 percent compared to the similar period last year. Over the last four weeks, motor gasoline demand has averaged 9.2 million barrels per day, or 0.2 percent below the same period last year. Distillate fuel demand has averaged nearly 4.3 million barrels per day over the last four weeks, up 1.0 percent compared to the same period last year. Jet fuel demand is down 3.3 percent over the last four weeks compared to the same four-week period last year.

It is going to be a close call on the $1,000 bet. I do believe the fundamentals for higher oil prices are generally worse now than they were 3 months ago. Peak driving season has passed, OPEC is already pumping more crude, and prices have had a dramatic run-up. On the other hand crude inventories, while still high, have been pulled down, and gasoline inventories continue to hover near record-low levels. But, the sentiment has certainly turned in favor of higher oil prices. And the sentiment of the market can move it quite a bit in a short period of time. You can see some of the analysts on CNBC – after having missed out on most of the run-up – have now moved their clients into oil and so are talking up the price.

But the recent fast run-up in prices, followed by OPEC’s decision to pump more crude, would make me very cautious about buying oil at this level. You might make some money, but it is a much bigger risk than it was earlier in the year when the fundamentals for higher oil prices looked better (at least to me). Of course over the long haul, I am bullish on oil prices and have been for 5 years. I thought $100 oil in 2008 was likely, but a move from $60.77 (the crude price the first week of January) to $100 in a single year would be unprecedented.

I would also add just a bit on refinery utilization. Analysts had predicted utilization to come up this week. Generally, refineries are coming out of their turnarounds now, and you would expect to see utilization at a higher level at the end of October. But you have to take the current crack spreads into account. When crack spreads are at $30/bbl, as they were earlier in the year, you do everything you can to maximize your utilization rate. If that means paying overtime, or paying extra to have equipment fabricated and delivered quickly, you do it. Money is not an object; you get your refinery up and running as quickly as possible.

But when crack spreads are $5/bbl, as they are now, you don’t do those things. You still want to have your refinery up and running, but it doesn’t make economic sense to go all out to boost your utilization. That $5/bbl margin will disappear pretty quickly if you throw money around. So, utilization rates will be less robust in times of low margins. It has absolutely nothing to do with inability to secure crude – as some have suggested. It has everything to do with economics. But given where gasoline inventories are currently setting, I don’t expect margins to stay soft for long.

The reason I am not a short-term trader is that you have that extra variable of market sentiment to take into account. Market sentiment can change in a hurry; it can shave the value of a stock by 50% in one trading session. In the longer-term, it is less of a factor and you can rely more on the fundamentals; i.e., there is less luck involved. So, I adopted a philosophy long ago that I would plan long-term, and ignore short-term trends. Those short-term moves can build wealth rapidly, but just as quickly destroy it. A lot of day-traders learned that lesson the hard way a few years ago.

In the oil markets, sentiment has changed dramatically since August, and this week’s inventory report saw another bullish shift. Prior to the report, oil had been drifting lower. But this week’s inventory report changed all of that. As I wrote on Wednesday, “I suspect crude will be off to the races again” and “this inventory report will provide a lot of fuel for the bulls for another week.” And in the past two sessions, oil has been sharply higher. If you were in the position to make an immediate trade following the release of Wednesday’s report, buying oil was a no-brainer for a short-term trader. But you have to be sitting in front of that terminal again next Wednesday, because a negative report will cause a fast sell-off.

In the wake of this week’s inventory report, you may have heard that crude set another record high yesterday:

Oil hits new record over $90

OPEC, which supplies about 40 percent of the world’s 84 million-barrel-a-day oil habit, agreed to boost production by 500,000 barrels in September, but the move did little to calm oil prices.

There had been speculation that the cartel would again boost production at its next meeting in December. One trader downplayed the notion that OPEC would increase production. “No one has any more to give us,” said Nauman Barakat, a trader at Macquarie Futures, the trading arm of Macquarie investment bank.

Of course following the statement that there is nothing left to give, the same trader contradicted himself:

While Saudi Arabia is generally believed to have the ability to pump about 2 million more barrels a day – the world’s only significant remaining spare production capacity – Barakat said they are keeping that in reserve in case of a real supply disruption.

I have long argued that we would find ourselves in this situation. In my first ever essay on Peak Lite, written a year and a half ago, I argued that we would find ourselves in a situation of higher and higher oil prices (which was the basis of my long-term strategy). The move up has been sharper than I expected, but has been exacerbated by speculators and a weakening dollar. However, I suspect these prices are here to stay. And if OPEC is really unable to boost production much more – as some suspect – then this is really just the tip of the iceberg. I wouldn’t bet that we will see $200 oil next year, but we could see $150 oil. If prices continue to ease higher, and OPEC doesn’t start boosting production significantly, the game will be over and oil will be on a run with no end in sight.

In the short-term, the direction of prices is going to be highly influenced by next week’s inventory report. Another large decline will probably sustain this bull market right past $100. However, if last week’s report was an anomaly (or a mistake, as OPIS suggested this week), then the rise will be arrested, and prices will await some other news for direction.

Back to OPIS, here was the blurb this week on the inventory report:

DOE statisticians have garnered a free pass for most of the year when it comes to petroleum numbers. Most of the criticism has been targeted at API or at the lofty demand quotes suggested by the newcomer on the block, the MasterCard SpendingPulse report.

But today, DOE is coming under some intense scrutiny by the physical traders and sellers that move refined products. That group believes that today’s surprising statistical bulletin is at best an anomaly, and at worst “bogus”. Many marketers also disagree with the notion that recent demand is exceeding supply. For at least the first ninety minutes after the data release, the paper markets regard the numbers as credible, with substantial across the board gains in petroleum.

Traders can’t quite come to grips with the 2-million bbl gasoline stock decrease, of which 1.2-million bbl occurred on the West Coast. The smaller 300,000 bbl decrease on the East Coast is attributable to the lower import number. Blendstock cargo arrivals have really tailed off in the last couple of weeks, but some weather delays were a culprit. Next week’s import number is predicted to go well back above 1-million b/d nationwide after this week’s low total of 838,000 b/d.

The distillate numbers were also questionable. Overall stocks fell by 1.8-million bbl and a drop of more than 3-million bbl in ULSD stocks was the major factor. That dip seems severe, even at harvest time, with some traders wondering whether a few exports might have been part of the mix. Distillate output also slumped, thanks mostly to a 193,000 b/d slide at the Gulf Coast.

That demonstrates the kind of hidden risk factors inherent in short-term trading. Was the report unusual? Yes. Could it have been an anomaly? Yes, we have seen those kinds of unusual moves before, only to see them undone the following week. And if it turns out that stocks are sharply up next week, I would take profits very quickly.

On the topic of speculators, I have just had an interesting exchange with a speculator at The Oil Drum. Like many of his tech stock predecessors, he attributes his success to his financial acumen and understanding, and yet at the same time displays a very faulty understanding of some of the “inside the fence” basics. But he can’t see this, because he is making money, and therefore he believes he is making shrewd decisions based on his special interpretation of news reports. More on that later, as the exchange provides a window into the thinking of a speculator.

A few newsworthy items to cover: Gas prices, gas gouging legislation, and food versus fuel.

Gas Prices on the Rise

Surprise! It seems that gas prices are rising:

Gas prices on the rise again, analyst reports

Gas prices are on the rise again, just as Americans hit the highways for Thanksgiving.

Gas prices rose about 5 cents per gallon nationwide compared to two weeks ago, industry analyst Trilby Lundberg said Sunday.

Of course if you read this blog, you knew this was coming. I have made this case in two recent essays, and I have been saying this at The Oil Drum for about a month:

A Case Study in Cluelessness

This Week in Petroleum 11-15-06

Gasoline inventories are being sharply pulled down for three primary reasons. First, demand has picked up as prices have fallen. Second, gasoline imports fell off as prices dropped and European refiners saw profit margins fall on exports to the U.S. Third, we are in the middle of fall turnaround season, when refineries shut down for maintenance. All of these factors are causing gasoline inventories to free fall, and that situation can’t continue, regardless of how the elections turned out, unless 1). Imports make up the difference; 2). Prices rise to slow demand; 3). We start rationing product; or 4). We just keep going like this until stations start to run out of gas.

Keep a close eye on the inventory report this week for a hint of which direction prices are headed in the short term.

Price Gouging and Fuel Supplies

A couple of days ago the following article was highlighted at The Oil Drum:

Congress seen passing price-gouging law

Some excerpts:

WASHINGTON – The head of the Federal Trade Commission predicted Thursday that Congress would pass a gasoline price-gouging law despite her warnings that the country doesn’t need one and it might cause fuel shortages.

FTC Chairwoman Deborah Platt Majoras said she has warned Congress publicly and privately about the dangers of such a law.

Majoras said she understood the public’s frustration and concern but said an upcoming FTC report on the price spikes found that consumer demand was up at the time.

“There is a distinction between a market determination you don’t like and a market failure,” she said.

Testifying in May before the Senate Commerce Committee, Majoras said retailers might let the gas run out rather than raise prices and risk facing prosecution. She noted the price spikes after Hurricane Katrina last year resulted in more fuel getting to market.

I commented on the story:

I think this is likely with the new political climate, but this is very short-sighted. What they don’t seem to realize is that if prices are frozen during a Katrina-like crisis, then rationing is the only other option. I think most people would prefer to pay more for their gas (rationing by price) than for everyone to be told they are only getting 75% of the gas they would like.

I generally get some negative feedback any time I write anything in defense of the oil industry (like this example), but one poster provided the following feedback:

Several years ago the Canadian province of Prince Edward Island implemented a similar scheme to set fixed gas prices for specific periods in an attempt to prevent price “gouging.”

The outcome was as described in the RR blockquote. Gas prices did not rise; there was also no gas available anywhere on the island and no plans to import any.

The legislation was repealed.

Anyone who understands the first thing about economics knows that this has to be the outcome. If you can’t raise prices when demand is high, then we have gas lines, rationing, and ultimately no gas. I don’t know if this is the solution they want, but it’s what they will get.

Food versus Fuel

Many ethanol advocates argue that increasing the amount of corn that is going toward ethanol production is not an issue. However, it is certainly an issue for the people who have relied on those corn imports, and are now watching the price rise. Today, Tyson Foods weighed in on the subject:

Tyson Foods Sees Higher Meat Prices

“The best thing I can say about fiscal 2006 is, it’s over,” Richard L. Bond, president and chief executive officer, said in a statement.

Bond said the price of corn, which is used as animal feed, is going up because of demand from ethanol plants that are springing up to provide alternative fuel sources to oil.

Corn prices recently reached 10-year highs.

“I believe the American consumer is going to have to pay more for protein. We are at new levels on corn that are not likely going to be retrenching back to ‘06 levels,” Bond said in a conference call with analysts.

Bond said meat producers, processors and retailers will have to pass the higher grain price on to consumers because they cannot absorb it in their profit margins.

“Quite frankly the American consumer is making a choice here. This is either corn for feed or corn for fuel, that’s what’s causing this,” Bond said.

Of course food versus fuel is a serious issue going forward. How could it not be? Some people will pay more for food so we can put inefficiently produced ethanol in our vehicles, and some people will have to start making some tough choices as budgets are stretched.

Another week, another all-time low on gasoline inventories. As I wrote last week:

Gasoline inventories were not this low following Hurricane Katrina, and yet we have had an uneventful summer. It is very possible that we will not dig ourselves out of this hole for a long time. In the short term, an upturn in gasoline prices is inevitable.

I have been closely watching OPIS reports this week, and gas prices have ticked up most days. I don’t have the numbers in front of me, but I think gas is at least a dime higher than it was a week ago. (It occurs to me that if I would ever act on my predictions and buy some futures, I could make a little money).

This week’s inventory report saw another gasoline draw:

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) fell by 3.9 million barrels compared to the previous week. However, at 329.7 million barrels, U.S. crude oil inventories remain above the upper end of the average range for this time of year. Total motor gasoline inventories dropped by 1.5 million barrels last week, and are well below the lower end of the average range.

“Well below” may be an understatement. Looking at my records, there haven’t been too many weeks on record where gasoline inventories have been lower on an absolute basis (and never on a days of supply basis). In fact, the last time gasoline inventories were this low was the week after Hurricane Katrina. Incidentally, this week’s gasoline inventory is 191.1 million barrels. The lowest number on record was on August 29, 1997 at 185.6 million barrels.

The next few weeks will be interesting. We are at the end of peak driving season, but we will soon be heading into fall turnaround season where gasoline production will drop. Winter gasoline is also right around the corner. This time of year typically sees gasoline prices fall (prompting conspiracy calls when it also happens to be an election year) but with inventories where they are we probably won’t see that typical price drop. In my opinion, we can’t afford to see it. Last fall prices fell, and demand picked up. We can’t afford for demand to pick up with inventories setting where they are.

I predict that prices will continue to rise. I think they have to. I also think we will see the ramifications of present inventory levels for quite some time. On the other hand, we did go into the end of 2003 with inventories in this range, so we do have some history suggesting that levels can recover without requiring sharply higher prices. But don’t bet on it.

Update: Conoco Sweeny, Texas Refinery To Shut Gasoline Unit

NEW YORK -(Dow Jones)- ConocoPhillips (COP) plans to shut a key gasoline production unit at its Sweeny refinery in Texas on Thursday to make emergency repairs, according to a filing with state environmental regulators.

A plug valve in the reactor associated with the fluid catalytic cracker is the source of the problem, said the report to the Texas Commission on Environmental Quality. The shutdown, said to begin at 11 a.m. CDT Thursday, is seen lasting about 36 hours. The report didn’t indicate how long repairs might take or when the unit would return to normal operations.

The Sweeny refinery is able to process about 247,000 barrels of crude oil a day.

That’s not going to help matters any.

I have never heard of James Mound, but I think he is correct in his assessment below. As I have mentioned, I absolutely would not buy oil at these prices. It may still go to $100 in the short term, and clearly that sentiment is helping drive the market, but the fundamentals have not changed so dramatically in the past 3 months to warrant this kind of run-up:

James Mound’s Weekend Commodities Review

Energies

Strong selling ensued on Monday as a follow through to a bearish Friday close. The market suckered in a lot of shorts, me included, and then rocketed back to fresh highs amid growing geopolitical concerns. While the concept of peak oil (the end of the growth cycle of this limited life natural resource) is well supported, it does not necessarily support the current extremes. The market is in a short covering frenzy, overextended beyond what any normal relative strength scale would measure and setting up for a serious bull suck-in and shakeout. Look to the exchange for increased margins at these prices and watch the market come crashing down. Put plays are really the only remotely intelligent way to play the bear move, but if you are thinking of going long this market here just ask yourself if you are the last person to the party. Natural gas remains independently a good market for playing long call volatility as price expansion is likely in the coming months.

If inventories pop back up this week, you could see a quick sell-off. Ditto if Saudi convinces the rest of OPEC to calm the markets. I think upside potential is small in the short-term (but high in the long term) and the risk of a decline is large. If I was investing short-term, I would be buying puts here. It is hard to believe that the price of crude has moved 10% on the back of last week’s inventory report, but I said it would provide fuel for another week. Of course the other wild-card is whether interest rates will be cut again this week, as expected. If that happens, we could run up a few more dollars. But, I think investors have already factored in an expected rate cut.

I had mentioned writing a post on a recent exchange I had with a speculator. I will get that done as soon as I can, because it will give you some insight into the financial acumen of some of the people who are currently piling in.

The weekly inventory report from the Energy Information Administration came out today, and it provided support for my latest essay. You can read the report at: This Week in Petroleum. A quick look at the gasoline inventory graph can tell you that upward pressure on gas prices is imminent:

In my previous essay, I argued that falling inventories had to cause prices to increase. Some excerpts from this week’s report:

…inventories dropping much faster than normal for this time of year. Moreover, with demand higher than in recent years, stocks considered in terms of the days of supply (or demand) that inventories can cover are lower than they appear on an absolute basis. This interpretation would lead one to think that markets are tightening and that oil prices could be poised to head higher soon.

On distillate (diesel, jet fuel, fuel oil) inventories:

There has also been discussion among analysts lately about the level of demand, particularly for distillate fuel. Over the most recent four weeks, demand for distillate fuel oil (which includes both heating oil and diesel fuel) is averaging nearly 4.5 million barrels per day, the sixth highest four-week average ever, and the highest four-week average ever for any period that doesn’t include weeks in January or February, when cold weather usually leads to a peak in distillate fuel demand.

Of course the high demand for distillate has already caused the spread between diesel and gasoline to become unusually large.

From the text version released earlier in the day:

Total motor gasoline inventories dropped by 3.7 million barrels last week, and are now in the lower half of the average range.

This was a much higher draw down of gasoline than was forecast. Gasoline inventories are being sharply pulled down for three primary reasons. First, demand has picked up as prices have fallen. Second, gasoline imports fell off as prices dropped and European refiners saw profit margins fall on exports to the U.S. Third, we are in the middle of fall turnaround season, when refineries shut down for maintenance. All of these factors are causing gasoline inventories to free fall, and that situation can’t continue, regardless of how the elections turned out, unless 1). Imports make up the difference; 2). Prices rise to slow demand; 3). We start rationing product; or 4). We just keep going like this until stations start to run out of gas.

Finally, on gasoline prices, they have started creeping up, which if you have been watching inventories is no surprise:

The U.S. average retail price for regular gasoline rose 3.2 cents to 223.2 cents per gallon as of November 13th, 6.4 cents per gallon lower than at this time last year. East Coast prices rose 2.8 cents to 219.8 cents per gallon. In the Midwest, prices rose 3.8 cents to 221.8 cents per gallon. Gulf Coast prices were up 2.9 cents to 210.9 cents per gallon. The West Coast saw the largest regional increase, with prices rising 5.7 cents to 243.8 cents per gallon. The only region that saw a price decrease was the Rocky Mountains, with prices falling 2.0 cents to 225.4 cents per gallon.

My prediction is that the drop in gasoline inventories will slow next week, as refineries begin to come out of their turnarounds, and creeping prices start to slow demand a bit. If not, I expect prices to turn up sharply in the near future.

Gas Prices in San Francisco

We no longer have to talk about the possibility of $4 gasoline. It is here.

Thanks to Stuart Staniford for providing this picture. He lives in San Francisco, and said he drove past this station and saw the price for himself. It is going to be very interesting to see the inventory report from the EIA this week. How high do gas prices have to go before demand starts to drop? And will imports hit the shores in time to save the day, as they did at this time last year?

The Senate Stops By

Occasionally my Site Meter shows some very noteworthy domains, and last week I spotted 2 visits from the U.S. Senate at the same time. Probably staff members, I know, but when people that close to the policy-makers are reading your stuff, there is hope that the message is getting through.

On the next snapshot, I have the Senate (same as #20 above), the U.S. Army, the USDA, NC State, The University of Chicago, the Wisconsin State Government, another domain in D.C., and UC San Diego.

I saw a comment from someone yesterday that if this week’s inventory report shows a sharp drop in crude inventories, oil will probably spike up above $100. I do think that because of the storms in the North Sea and the flooding in Mexico we will see a decent inventory draw this week. But I don’t think the price will spike to $100 on the news, because this week is complicated by a number of factors.

The first is that the inventory report will be delayed by a day this week, due to the government holiday on Monday. The second is that the front-month WTI contract expires the day after the inventory report is released. There are a lot of people holding contracts that must be sold by Friday. What I expect then is that any bad news that pushes prices higher will be met by speculators selling into the rise.

Another factor that may cause tremendous volatility is that December options contracts expire on Tuesday. If crude doesn’t trade at or above $100, those options expire worthless. This means that there is a tremendous incentive for a lot of people to talk up the price today and tomorrow. I would expect a load of analysts over the next couple of days to appear on TV and “explain” why things are much worse than they seem.

Today’s Houston Chronicle has a story on the expected roller-coaster this week:

Wild week ahead for price of oil

Here is a quick summary, pulled from excerpts in the story:

It’s a situation one analyst likened to a high-stakes poker game. A showdown between traders who believe the price will rise and those who believe it will fall could bring both results — a brief taste of $100, followed by a rapid sell-off.

Lehman Brothers’ Morse said in the report that the Dec. 7 futures contract for West Texas Intermediate crude — the U.S. benchmark — will expire Friday, and 360,000 contracts remained outstanding. Most of those contracts are held by financial players in the oil market and must be sold by the expiration date, Morse said.

“Presumably, market participants know that the exits are going to be crowded over the next few days if they do not sell their positions soon,” he said.

Adding fuel is the West Texas Intermediate options market on the Nymex, where 42,000 Dec. 7 call options for $100 are set to expire Tuesday.

An option to buy at $100 a barrel will only be profitable if oil costs more than that sometime before the option expires. So those 42,000 call options will “expire worthless” on Tuesday if oil doesn’t reach $100 a barrel by then.

“Perhaps, before Tuesday, holders of these calls will attempt to push oil to $100 in a last effort to force these options into the money,” he said.

So there are 360,000 contracts, most of which must be sold between now and Friday. And there are 42,000 options that will only benefit if oil makes it to $100. The expectation is that the traders holding those 42,000 options will talk the price up. But they are going to face the headwind of those holders of those 360,000 contracts trying to liquidate by Friday. I just can’t see oil reaching $100 in the face of that.

Eric Wittenauer, an analyst with A.G. Edwards & Sons, said 42,000 call options at $100 indicated that the holders expect they will be able to exercise them at that price.

“I think it’s a logical argument that someone’s going to have a lot of money on the line and potentially want to drive the price up to $100 and above,” he said. “If you break through $100 and tack on some more, you make that much more profit on your positions.”

Morse said speculators could back off and take profits before a barrel hits $100, but the price most likely will make “a serious run at $100″ by Tuesday and perhaps reach $105 before selling pressure ensues.

It is certainly a credible argument that the holders of those options will try to talk up the price. But I don’t think it is at all credible that they can actually talk up the price to that level. It will take a major geopolitical event or natural disaster to affect prices that strongly. If we don’t see any major news by Tuesday’s close, and oil trades over $100, I will be stunned. As I write this, WTI is trading at $94.94. It’s not going to make it to $100 by tomorrow just on the basis of traders trying to talk it up.

I do agree that we could see a sharp sell-off by Friday:

Then, with the contracts that must be sold by Friday, the rush to sell “may be stronger than anything the oil market has seen in several years,” Morse said.

He said prices could fall to the low $80 range by early December.

I don’t think oil is going to fall to $80 in 3 weeks, but I have said again and again that I don’t think the current price is sustainable in the short term. I think we will pull back shortly, and make another run at $100 in 2008. However, if OPEC doesn’t say the right things following their meeting this week, they will toss more fuel on the fire and make it more unlikely that prices will have a huge correction.

Full Disclosure: I don’t hold any commodities positions. Although I am beginning to think that I should.

Updated Following Report Release

About 10 seconds after the report was released, I scanned down and found what I was looking for: U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) fell by 0.8 million barrels compared to the previous week. I turned to the guy sitting next to me, as we had been talking about this today, and I said “$100 oil may have to wait for another day. The inventory draw was half what was expected.” We could still pop $100 today, but this inventory report doesn’t favor that. A higher expected draw was already factored in, so I don’t think this supports a quick move up from the current price level. But I wouldn’t put $1,000 on it.

However, we are still close enough that it won’t take much volatility to push oil over $100. A single negative geopolitical event should do it. But in the absence of a brand new geopolitical or weather-related event, I will be very surprised if we don’t pull back a bit from $100 in the next couple of days.

So, why were oil inventories down less than expected? Because refinery utilization continues to languish. You can see that in the utilization numbers, and you can see it in the fact that gasoline had an unexpected draw. Imports were also up from the previous week, surprising given the situation in Mexico. The other big surprise? Gasoline demand is still almost 1% above last year’s level. (Don’t overlook the role of ethanol there. As ethanol is added to the fuel supply, volume demand will go up even if miles driven don’t. I have documented that here).

Here were the highlights:

U.S. crude oil refinery inputs averaged 14.9 million barrels per day during the week ending November 2, down 43,000 barrels per day from the previous week’s average. Refineries operated at 86.2 percent of their operable capacity last week. Gasoline production fell compared to the previous week, averaging nearly 8.9 million barrels per day. Distillate fuel production rose last week, averaging nearly 4.2 million barrels per day.

U.S. crude oil imports averaged nearly 9.7 million barrels per day last week, up 275,000 barrels per day from the previous week. Over the last four weeks, crude oil imports have averaged 9.6 million barrels per day, or 461,000 barrels per day less than averaged over the same four-week period last year. Total motor gasoline imports (including both finished gasoline and gasoline blending components) last week averaged 1,131,000 barrels per day. Distillate fuel imports averaged 270,000 barrels per day last week.

U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) fell by 0.8 million barrels compared to the previous week. At 311.9 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 decreased by 0.8 million barrels last week, and are at the lower end of the average range.

Both finished gasoline inventories and gasoline blending components fell last week. Distillate fuel inventories increased by 0.1 million barrels, and are at the upper limit of the average range for this time of year. Propane/propylene inventories decreased 0.4 million barrels last week. Total commercial petroleum inventories decreased by 0.9 million barrels last week, but are in the upper half of the average range for this time of year.

Total products supplied over the last four-week period has averaged nearly 20.7 million barrels per day, down by 0.4 percent compared to the similar period last year. Over the last four weeks, motor gasoline demand has averaged 9.3 million barrels per day, or 0.8 percent above the same period last year. Distillate fuel demand has averaged 4.2 million barrels per day over the last four weeks, down
2.4 percent compared to the same period last year. Jet fuel demand is down 1.2 percent over the last four weeks compared to the same four-week period last year.

$100 Edition? – to be updated following the release of the report

Note: The Oil Drum is down at the moment following an upgrade, but this will be posted there as soon as the technical problems are resolved.

It seems that every bit of news lately favors higher oil prices. In the wake of a perfect storm of weather-related and geopolitical events, Tapis went through the $100 mark overnight, and WTI is knocking at the door. In case you have been asleep for a week, the Fed cut interest rates, Mexico’s oil-rich Tabasco region is underwater, and oil companies are evacuating platforms in some parts of the North Sea ahead of a fierce storm predicted to generate 35-foot waves. The wind is howling in Aberdeen already, and did so throughout the night. (One of my engineers is stuck offshore and may have to ride out the storm, forecast for Thursday.)

Predictions are for a 1.6 million barrel draw for crude oil stocks this week. That expectation is factored into the price, so if we see less than that, crude could quickly give up some ground to profit-taking. However, the predictions for a draw may be too conservative, in which case WTI should quickly pop over $100. Gasoline inventories are forecast to rise by 200,000 barrels, and distillate inventories are expected to fall by 500,000 barrels.

Consider that the draws of the past 3 weeks have been much larger than predicted. I think the primary reason for that is a variable that analysts haven’t factored in: Some refiners are drawing down stocks and trying to wait out these prices. Consider it from their perspective, and it makes perfect sense. You have filled your tanks with oil at $80. You believe that we are in a speculative bubble. Therefore, you will risk drawing down inventories somewhat, and hoping that prices correct soon. If you fill your tanks at $100, and the price corrects back to $85, you are going to sell gasoline at a loss for a while. The risk in that strategy is obvious. But I do have direct knowledge that some are employing such a strategy.

So, there is that factor to consider with respect to the crude draw down. But the situation in Mexico, a large provider of U.S. imports, may cause the draw to be much steeper. This event has gotten very little attention in the media, but Mexican President Felipe Calderon said that the oil industry there has been devastated, and exports have ground to a halt. If it is as bad as it sounds, we should see a much larger draw than anticipated.

The final factor that may contribute to a larger than anticipated draw is the one that analysts have factored in: Refineries will be coming out of turnarounds. However, utilization rates have been lower than expected, primarily due to low margins. As I have mentioned before, if margins are poor, you aren’t exactly scrambling to process as many barrels as you can. So the utilization patterns of the past couple of years may not be a good guide for this year’s utilization pattern. Utilization should come up, which would lead to downward pressure on inventories, but it’s not a sure thing.

My prediction? While I have made it through 85% of the year, I think I will lose my $1,000 bet within 24 hours. However, I don’t expect oil to stay there for very long. I think it will return – probably to stay – in 2008, but I believe it has gotten ahead of itself at the moment.

There were two scenarios that I foresaw as potentially causing me to lose the bet. One, Saudi production could continue to decline, and I would surely lose it. That did not happen. In fact, indications are that Saudi is increasing production, although just how much spare capacity they have is debatable. Two, a series of unfortunate events, which I identified as “a bad hurricane season in the Gulf of Mexico, combined with terrorist attacks or pipeline problems (or any number of things)” could cause me to lose it. Well, we have had saber-rattling and finally sanctions with Iran, storms in Mexico, storms in the North Sea, a collapsing dollar, and growing demand combined with flat production. I think that qualifies as a series of unfortunate events. If that happens, I will have a post dedicated to the bet, including a bit of information about my mystery betting partner.