Engineering News

Oil Futures Market Settles Into Lower Range
Thursday, July 24, 2008

A record downturn has shaken the oil futures market from its lengthy quest to push prices to new record highs.

Oil prices have lately been rattled by signs that U.S. economic weakness is cutting demand from the world's largest oil consumer. Crude futures in New York have ended lower in six of the last seven trading sessions, and the drop from the July 11 record high of $147.27 a barrel to Wednesday's settlement at $124.44 is a record correction in dollar terms. Oil prices were trading at $125.31 Thursday.

But even a $23 correction hasn't sparked talk of a return to the relatively cheap oil prices of a year ago. Instead, oil is perched at the exact midpoint between two symbolic price levels that analysts say is likely to form a trading range for the rest of the year. The oil market has discovered that crude cannot top $150 a barrel without hurting demand, perhaps permanently. An equally solid floor is forming around $100, where refiners and other commercial buyers would start buying out of concern for the world's tight spare supply capacity.

"Oil started to seem like a one-way bet," said Rachel Ziemba, an analyst with the RGE Monitor, a financial research Web site. "Now some people are starting to...question whether $145 a barrel is sustainable."

The drop began on July 15 as Federal Reserve Chairman Ben Bernanke told Congress that the U.S. economy would likely remain mired in a downturn through the end of 2008. High oil prices were partly to blame, he said, by making inflation unpredictable and reducing consumer spending.

U.S. oil demand already reflected the weakness Bernanke described. Gasoline inventories have grown for four straight weeks, even though refiners are processing crude into gasoline at a 17-year low rate for July.

The extent of the problems in the U.S. economy was well known by the time Bernanke spoke, yet the oil market had paid little heed up until last week. Traders figured that crude supplies, rejected by cash-strapped U.S. consumers, would find their way to expanding economies in the developing world. The International Energy Agency and other leading industry observers still back that view, predicting that world demand will grow faster than new supplies through 2009.

Supplies Not Secure

Supplies are no more secure than they were two weeks ago, either. Nigerian militants threatened new attacks on Wednesday, and Hurricane Dolly earlier this week became the first storm to enter the Gulf of Mexico this year.

"I don't think things have changed that much in the oil market," said Harry Tchilinguirian, senior oil market analyst at BNP Paribas in London. "Geopolitical tensions are unresolved, and we have yet to go through hurricane season."

Bernanke's testimony, while no revelation, provided a cue for the market that the rally could go no further. So did fuel price hikes by governments across Asia in early June.

Demand has yet to fall, though the market is watching how Chinese demand fares after the Summer Olympics end in August. But the act itself - coming when oil was trading between $120 and $130 a barrel - provided an early hint that oil was nearing a price cap.

"That high of $147 came after the fundamentals had already turned bearish, it had the look of a last-gasp investment rally," said Darin Newsom, senior analyst at DTN, a market information service in Omaha, Neb.

Finding A Center

Oil may have little room to rise, but it may not have much further to fall, either. U.S. gasoline demand has stabilized at about 2% below 2007 levels, and could quickly bounce back should gasoline prices - currently holding just over $4 a gallon on average nationwide - at the pump fall.

"Our expectation is that U.S. gasoline demand has not been destroyed," wrote analysts at Barclays Capital. "The demand would return with lower prices."

Near-term oil futures traded at a premium to their outer-month peers when oil prices rose to $120 from $80 a barrel, indicating that refiners and other buyers believed that oil supplies were tight. As U.S. demand weakened and Asian fuel prices rose in May, the supply situation was seen easing, and the market structure flipped.

Now that oil prices are dropping, the front-month premium is again narrowing, a clear sign that the market is finding a price range where supply and demand are more balanced, Newsom said.

Any equilibrium found this summer would likely be shattered by early 2009, however.

The IEA expects world oil demand to rise by 860,000 barrels a day next year, while new supplies outside the Organization of Petroleum Exporting Countries are seen increasing by only 640,000 barrels a day.

Bernanke also said last week that he expects the U.S. housing market to bottom out by late 2008 or early 2009, which should help the wider economy recover.

Tchilinguirian, with BNP Paribas, noted that there were still considerable contracts open and betting on prices going higher.

"Open interest is bunched around $150 and $200," said Tchilinguirian, with BNP Paribas. "We're only at the beginning - perhaps that rise to $145 came a little too quickly."

Source: Dow Jones Newswires

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