HardAssetsInvestor

Written by Sumit Roy  |

October 13, 2011

Crude Oil Report: Prices Should Continue Higher Despite Lower Demand, Surging Production

Details

Brent has rallied nicely off last week’s lows, but there is still more upside potential.

The Department of Energy reported this morning that in the week ending Oct. 7, U.S. crude oil inventories increased by 1.3 million barrels, gasoline inventories decreased by 4.1 million barrels, distillate inventories decreased by 2.9 million barrels and total petroleum inventories decreased by 1.4 million barrels.

Crude oil prices were lower after the latest EIA figures, with Brent near $110/bbl and WTI near $84.

Brent prices rallied strongly over the past week, with prices surpassing $112 at one point. That’s well above the $99 level hit just last Monday. The benchmark is now testing a significant downward trendline that extends back to this year’s highs set back in April.

A breakout above the trendline would open up a path to the next level of resistance at $115.50, followed by $120 and then the year’s high near $127.

In our view prices should continue higher amid strong global supply-and-demand fundamentals. Investor risk appetite may also continue to improve as European sovereign debt concerns ebb.

The S&P 500 is once again edging up toward the upper end of its range at 1220. A break would send a strong signal that the correction in financial markets is over, boosting market confidence in the process.

In its latest Oil Market Report, the International Energy Agency revised its demand growth forecasts for 2011 and 2012 down by 50Kbbl/d and 210Kbbl/d, respectively. Now the agency sees demand at 89.2 mmbbl/d (+1 mmbbl/d year-over-year) in 2011 and 90.5 mmbbl/d (+1.3 mmbbl/d year-over-year) in 2012.

Even so, global demand continues to outpace global supply. Based upon OPEC’s September output of 30.15 mmbbl/d, demand will exceed supply by 650Kbbl/d in the fourth quarter of this year and 350Kbbl/d in 2012 as a whole.

Ongoing supply disruptions in Libya; weak non-OPEC supply growth; and resillient demand in the face of $100+ crude oil are all contributing to the tightness in the oil market.

Specifically, non-OPEC supply may have only grown by 0.2 mmbbl/d this year, according to the IEA. Given demand growth of 1 mmbbl/d, the burden of filling the gap has been on OPEC. But amid turmoil and significant supply disruptions in OPEC-member Libya, the other members have had to step up that much more.

Saudi Arabia, the only member with significant spare capacity, raised its production to compensate. The result is immense pricing power in the hands of a single producing country. Hence, the high prices we now see.

For 2012, the IEA sees non-OPEC supply growing by 0.9 mmbbl/d. But keep in mind, at this time last year, the agency forecasted growth of 0.5 mmbbl/d for 2011 — significantly above the 0.2 mmbbl/d growth it now sees.

Turning to this week’s EIA inventory figures, total petroleum inventories in the U.S. decreased by 1.4 mmbbl, against the 5-year average of a 0.4 mmbbl withdrawal. In turn, the surplus over the 5-year average fell to 8.9 mmbbl, or 0.8 percent.