Inventories May Have Dropped, But Crude Oil Prices Still Constrained by Natural Gas Oversupply

The WTI crude oil futures curve (click to enlarge) 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 (click to enlarge).




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 (click to enlarge).



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.

Comments

[Henri DeToi:]

We are saturated with diverging opinions. Who knows? Not me for sure. Neither do you!

Sep 18 05:25 AM

[Stefan Sida...:]

"Heating oil in many instances can be substituted with cheap natural gas, forcing more distillates to go into storage."

When I see lines drawn between natural gas and crude, I can't figure out the connection. Trucks and cars around the world are designed to either run on gas, diesel or LNG, but I don't think they can switch to take advantage of price differences between crude products and natural gas. My house uses NG. My previous house used heating oil. To switch, I have to buy a new boiler. While some may so this, it doesn't seem like a market driver.

Sep 18 06:11 AM

[jerrydd:]

Just maybe inventories are dropping for crude because there is little profit in storing it? Just costs with little chance of higher prices. The only real reason crude is as high as it is is speculators, hedge funds which I wouldn't be surprised all get out at these prices.

Investing in oil, other commodities should be limited to users and prices would fall nicely to where they belong. A .25% tax on all trades would take all but real users, long term investors out of the markets and make them rational, true investments again instead of the gambling now making most poorer and a few rich. Without such devices we will just hit bubble after bubble, only good for brokers, hedgefunds, etc by churning.

Sep 18 09:23 AM

[Mark Divy:]

Please explain the link from Crude Oil to Natural Gas. Other than some trend lines, what is the actual link? What current use of crude is easy to transfer to natural gas with minimal investment? Just like Stefan, I wonder why so many investors and investment talk treats these two fuel sources as interchangeable. Other than a BTU equivalency, not sure there is any real market factors that would make them correlate. Coal also has a BTU rating, but I don't notice folks predicting price of coal based on price of oil...

Sep 18 12:36 PM

[LKofEnglish:]

I can tell you the link as so can the author: NONE. Oil can be move anywhere on planet earth to where it gets its highest return. Not true with nat gas. Nat gas is cheap because it's stuck in this dog of an American economy. not true with oil. that can bypass this country and it's worthless peso which is exactly what it should do.

Sep 18 02:26 PM

[Gigem77:]

Where can heating oil be replaced by natural gas? Residential users can make the conversion, but where is the evidence that they are doing so this year?

Distillates include diesel as well as heating oil. Diesel demand is greatly reduced by the recession. That is the main reason for the builds in storage.

LK is right, oil is fungible and natgas is not. I add to that, that while the futures were moving higher on speculation, spot prices fell. intelligencepress.com/.../

Sep 18 09:32 PM

[Dave Wrixon:]

Sorry, but I cannot see Natural Gas having a signficant short-term impact on Oil prices. To what extent are they really substitutable from day to day?

Sep 19 06:29 AM

[MexCom:]

If I was a cash market speculator sitting on a tank farm full of oil and see the price is declining with no prospect of an increase in the near term - I'd sell. This selling is driving the price lower with declining inventories. Its not supply and demand economics 101 at work here.

You need to anticipate market psychology.

In the short run there is little substitution between Nat. Gas and oil. Also, there is little energy price compatibility. IMHO, Nat. gas is a bi-product of oil exploration and in many cases is flared off as being worthless economically until a capture/pipeline infrastructure can be provided to have any economic value.

As such, as the demand for oil increases, so does exploration. With new wells coming on line, the increase in worthless Nat. gas increases. This causes oversupply as infrastructure is provided to capture it until the price declines to the cost per unit of transport. As the economic value approaches zero it is simply flared off at best or becomes a cost of oil production from pollution, fire and explosion accidents.

As oil prices increase I would expect Nat. Gas to continue to decline.

On the demand side. With the weak economy and the global warming trend, expect Winter demand to decline along with weak industrial demand. Warmer weather will prompt more travel to go to the beach and mountains. Oil demand increases - Nat. gas demand declines.

Sep 20 12:01 PM

[Walter Kurtz:]

thanks everyone for their comments. Fuel switching is actually quite common at power plants: narrowtranche.blogspot...

Sep 20 12:53 PM

[JeffDB:]

On Sep 20 12:53 PM Walter Kurtz wrote:

> thanks everyone for their comments. Fuel switching is actually quite common at power plants: narrowtranche.blogspot...
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Yeah, I knew they did some switching, but was under the impression that most of that switching was between coal & natural gas. I'm not sure of the numbers, but thought I had read somewhere that diesel use for electricity generation in the US had dropped to about 2% or so some time ago. Not positive of that, however.

It does seem that there might be some switching to natural gas on home heating, but as Stefan noted, that's probably a fairly gradual process, though the very low natural gas prices lately may have sped that up a bit. I'm surprised they haven't switched a lot more of the homes in the northeast, but I guess they just don't have the infrastructure for it yet.

There is already some "Gas To Liquids" processes in place, but I think a lot more will be coming online:

en.wikipedia.org/wiki/...

www.shell.com/home/con.../

www.msnbc.msn.com/id/7.../

and in another thread Jerrydd said:

seekingalpha.com/user/...

"While GTL isn't as eff as we would like, it still makes diesel for about $1/gal at today's NG prices. And if the waste heat from the FT process is captured to make electricity added to the diesel/gasoline which I might add are far cleaner than oil based ones, it is profitable by a good amount."
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Not sure how much of that is in play in our own situation, though.

Sep 20 10:48 PM