London, 20 May 2010

Steadily increasing stockpiles of crude oil and refined products in the United States this spring preceded the recent collapse in the timespreads and sharp sell off in NYMEX futures, according to weekly data published by the Energy Information Administration ( EIA).

It underscores how much of the recent softness stems from poor fundamentals rather than negative sentiment infecting the market from equities and other risk classes -- and just how far the market got ahead of itself discounting future expected tightness rather than actual supply-demand dynamics.

Chart 1 (download below) shows stocks of crude oil and refined products in commercial storage (excluding the strategic petroleum reserve) compared with consumption of refined products (in days' worth of petroleum products supplied). Chart 2 (download below) shows the most recent period in more detail.

For most of the period between 1991 and 2008, stocks of both crude oil and refined products trended lower in relation to consumption, as inventories became leaner. Historically low stocks contributed to the unprecedented rise in crude and product prices in 2007 and 2008.

Stocks had already begun to increase even before the global recession triggered by the collapse of Lehman Brothers in September 2008. But the recession's sent combined crude and product stocks to a 15-year high of around 60-62 days worth of product consumption in May 2009.

A combination of OPEC output restraint and U.S. refiners' run cuts has subsequently worked stocks down, with total inventories falling almost 9 days to 53 days consumption by early March 2010.

Inventories have since risen by the equivalent of almost 5 days worth of consumption (stocks rose 32 million barrels while consumption declined 1.2 million barrels per day) to hit a recent peak at 58 days in mid April. In the last three weeks, the stock ratio has pulled back to 55.5 days.

But the change has come through stronger reported consumption (up 1.2 barrels per day) rather than a draw in crude and product stocks, both of which have continued to rise (by 4.9 million barrels in the case of crude and 9.6 million barrels for refined products).

Slack Physical Market

Near-term consumption is notoriously difficult to estimate. The EIA has no way to differentiate in real-time between increases in domestic use and rising exports. Implied consumption is simply the residue after the agency has allowed for reported changes in imports, refinery runs, stocks and its estimate for exports based on past trends.

Any error in estimating exports shows up as an equal but opposite error in estimating consumption. Definitive data on exports is not available for another six weeks when customs returns are published. So there is no way of knowing whether the apparent improvement in consumption reported over the last three weeks is in fact due to higher domestic usage or a pick up in exporting.

The sudden breakdown in crude prices (first the softening of the timespread from April 1, then collapse in outright prices since May 4) seems to have been a delayed response. Previous upward momentum that had fuelled technical buying stalled and the build of inventories began to outweigh bullishness about the medium-term outlook.

How much of the build was new oil, and how much was simply previously hidden stocks offshore and in floating storage, now made more visible, is beside the point. As is the fact crude and product inventories typically rise during the shoulder period between the end of the winter heating season and the onset of the summer driving season at the end of May.

The reported build belied claims about how quickly the supply-demand balance was tightening and confirmed the continuing sloppiness of the physical market.

Wariness About Demand

Assuming the consumption trend is confirmed, the distinct pick up could eventually put a floor under nearby futures prices. But so far it has not halted the slide. One problem is that the rise in consumption is largely confined to distillates, where daily consumption has reportedly risen almost 490,000 barrels per day (14 percent) in the space of just three weeks, as well as propane, where consumption is up 455,000 barrels per day (66 percent). Gasoline consumption is flat or lower over the same period.

The abrupt increase in distillate and propane consumption looks suspiciously like a statistical aberration or the result of exporting rather than a genuine improvement in demand, although it is too early to say for certain.

The market has been waiting for signs of a pick up in transport- related distillate demand. But increased rail freight and trucking activity could not account for such a big increase in so short space of time. The absence of a rise in gasoline consumption makes it clear demand strength is not being fuelled by a driving season come early.

Given continuing slackness evident in the U.S. supplydemand balance, and ample inventories, the pull back in nearby prices from the mid-$80s to $70-75 looks justified on fundamentals alone, without having to blame negative sentiment from other financial markets.

Ends --

By John Kemp, Reuters market analyst - for Commodities Now

The views expressed are his own. Download charts here:

Attachments:

US-STOCK-RATIO1.pdf	26 Kb
US-STOCK-RATIO2.pdf	11 Kb