Why are oil prices falling?

Escrito el 21 enero 2007 por Juan Toro en Financial Markets

Oil markets have had a bumpy road from the start of the year 2007. On the first week of January the WTI (West Texas Intermediate) price dropped over 9 %. This drop in prices has been justified on warmer weather than usual and by some index fund initiated sell offs (one major commodity index seems to have reduced the share of petroleum in its portfolio). This trend has been exacerbated by some so called black box investors. It seems odd that this type of blind investors could have led prices plummeting towards 50 $ the barrel, but more than one source has reported these type of sellers being very active in the first two weeks of the month.

The downward trend took new force when the Department of Energy and the American Petroleum Institute (API) reported level of inventories last Wednesday (17th of January). These two institutions report on a weekly basis the level of inventories and provide a measure of market tightness. The levels o inventories is made out of home oil production, minus intakes from refineries, plus imports. Last week oil inventories have witnessed the higher weekly increase since 2004. Suddenly, oil was not a tight market (one in which demand outstrips supply). Some people believe this is just a seasonal effect than can be explained by spring maintenance turnarounds. Refineries in the US are generally brought down for maintenance in spring, leading to larger inventories. The fact that margins (yields obtained from refineries from purchasing oils and selling refined products) are low has reduced the intakes by refineries and brought forward some maintenance, augmenting the level of oil inventories. But there seems to be an even more appealing argument to this build up in inventories: the large volume of imports into the US. This latter explanation offers the link to a more fundamental question concerning the oil market: are the OPEC (Organization of Petroleum Exporting Countries) production cuts working through their way in the global economy? The OPEC generally faces a downside price risk when trying to balance the oil market with output cuts. This seems to be happening with the oil production cuts agreed by the end of last year. The OPEC itself appears to agree with this. Venezuelan Oil Minister, Rafael Ramirez, declared last week that «the oil market is clearly over-supplied, due to a warm Northern Hemisphere winter so far and other factors, so OPEC must concentrate on compliance with its agreed upon production cuts for now.»

More fundamental news were reported last week. In a report the OPEC reduced its forecast for 2007 world demand. So did the International Energy Agency. In the near front, winter seems to be arriving (a cold snap is predicted in both the US and Europe) and this will probably increase volatility not only in oil, but in other fuels too.


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