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Low Oil Inventories in U.S. Signal High Prices May Stay a While

THE WALL STREET JOURNAL: Low Oil Inventories in U.S. Signal High Prices May Stay a While

“Royal Dutch/Shell Group, the largest operator in Nigeria, has withdrawn nonessential personnel from Nigeria’s southern petroleum regions. Nigeria produces about 2.4 million barrels a day of highly desirable, light, low-sulfur oil.”

By BHUSHAN BAHREE

Staff Reporter of THE WALL STREET JOURNAL

September 28, 2004; Page A1

As oil prices headed toward $50 a barrel Monday, one of the world’s most important fuel gauges — U.S. commercial inventories of crude oil — signaled that the surge in prices may well continue.

Inventories in the U.S. have plunged substantially below last year’s level, confounding predictions by many analysts that stocks were building.

That may portend bigger jumps in the price as the Northern Hemisphere approaches winter, the season of peak oil use due to consumption of heating oil. To rebuild stocks and keep refineries humming, the actual users of oil — rather than speculators — are likely to snap up petroleum, keeping up the pressure on prices.

The decline in American inventories is roiling markets because the U.S., as the world’s largest oil user by far, is the main setter of world prices. The fall in stockpiles was exacerbated by Hurricane Ivan’s hammering of key producing and transport facilities in the oil-rich Gulf of Mexico. Oil output in the U.S. gulf is still running about 25% below normal, robbing U.S. refiners of needed supplies and prompting the Bush administration to make some emergency loans to buyers from the U.S. government’s Strategic Petroleum Reserve. The government is considering making more such loans.

Oil inventories typically peak ahead of the Northern Hemisphere winter and are drawn down to meet high demand during the cold season, leaving stocks depleted by February, when the cycle begins again to meet high gasoline demand in the summer months. In recent weeks, however, U.S. inventories have been falling. Last week they fell to 269.5 million barrels, or about 17 days of refinery demand. The industry considers 270 million barrels to be the rough minimum needed to keep the oil-supply chain operating smoothly.

Worries over the tight inventories and fresh signs of trouble in oil-exporting countries prompted traders to bid up U.S. oil prices to just below the $50-a-barrel level Monday. Light, sweet crude for November delivery hit a new high of $49.75 a barrel on the New York Mercantile Exchange before giving up some of its gains. It settled at $49.64 a barrel, 1.6% above Friday’s settlement price of $48.88.

The inventory pinch comes at a time when the world’s oil producers, including members of the Organization of Petroleum Exporting Countries, have little or no effective capacity to produce more oil. Oil markets also have been fretting about instability in the Middle East, the world’s largest oil region, and the threat of a disruption to exports from OAO Yukos, which produces about 2% of the world’s oil and which is locked in a long-running tax dispute with the Russian government.

On Monday, spreading unrest in Nigeria, another major oil producer, also sent ripples through the markets. The leader of the rebel group fighting Nigerian government troops in the oil-rich Niger delta said the rebels will launch “all-out war on the Nigerian state” from Oct. 1 and advised all oil companies to shut production by then, according to Reuters. It isn’t known whether the rebels have the power to disrupt oil production.

Royal Dutch/Shell Group, the largest operator in Nigeria, has withdrawn nonessential personnel from Nigeria’s southern petroleum regions. Nigeria produces about 2.4 million barrels a day of highly desirable, light, low-sulfur oil.

The world’s refining system, which converts crude oil into usable products such as gasoline, diesel fuel and heating oil, is operating at close to its maximum capacity and can’t make up for losses in the supply chain. And broader inventory data in the world’s other major consuming areas, such as Western Europe, aren’t comforting. Earlier this month, the Paris-based International Energy Agency reported that inventories of crude oil held by the European industry fell in July, the latest period for which data are available.

“We’ve never seen such low inventories and such low [spare production] capacity,” says John Cook, director of the petroleum division at the Energy Information Administration of the U.S. Department of Energy. “If I were a trader, I’d be very hawkish, very bullish” on oil prices.

The closest parallel that Mr. Cook has found dates back to October 1990, after Iraq invaded Kuwait and the oil output from both countries was disrupted. But Saudi Arabia and others had the ability then to sharply increase their production by millions of barrels a day, which they did. The cushion today — the number of barrels above current output that can be produced daily at short notice — is estimated at one million barrels or less. And the tally of crude-oil inventories in North America, Western Europe, Japan and other industrial countries at that time was about 20% greater — about 61 days’ worth then, compared with 51 days today.

Oil prices in October 1990 rose to about $57 a barrel in today’s terms, according to Mr. Cook. He says he has begun researching as far back as 1973 — the first oil shock — to seek closer parallels to today’s situation.

U.S. inventories of crude oil had already been falling when Hurricane Ivan hit. By last Friday, according to PFC Energy, a Washington-based consulting company, 10 million barrels of production had been lost in the Gulf of Mexico, with an additional 471,000 barrels a day remaining closed down. Total output from the Gulf of Mexico is usually around 1.6 million barrels a day of mainly sweet, or low-sulfur, oil.

Supply is particularly tight for the light, low-sulfur crude oils that the industry needs for its refineries, especially to make gasoline. That crunch has prompted the U.S. Energy Department to dip into its strategic reserves for the first time since Hurricane Lilli caused a similar drop in inventories in 2002. The department on Friday announced the loan of small quantities of oil for short periods to Shell and another refiner desperate for supplies.

The refining system’s capacity for handling high-sulfur oil is already about fully engaged. Middle East exporters such as Saudi Arabia largely produce high-sulfur crude, and their oil is attracting relatively little buying interest, even though they are offering larger-than-usual discounts compared with low-sulfur crudes. Those discounts are now as much as $10 a barrel for Dubai benchmark crude versus the European Brent benchmark, for instance, up from an average of just under $2 a barrel in 2003.

All that means that the world’s only big supplier of oil with additional pumping capacity, Saudi Arabia, has limited power to moderate oil-price increases.

Experts say it is likely the industry can get by with inventories below the 270-million-barrel level, in part because of efficiency gains by refiners. Lawrence Eagles, an analyst at the IEA, figures that the decline in U.S. inventories to below 270 million barrels is a temporary blip, as it proved to be in 2002, and that the industry “is comfortably prepared to meet winter demand.” Yet Mr. Eagles notes that world demand for oil is running at a much higher rate at a time of capacity constraints.

That is leading to higher prices, because oil markets typically price in the increased risk posed by supply disruptions when inventories, a major cushion against shocks, are slimmer than usual, and there is no let-up in demand.

“Oil is a necessity — you have to buy it,” says Lawrence Goldstein, president of New York-based Petroleum Industry Research Foundation. For gasoline, he says, “you need at least a 10% change in the price to clear a 1% imbalance” in supply. In short, prices would have to rise sharply to curtail demand.

Write to Bhushan Bahree at [email protected]

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