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December 07, 2007

What A Difference A Day Makes

Yesterday around 1 p.m., the EIA released its weekly “This Week in Petroleum” report. As always, the market was poised to jump (or dump) on any deviation from expectations. Depending on who you read, Reuters or the Financial Times, analysts expected distillates inventories (which include heating oil) to drop between 1.3 and 1.4 million barrels and crude oil stocks to drop between 800,000 to 900,000 barrels. Gasoline stocks, on the other hand, were expected to increase, with expectations ranging from 600,000 and 1 million barrels. Well, the analysts got the directions right at least.

Distillates did drop, but only by a measly 100,000 – far off the million-plus barrel drop expected. Crude inventory was closer, but still only fell 400,000 barrels – roughly half of what was projected. Gasoline stocks rose by 1.4 million barrels which means someone was really wrong, and other folks were just kind of wrong.

Why do we care? Because this is more than just a fun exercise in predicting the future. These numbers move the market and after they came out the market responded accordingly, with crude prices falling because these numbers pointed to better supply prospects.

But Oil loves to make everyone hop around like beachgoers running across asphalt parking lots in bare feet.

First, There’s OPEC

OPEC’s December meeting looms near, and rumors (and hopes) are rampant. They won’t raise production. They will raise production. The market reacts like a yo-yo on the tense string of opinion. On Tuesday, oil fell more than 3% on expectations of increased OPEC supply. But OPEC, as usual, ain’t talking. People around the organization are, but it is almost as if rumors are used to test the waters to see how the market will react before an official OPEC decision and announcement is made. Plus, Venezuela is part of OPEC, which ads the crazy-uncle [Chavez] wild card into any rumor. So, basically it is business as usual.

So prices were falling because of positive supply prospects in the form of inventory data, and hope of increased OPEC production – which in turn may have served as a detriment for actually getting said increased production, the logic being “see, prices aren’t too high, there is plenty of supply! We don’t need to pump anymore.”

And Then Some Real News Happened

Wednesday afternoon an explosion occurred at one of Enbridge’s Canadian pipelines, which necessitated closing four active pipelines. Those pipelines supply about a fifth of U.S. oil imports. At first the news was sketchy and it was unknown how many pipelines were involved, how long it would take to open them back up and exactly what it was going to mean for oil supply. Overnight trading saw oil prices jumping more than $4 a barrel, stopping the downward slide oil had been on this week. 

What’s the point? This is normal for oil. When things change in Copper or Wheat, it tends to be from just a handful of common factors: weather, mines, stock reports. But oil is subject to these massive exogenous events. It’s the Achilles’ heel. And knee. And elbow.

Cases In Point

While not an explosion, we’ve seen other pipeline problems. In October, the Russians were playing politics with pipelines, blocking capacity increases because it wanted a bigger part of the revenue pie. It is not the first time Russia has been embroiled in pipeline conflict. In January, an oil pipeline was used as a bargaining tool with Belarus when Russia wanted to increase LNG prices, to which Belarus responded by slapping a surcharge on the oil passing through the pipeline. Russia responded by halting oil transport through the pipeline, saying that Belarus was siphoning oil off as payment. Tit for tat and all of that.

Politics is everywhere in Oil, but nowhere more so than in Venezuela. Back in July, President Hugo Chavez made an oil grab in Venezuela. Chavez took control of the country’s oil assets to further fund his socialist agenda. We’ll see how well that is going after December 2nd’s vote, which includes such items as ending presidential term limits and expanded spending and budget control.

And of course, violence follows the politics. Back in June, we wrote about Royal Dutch Shell cutting its investment in Nigeria due to security problems and civic unrest. No one could blame Shell for wanting out. But here’s the interesting part that was pointed out in this article – Shell is now privately looking to sell its stake in two offshore oil licenses. Here’s the significance:

“Analysts said the decision to divest two of its offshore blocks, which, unlike onshore blocks, are not vulnerable to militant attacks, suggested the company was probably considering a wider disinvestment policy in Nigeria as it looks to focus on other projects round the world.”

While it is not quite a pipeline explosion, this news does bring up supply issues in the long run because one of the two front-runners for the purchase is CNOOC, China’s leading offshore producer. Given China’s appetite for oil, the future could see Nigeria oil heading East instead of West. You can guess what happens to U.S. oil prices if this scenario plays out.

And then there is always Iraq. Along with the multitude of political problems arising from the war, oil production numbers have not risen as expected. Yes, there is oil coming out of Iraq, about 1.5 million barrels per day, but for the country that has the second-largest proven oil reserves in the world, it is a mere fraction of what could be produced. The problems range from sabotage to smuggling to security issues. None of these issues is new – in fact, the market has had the effects of the Iraq war priced into oil for years. Only rumors of new conflicts in the area move the market now.

To make matters worse, we’re headed into an election year. Posturing over the War in Iraq and U.S. Energy Policy are about to get factored in as well. All of these Achilles’ Heels and Knees are, by definition, priced into a barrel of oil at any moment in time. Prudent investors in energy commodities need to remember that actual supply and demand – the number of barrels being delivered to market and needed by customers – is often the least important factor in setting a market price for oil. It’s the perception of the ever-present threats to supply and the unknowable demand curve.

It makes Wheat and Copper seem downright easy. and its sister websites,,,,, and are all owned by John Donovan. There is also a Wikipedia article.

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