20-06-2016

‘Undertow’ could drag oil back below $40 a barrel

oil

Oil futures could fall back below $40 a barrel this year, pulling retail gasoline prices significantly lower with them, an analyst says, but the reasons may surprise you.

West Texas Intermediate and Brent crude futures lost more than 2% in the latest week and both are poised for their first monthly decline in five months. On Friday, WTI settled at $47.98 a barrel, while Brent finished at $49.17 a barrel.

Analysts have attributed recent weakness to the U.K. referendum next week on whether to stay in the European Union, changing expectations about U.S. Federal Reserve monetary policy and the economic impact and potential slowdown in energy demand that may ensue.

But those factors offer “excuses” rather than reasons for oil’s recent price retreat, Tom Kloza, global head of energy analysis at the Oil Price Information Service, told MarketWatch.

Instead, an “undertow” in the market linked to refiners’ demand for crude is to blame, he said.

“There really is no precedent for transitioning from a glut of crude to a more balanced supply picture without creating at least a temporary glut of [crude] product,” said Kloza. In the U.S., the Energy Information Administration characterizes motor gasoline and distillate-fuel supplies as being “well above the upper limit of the average range” for this time of year.

“Gasoline and diesel prices are depressed in most of the global markets right now and gasoline…is priced at numbers that represent red ink for refiners in the fourth quarter,” Kloza said. And if refiners are losing money on manufacturing gasoline, “they cut runs, plain and simple.” Refinery crude runs offer a measure of refiners’ demand for crude.

If refiners sell gasoline at the Gulf Coast in December for a price of about $1.21 a gallon, or $50.82 a barrel, for example, that would be well below refiners’ break-even number of about $59.75, he said.

Refiners will cut production when high production results in a loss, said Kloza. Given that, he said he wouldn’t be surprised to see October to November crude-oil runs “that are 1.5 million barrels per day lower than they are at the summer peak.”

“Run cuts this year would be disastrous for crude,” and those run cuts are likely to materialize in the last 100 days of the year, he said. “The less crude that is processed, the more pressure the ‘undertow’ puts on the crude-oil market.”

Emphasizing that he doesn’t own or trade oil futures or oil stocks, he said he expects WTI oil prices to trade between $45 a barrel and, possibly, the low $50s, with a possibility of autumn number retesting $40 a barrel. “Lower for longer is an accurate forecast,” Kloza said.

Read: Man who nailed 2015 oil plunge is predicting a dismal 2016

While the crude-oil market has seen nearly 4 million barrels a day of lost production “thanks to new and old problems” in Libya, Ngeria, Kurdistan, Sudan and Canada, restarts of some of this output “could thwart crude-oil rallies,” he said.

Macroeconomic risk is also to the downside, with the “notion of a slowdown, let alone a recession in the U.S., Europe, or in various Asian or South American countries has to be considered,” he said.

Oil prices will “eventually clean up,” said Kloza, but “I don’t think it happens this year.”

He won’t rule out the potential for sub-$40 a barrel crude prices this year—and a return to $2-a-gallon or less is a possible standard retail price for gasoline in many states later this year.

Source: MarketWatch

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