The dovish September FOMC statement heightened speculations that the Fed will announce additional monetary easing measures later this year. Provision of extra liquidity to the market is negative for USD. The dollar index dropped below 80 for the first time since March 2010. Weakness in USD drove commodities higher. WTI crude oil rallied, after a week of selloff in the prior week due to earlier than expected resumption of operation in the 6A pipeline, as a lower dollar increased it appeal despite unexpected rise in crude inventory. Precious metals strengthened with gold reaching rising above 1300 for the first time on record while silver outperforming its counterparts. Base metals were generally higher as robust demand from China boosted confidence in the complex's outlook.
Crude oil rallied on Friday as driven by strength in Wall Street. WTI crude oil for November delivery jumped to 76.68, the highest level in more than a week, before settling at 76.49, up +3.84% during the week. Meanwhile, corresponding contract for Brent crude gained +0.84% during the week. WTI-Brent spread widened to 4.9, a level not seen since mid-May, on Wednesday, as crude inventory surprisingly increased despite shutdown of the Enbridge pipeline, before narrowing to 2.4 on Friday.
When sovereign crisis in the Eurozone reached its peak in May/June, rally in the dollar and selloff in growth assets had sent crude oil price to as low as 64.24. As the concerns gradually abated and risk appetite increased slowly, oil buyers became active again and sent prices above 80 in August. Nevertheless, crude oil price has remained within a range of 70 and 80 for most of the time. In fact, we expect the 'range-bound' situation will continue for the rest of the year as we see price below 70 would attract buying, e.g. from the Chinese government as strategic reserves, and trigger 'intervention' by the OPEC while price above 80 is unsustainable giving growing non-OPEC production and ample OPEC spare capacity.
China's strategic petroleum reserve (SPR) plan aims at completing the 3 phases of oil reserve base construction in 15 year (around 2020). While the sky-high oil price in 2008 had discouraged stockpiling, China's oil imports rebounded sharply in March 2009 when oil price stabilized after a sharp selloff. In 2010, China has been importing a large amount of oil and a record high being set in June 2010 (at 22.27M metric tons). We believe part of the oil imports went to the country's national oil reserves and the commercial oil reserves of China National Petroleum Corporation (CNPC) and the Sinopec Group. Now that the country's is in the middle of the 15-year plan and, given the opportunistic nature of the SPR buying, it's likely for the country to accelerate the pace of stockpiling when global oil price fall below 70, the lower boundary of the trading range.
OPEC is in control of the world's 40% oil supply and has proven capability of 'adjusting' oil prices using its output. The cartel appears satisfied with recent price levels and some oil ministers expressed they preferred oil to trade at around 70-80. Saudi Arabia's King Abdullah said that 75 is a level he wants. Therefore, it's reasonable to believe the cartel will do something, i.e. cut production, to defend the floor.
Yet OPEC's supply is a 2-edged sword. While it may cut production so that oil price will not fall to a level that hurts oil investment and national revenues, its abundant spare capacity is limiting the upside of oil price.
According to the September Short-Term Energy Report by the US Energy Department, OPEC's crude oil production will increase +0.3M bpd and 0.5M bpd 2010 and 2011, respectively, with non-crude petroleum liquids expected to increase by 0.6M bpd 2010 and 0.7M bpd in 2011. Spare capacity in the cartel should remain near 5M bpd compared with 4.3M bpd in 2009 and 1.5M bpd in 2008.
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