Tuesday, October 25, 2011

Phil Flynn: The Dead Spread

Trying to explain the impact of the death of Moammar Ghadfi on oil might best be described as what I guess can now be called the "Dead Spread". Oh sure, you used to be able to call it the Brent crude oil West Texas intermediate spread but the way the spread has come in since the death of the murderous dictator, I guess "The Dead Spread" might be entirely appropriate.

The Brent/WTI spread almost became a household word in the conflict between Gaddafi loyalists and the Libyan rebels. Libyan crude is of a very high quality oil that found its nitch in Europe subbing for the production challenged North Sea brent crude. The loss of that crude created a void because European refiners accustomed to a regular flow of light crude failed to have the type of units needed to refine those heavier grades. The loss of that crude caused the Brent/WTI spread to go to a record high. Now coincidentally or not, the spread has come in dramatically since Mr. Gaddafi's demise.

In fact the spread has come in from an all time high of approximately $28.07 to a mere $18.97 as of this writing. With Gaddafi out of the way the hope is that Libyan oil will once again fill that void. Well early on that is even going beyond hope. Yesterday ENI told Dow Jones that the big elephant in the room, or Libya's giant Elephant oil and gas field in Libya, could restart as early as next month and that there was "no big damage". That field accounts for almost 25% of Libya's natural gas output. A resumption of that much oil that soon obviously could ease concerns that it will take "years" to get Libyan oil production back up to normal.

That not to say that there are not some tensions as Dow Jones reports of a strike at Waha Oil Co., Libya's largest oil partnership with foreign companies, is entering its eighth week after a failure to reach an agreement over the dismissal of Gaddafi era managers, staff at the company said. Dow Jones says, "Unrest at Waha, on which U.S. partners Marathon Oil Corp. (MRO), Hess Corp (HES) and ConocoPhillips (COP) have previously declined to comment, is part of broader strife at some oil operations. It underscores the challenges still facing the country's oil industry despite the death of former ruler Moammar Gadhafi last week."

Yet at the same time the WTI has found strength as the US economy looks stronger than Europe and the decline of crude stocks at Cushing, Oklahoma, the delivery point for the Nymex WTI futures. While the world waits for Europe, data seems to suggest that the sparing over Greek haircuts (no, I am not talking about Telly Savalas) and bank rescue funds has zapped the confidence of Europe, increasing the odds of a recession.

It seems that market are also reacting to the spread sending light sweet crude to Europe as opposed to the formally oversupplied US. Gas and Oil Daily says, "Oil stockpiles in Cushing dropped 760,000 barrels to 28.1 million. The Energy Department said last week that Cushing inventories, including floating and fixed tanks, totaled 31.1 million barrels as of October 14th, down 26% from a peak of 41.9 million on April 8th." Bloomberg News says that crude oil inventories in Cushing, Oklahoma, dropped 2.6 percent on Oct. 21 from Oct. 18, according to data compiled by DigitalGlobe Inc.

They say that stockpiles held in floating roof tanks at the hub fell 760,000 barrels to 28.1 million, satellite images taken by the Longmont, Colorado based company show. In other words, the market forces are starting to correct the anomaly between the spread as oil is seeking higher prices. That is reducing Cushing supply and more than likely increasing European supply.

What is also helping is that we are seeing an increase in Nigerian exports as well. Nigeria also has the very desirable light sweet grade of crude oil. Dow Jones says that Nigeria will export 7,950,000-barrel cargos of Bonny Light in December, one more cargo than in November. They report a total of 214,516 barrels a day of QuaIboe crude will be available in December, compared with 157,000 barrels a day in November, the program shows.

This should put more pressure on "The Dead Spread" as well. It also put the WTI market in backwardation for the first time since the financial crisis began. It seems that the market is worried that with all the oil ending up in Europe, supplies may tighten in the US. It is also showing a vote of confidence in the US economic growth outlook or at least a more pessimistic outlook for Europe.

Also with oil on fire yesterday William Dudley of the Fed, fed into the flames talking about QE3D! QE is bullish for oil and with the Dead spread out of whack we could see WTI try to attract supply. While WTI flies gas prices were mute as the Brent crude should help US imports of products. Mr. Dudley is sending a signal to the market that QE is back in play and most likely will be in the form of printing money to buy back mortgage backed securities. Very bullish for WTI oil!

The Energy Information Agency has some good news I suppose. They said that the national average retail price of regular gasoline is down 1.4c to $3.462 a gallon. Yahoo! Now not that I want to ruin that god feeling you had but they also want to remind you that prices are still 64.5c a gallon, or 22.9%, higher than they were a year ago.

Want some news that might warm your heart? Reuters News points out that the average of the first 12 months of New York Mercantile Exchange natural gas futures contracts slid to its lowest in nine years on Monday as growing supplies and moderate weather weighed on the complex. The 12 month futures fell 2.3 cents to settle at $3.923 per million British Thermal Units, the lowest settle since Nov. 15, 2002, when the average closed at $3.926, Reuters data showed. Despite record heat this summer that drove NYMEX front month gas to its 2011 peak near $5, record high gas production, primarily from shale, has been the main factor pressuring price expectations.

Phil Flynn

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