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We are short term bearish crude oil prices but bullish on where they might be toward the end of 2009. In the short term, slackening seasonal refinery demand will probably result in another expansion of the annual US crude stocks surplus at the EIA. Historically, refiners gear down refinery activity under the guise of slack seasonal product demand and because of a rotation from summer to winter fuel needs. This year it would appear that an already low US refinery operating rate is set to become even lower in the weeks ahead. If the US refinery rate does fall markedly in the coming weeks, it could put as much as 20% of US energy refinery capacity “on idle.” While we think that much of the impetus behind the operating slide will be seasonal in nature, the significant cushion of distillate fuel and crude oil stocks crude slow the output rate even more. US distillate stocks recently were sitting as many as 40 million barrels above year ago levels, and crude oil stocks were seeing a year-over-year surplus of 32 million barrels, which would seem to suggest that the energy markets are facing a burdensome supply situation ahead.
Another important factor determining where the refinery operating rate might be headed is the profitability of the refinery effort (or the crack margin). A look at the general profitability of refinery products suggests that while the incentive to refine oil into products might be markedly improved from the low levels that were seen at the beginning of this year, comparative returns are still well below what they were a year ago. We suspect that product prices will have to fall (which might result in the crack margin falling back below $10 per barrel) before supplies are cleaned up and the refiners have the incentive to expand output.
As it stands now the “reformers” and the media have little to no interest in investigating the prospect that managed profit margins in the US refinery industry is periodically sparking sharp run-ups in energy prices. Therefore, expect the US refinery rate to fall more than normal, which in turn should set the table for a mid-winter product shortage in the face of the anticipated colder than normal winter ahead.
While we doubt that November crude oil prices will see a full return back below the seemingly important pivot price zone on the charts around $62.50, we suspect that the crude oil market will have the capacity to fall below the $66.00 level in the aftermath of sagging seasonal demand and especially in the wake of the next US monthly unemployment report. With the cushion of supply in the energy sector considered particularly burdensome this year, it is possible that many refiners will be forced to aggressively reduce product supplies. That could initially pump up the amount of excess crude oil supply and should in turn drive down crude oil prices.
While we are decidedly bearish toward crude in the weeks ahead, a significant slide in the US Dollar, evidence of an unfolding US recovery and a colder than normal winter could see December crude oil back above $77.00 before the end of the year.
