Oil & Gasoline Back To Reality

Oil prices fell over US$1 yesterday after the US government reported a high level of domestic petroleum supplies and tensions eased with Iran over its nuclear program. U.S. light crude for October delivery slid US$1.20 to US$71.90 a barrel on the New York Mercantile Exchange. In its weekly inventory report, the Energy Information Administration said crude stocks fell by 600,000 barrels last week. Analysts were looking for a drop of 1.2 million barrels. Gasoline supplies posted a surprise gain of 400,000 barrels, while distillates, used to make heating oil and diesel fuel, swelled by 2.3 million barrels. Analysts were looking for a 1.9 million barrel drop in gasoline supplies and a 600,000 barrel build in distillates. EIA said stocks of crude, gasoline and distillates were all above average for this time of year.

Analysts had factored in a loss of 200,000 barrels a day from the closure of 200,000 barrels a day from BP's giant Prudhoe Bay oil field in Alaska. BP had originally said 400,000 barrels a day, the entire field's capacity and 8 percent of the country's domestic production, would be shut in for months after severe corrosion was found along sections of pipeline. But the company later said half the field could remain open, easing jittery markets.

Also pushing prices down Wednesday was an apparent cooling of tensions between Iran and the West over the country's nuclear program. The Tehran government offered Monday to resume talks about its nuclear program but gave no public indication on whether it would agree to halt uranium enrichment and reprocessing. It was unclear if the gesture by Iran would avoid United Nations sanctions, threatened if the country doesn't halt uranium enrichment by Aug. 31. Western diplomats are still studying the proposal, but the the fact that it wasn't rejected outright has offered hope of a breakthrough. The threat of sanctions against OPEC-member Iran has rattled traders for months, as the country is the world's fifth largest oil producer and sits astride the narrow Strait of Hormuz, through which 25 percent of the world's oil passes. But the likelihood of sanctions actually passing the security council is far from certain, as veto-wielding China and Russia have been cool to the idea.

There are still some upward pressures such as a continued tight supply and demand situation and other geopolitical standoffs, including trouble in Nigeria. On Wednesday, the president of the Petroleum and Natural Gas Senior Staff Association of Nigeria said oil workers' unions might pull all members from the Niger Delta over safety fears following a spate of abductions by militants and a military crackdown. Over half a million barrels of Nigeria's high quality crude remains shut in as militants from poor but oil producing sections of the country fight for a larger share of the nation's oil wealth.

For equity investors, you do not want oil prices to drop dramatically, it would be much better if prices atyed around the US$70 level for another 3-4 months before easing to US$65. Too sharp a drop will create irrational exuberance - pockets of economy and capital spending will arise and create unecessary inflationary spikes, which will lead to the Fed having to raise rates further. Higher rates is a much more potentially damaging thing than oil prices hitting US$90. The firm oil prices have forced consumers to rein in spending, which is largely responsible for the lower housing stats, which in turn allows Fed to pause the rate hike cycle. The underlying US and global economy strong enough already, plus corporate earnings growth are at a good level. Its a balancing act which is tricky in a bullish market.