Why oil and natural gas prices turned around a bearish spell

Why oil and natural gas prices turned around a bearish spell (Part 1 of 2)

Why crude oil inventory dynamics sent prices up and boosted stocks

Oil inventory figures reflect supply and demand dynamics and affect prices

Every week, the U.S. Department of Energy (or DOE) reports figures on crude inventories, or the amount of crude oil stored in facilities across the U.S. Market participants pay attention to these figures, as they can indicate supply and demand trends. If the increase in crude inventories is more than expected, it implies either greater supply or weaker demand and is bearish for crude oil prices. If the increase in crude inventories is less than expected, it implies either weaker supply or greater demand and is bullish for crude oil prices. Crude oil prices highly affect earnings for major oil producers such as Oasis Petroleum (OAS), Hess Corp. (HES), Chevron (CVX), and Exxon Mobil (XOM).

2014.01.21 - Crude InventoriesEnlarge Graph

Crude inventories dropped more than expected, helping to boost crude oil prices

On January 15, the DOE reported a decrease in crude inventories of 7.66 million barrels, compared to analysts’ expectations of a crude oil inventory draw of 0.67 million barrels. Larger-than-expected decreases in inventories generally drive oil prices higher, as they indicate either more demand or less supply than expected. WTI oil prices finished up on the day, at $94.17 per barrel, compared to the prior day’s close of $92.59 per barrel.

Background: U.S. crude oil production has pushed up inventories over the past few years

From a longer-term perspective, for most of 2013, crude inventories were much higher than they were in the past five years at the same point in the year (though they closed in under comparable 2012 levels at points throughout the year). There has been a surge in U.S. crude oil production over the past several years. Inventories had accrued because much of the excess refinery and takeaway capacity had been soaked up, and it took time and capital for more to come online. This caused the spread between WTI Cushing (the benchmark U.S. crude, which represents light sweet crude priced at the storage hub of Cushing, Oklahoma) and Brent crude (the benchmark international crude, which represents light sweet crude priced in the North Sea) to blow out.

However, over the course of 2013, this closed in considerably, so that the two benchmarks traded almost in line again, as more takeaway capacity from the Cushing hub came online. Recently, however, the spread has widened back out (see Why WTI crude oil is trading ~$15 per barrel below Brent).

This week’s much larger-than-expected draw in U.S. crude oil inventories was a positive short-term indicator for WTI crude prices, driving the crude prices up nearly 2% on the day. WTI price movements and broader oil price movements affect crude oil producers, as higher prices result in higher margins and earnings. Names with portfolios slanted towards oil such as Oasis Petroleum (OAS), Hess Corp. (HES), Chevron Corp. (CVX), and Exxon Mobil (XOM) could see margins squeezed in a lower oil price environment. Also, oil price movements affect energy sector ETFs such as the Energy Select Sector SPDR Fund (XLE), an ETF that includes companies that develop and produce hydrocarbons and the companies that service them.

To learn about why recent oil rig dynamics have also affected prices, see this Market Realist series.

The Realist Discussions

  • Brett Kuntze

    There is still a long held belief that natural gas is competing against coal, but there is a growing competitor. It is firewood. Firewood is much dirtier by far than coal or natural gas. The public continues to ignore this because environmentalists hail firewood as carbon neutral without giving any second thoughts on the health effects associated with firewood smoke. Environmentalists are not to be confused with health experts. Health experts are oddly silent on firewood smoke and related health effects. I am not trying to promote natural gas or coal over firewood, but it is plain common sense to know that we cannot continue to switch to firewood away from natural gas or coal. We will continue to face soaring healthcare costs in form of monthly premiums we will see being deducted from our paychecks or salaries. I am not trying to overplay firewood as a really bad substitute for natural gas or coal simply because I don’t need to.. People knows that but doesn’t care to be bothered with. This is plain dumb energy policy that still allows firewood usage because healthcare costs is clearly connected to the quality of air . We are measuring air quality at wrong locations because daily firewood users are the worst offenders. We need to measure where they burn firewood on a daily basis. We will get completely different if not very alarming results.. Come to think about neighbors who are unfortunate enough to live next door. Same goes for chemical plants and other polluting industries as well. Don’t discount firewood as a harmless pollutant.. Firewood kills!!!!