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Must-know: Why oil prices rallied while natural gas prices dropped

Part 2
Must-know: Why oil prices rallied while natural gas prices dropped (Part 2 of 2)

Why inventory figures helped push crude oil prices up

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).

2014.02.28-US Crude InventoriesEnlarge Graph

Crude traded high on the reported inventories data

On February 26, the DOE reported the inventories data for crude for the week ended February 21. Crude oil inventories increased by 0.07 million barrels—much lower than analysts’ expectations of a build of 1.16 million barrels. Generally, a smaller-than-expected build of crude storage raises prices, as it indicates either stronger demand or weaker supply than expected. Plus, oil stocks at Cushing, Oklahoma (where the benchmark of WTI crude oil is priced), declined by 1.08 million barrels last week, as a portion of pipeline has been put into operation to move oil away from Cushing and towards Texas and Gulf Coast refinery markets.

For gasoline, one of the refined products of crude oil, the reported data showed a greater-than-expected fall in inventories. Last week, gasoline inventories decreased by 2.80 million barrels, compared to the market’s expectation of a 0.76 million-barrel drop. Distillate, another refined product of crude oil, however, experienced a greater-than-expected build in inventory on the week. The DOE reported a build of 0.34 million barrels of distillate inventory, compared to analysts’ expectation of a 1.16 million-barrel drop. Generally, a larger-than-expected build or a smaller-than-expected fall in inventories data indicates weaker demand for crude oil, and we can view this as a negative signal for crude prices and vice versa. As a result, last week’s gasoline inventories data were bullish for crude prices, while distillate inventories were bearish for crude prices.

The market weighed more on the bullish signals showed by a smaller-than-expected build in crude inventories and the drawdown of Cushing inventories, so that crude closed at $102.59 per barrel, compared to $101.83 per barrel the previous day.

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’s 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 out again (see WTI-Brent spread fell below $8.00/barrel, the 1st time since October.)

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 more about investing in the upstream oil and gas industry, see the Market Realist series Upstream energy outlook: Oil and natural gas rigs both ticked up.

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