MARKET WATCH: European Union agreement boosts oil prices

Crude oil and stock prices soared higher in “a monster market bounce” Oct. 27 after European Union leaders agreed to reduce Greece's sovereign debt, support European banks facing additional losses on Greek bonds, and increase the European Financial Stability Facility to €1 trillion.

The Standard & Poor’s 500 Index and the front-month crude futures in the New York market escalated 3% each. “Energy investors cheered,” said analysts in the Houston office of Raymond James & Associates Inc., as the SIG Oil Exploration & Production Index and the Oil Service Index gained 7% and 6%, respectively.

The only downer, they said, was the front-month natural gas contract dropping 1.8% after the Energy Information Administration reported injection of 92 bcf of gas into US underground storage last week, up from the Wall Street consensus of 87 bcf.

In early trading Oct. 28, Raymond James analysts said, “It looks like lower than expected Japanese industrial output numbers are sending futures mildly lower.”

In Oct. 27 trading, James Zhang at Standard New York Securities Inc., the Standard Bank Group, said, “Oil products followed crude higher, with gasoline outperforming the rest of the oil complex and refining margins improving on both sides of the Atlantic. Despite the rally in flat prices, Brent structure softened at the front end of the curve on improved supply from Libya and the North Sea.”

Possible problems

Among the general market euphoria, however, Olivier Jakob at Petromatrix in Zug, Switzerland, warned, “One of the key problems in our opinion with the latest European rescue plan is that it is not an ‘EU deal’ but a ‘Chinese deal.’ It will come at a great political cost. We are not sure that it will do much for European consumer confidence and is for us a sign of total failure of Europe. Athens has its fate in the hands of Brussels [EU headquarters], and now Brussels has its fate in the hands of Beijing.”

Indeed, Chinese and European officials are playing down expectations for near-term investment by China in the Euro-zone. China’s vice finance minister said his country won’t act until details of the EU agreement are clear in late November or December.

The European Commission previously acknowledged China’s emergence as an economic power and the biggest exporter in the global economy “is the single most important challenge for EU trade policy.” China is the EU's second largest trading partner behind the US and the EU's biggest source of imports “by far.” The EU also is China's biggest trading partner.

The EU is expected to push China to commit to appreciation of the yuan at the Group of 20 (G-20) summit meeting Nov. 3-4 in Cannes, France. The EU also is likely to push the US to reduce its budget deficits and to support European efforts to manage the sovereign-debt crisis.

Jakob said, “Economic growth in the Euro-zone will remain problematic, and the region is certainly not out of the deadly mix of high unemployment and high commodity costs.”

He said most investment banks expect the US Federal Reserve Bank to launch its third economic stimulus program in early 2012. “While it might come at a cost for the US consumer, it is also true that in the current economic wars both China and Europe might be more at risk to the high commodity prices than the US. Meanwhile, Europe will have to struggle with growing economic and social imbalances between the northern and the southern countries,” Jakob said.

Backwardation

The shift of US benchmark crude prices into backwardation in the futures market (with monthly contracts priced sequentially lower than the previous contract into 2014 and beyond) attracted much attention this week. “It will be interesting to see if next week the focus starts to shift to the weakening backwardation in Brent,” said Jakob. “The West Texas Intermediate December-January split has tightened by 21¢/bbl this week, but the Brent December-January spread has weakened by 34¢/bbl, and the weakening trend is not stopping for now as the higher output from Libya and Buzzard [oil field in the North Sea] is starting to work through the supply chains. One thing that we have noticed is that a few New York-based investment banks have been downplaying the comeback of Libya on the oil markets, and that might leave some investors a bit behind the curve on the progress being made in Libya.”

Adam Sieminski, chief energy economist, Deutsche Bank AG, Washington, DC, said, “The shift in the WTI forward curve into backwardation illustrates that physical fundamentals in crude oil have not been polluted by the financial shocks that have driven industrial metal prices lower in the past few months.”

While the speed of that shift was accelerated by short-covering and technical factors, he said, “Fundamental catalysts played an important role. The incentive of stellar margins led to higher refinery runs, and producers worked to overcome logistical hurdles to curb delivery to the Midwest. This has helped to bring down high Midwest and Cushing, Okla., crude oil inventories.”

The price ratio between Light Louisiana Sweet crude and US natural gas has moved to a recent high. “Without a strong pick-up in gas use, any tempering in this ratio is dependent on an equally elusive drop in global oil prices,” Sieminski said. In the European market, he said, “The recent announced off-take agreement for US LNG exports raises the odds that such projects will eventually go forward.”

Energy prices

The December contract for benchmark US light, sweet crudes climbed as high as $94.25/bbl in intraday trading Oct. 27 before closing at $93.96/bbl, up $3.76 for the day on the New York Mercantile Exchange. The January contract jumped $3.64 to $93.82/bbl. On the US spot market, WTI at Cushing mimicked the front-month futures price, up $3.76 to $93.96/bbl.

Heating oil for November delivery rose 8.26¢ to $3.10/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month escalated 9.04¢ to $2.74/gal.

The November natural gas contract, however, fell 6.6¢ to $3.52/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., was down 5.9¢ to $3.60/MMbtu.

In London, the December IPE contract for North Sea Brent gained $3.17 to $112.08/bbl. Gas oil for November jumped by $15.75 to $969.75/tonne.

The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes was up 26¢ to $109.09/bbl.

Contact Sam Fletcher at [email protected].