Peak Oil Passnotes: Supply 'Cushionitis'

By Edward Tapamor
18 Aug 2006 at 11:49 AM EDT

PARIS (ResourceInvestor.com) -- You have seen what Resource Investor was mooting about the oil market last week, basically come true. Oil has actually fallen a little faster than we expected - to around $71 - but it still has an important couple of barriers to break before it goes really wild to the downside. So let us take a little look at some recent history and see if we can figure out why.

On April 21st the Nymex WTI price reached $75.17 on the back of worries over Iran and general supply tightness. By June the Nymex WTI was at $69 before it set off on its latest run. In other words it had hit a strong high before falling back. It then surged back once more to hit $78.40 on July 14th before dropping off once again. Then we reached an odd moment a few days ago, on August 7th when some genuine myopic hysteria set in around the crude markets.

Brent crude had broken up past the WTI by August 7th as supplies of Brent became constrained by declines and increasing seasonal demand, pushing up past its historically higher-priced relative. The price was spurred by a number of reasons, not of which were crystal clear. One being the Israeli attack on Lebanon, others being the problems in Nigeria and the first signs of the difficulties for BP [NYSE:BP; LSE:BP] at Prudhoe Bay.

At the time we pointed out that although significant these events were underpinned by the - now seemingly age old - supply cushion absence. As there was no supply cushion the market had driven itself into hysteria. The Prudhoe Bay outage was not that significant although it was not helpful. Lebanon did not produce oil even though indirectly the invasion was about energy being a proxy war between the U.S. and Iran. Nigeria was going on the same as it has been in recent months.

Brent boomed up to an all time record of $78.64 intraday and $78.30 at the close with the WTI chipping in at a healthy $77.05 at the end of trading.

Now just 10 days or so later Nigeria actually seems to have got worse, armed men stormed a bar in Port Harcourt (who calls a bar Goodfellas in a place like that?) although the short-term outage at Nembe Creek of around 180,000 barrels per day has been restored. Meanwhile the Lebanon situation is still not really impacting oil and its supply. BP on the other hand has managed to keep somewhere around half of its Prudhoe Bay output online, even so you will note that is a loss of some 200,000 barrels per day. A loss is after all a loss.

Yet we are seeing the WTI hit exactly $70 intraday, some seven dollars off its high in around eight days active trading. Brent is around $72. A big, big move to the downside.

There is one other reason, Goldman Sachs. They are not excited about the new gasoline contract for - cough - reformulated gasoline blendstock for oxygenate blending or RBOB. New regulations in the U.S. have meant that RBOB is replacing methyl tertiary butyl ether (MTBE) in gasoline. Sachs are not about to risk a load of cash on this new contract so they have simply stopped playing.

The result of such a big player leaving the table is that there is no liquidity - or relatively little - in the gasoline market. This has pulled down the price of gasoline which has impacted on the price of crude. So the combination of events, Lebanon ceasefire, Prudhoe Bay, staying half-online, Nembe Creek being repaired and RBOB illiquidity have stuck a knife in the gut of the oil price. Then we hear stuff like this.

"Some of the factors and disruptions that helped drive us to very high levels have been resolved now," according to a statement by from Eoin O'Callaghan at the French bank BNP Paribas.

No they have not.

Lebanon is not resolved, Nigeria is not resolved, Prudhoe Bay and BP's general behaviour is not resolved, Iran is still awaiting the outcome of its nuclear enrichment programme and demand is still healthy. What has happened is the market has seen a great time to take a big chunk of profits. A breather. That is all.

If we were smart guys we would open a book on the first "Oil Makes Dramatic Surge" headline. No doubt you will see it in the next sixty days. We will be told all the stories about collapse, markets imploding, frenetic activity on the trading floor and `peak oil freaks' will be telling us to ride Oxen to work. Then we will do the same dance all over again. Isn't energy great?