March 10, 2004
Do the financial markets
reflect economic conditions, or do they cause them?
That question again is being raised as oil prices and inventories both
rise sharply as the heating season is in its final weeks.
Last year, when oil prices
exceeded $55 per barrel, open energy contracts on the major commodity exchanges
also spiked to more than 85,000. That
both collapsed soon after suggests that more speculation than reality was
contained in that price spike.
As oil prices again climbed
past the $50 barrier last week, open contracts took a one week jump of 22,548 to
reach 54,176. Certainly, the
contract purchases, mainly from hedge funds, did not restrain the oil price
rise, but were they the primary reason why prices rose?
Every Wednesday, the energy
department releases a publication on oil markets showing price patterns and
inventories in the U.S. The recent and continuing cold weather not surprisingly
is drawing down heat fuel stocks. They
are below last yearís levels and fell 1.8 million barrels last week.
Moreover, Europe is suffering a
very significant cold spell. This
means that their refining capacity is fully employed to provide heating fuel for
their citizens. Normally, Europe
has excess refining capacity in the winter that can be used to meet heating
shortfalls in the U.S. Not this
Historically, another month of
heating fuel inventory reductions occur before the driving season causes
gasoline to become a greater concern for refiners.
There is no question that stocks of heating fuel are low around the
world. In the U.S., they barely are
in their ten year range of holdings for this time of year.
Nevertheless, natural gas
supplies remain ample. At nearly
300 million barrels, U.S. petroleum inventories are near the high end of their
ten year range, and they grew last week.
While refineries were pushing
for heating oil, they had to also produce gasoline.
(The product mix can be altered by refiners, after some significant
adjustments, but more gasoline than heat fuel is produced even when the mix is
for maximum heating fuel.) As a
result, gasoline stockpiles are 22 million barrels above last year and well
above stocks held at this time of year in normal times.
Indeed, gasoline inventories are near a record about two months before
the driving season begins.
Yet, buying pressure on
gasoline contracts have been driving up oil prices.
The latest worry is not the heating season (although this winter is
hanging around longer than we would like).
Nor is it the continuing decline in fuel economy as SUVs supplant
passenger cars on our highways. No
one seriously believes that Russia can produce a million barrels per day of oil
more than a year ago, as they claim. But
the million barrel expansion in capacity by OPEC probably will happen.
Chinaís demand continues to
surge, but needs should be for an additional half million barrels per day, not
the million daily increase of a year ago. Europe
already is showing slower growth and the world economy probably will grow nearly
a percentage point slower with less energy needs per percentage point of growth
than a year ago.
And, if everything breaks
right, we might even have more energy production supplied by the U.S. and Iraq.
So, why are oil prices rising,
except for the speculation?
The speculatorís answer is
refining capacity. Refineries are
not clean industries. No new
refinery complex has been built in the U.S. in the past 25 years.
When refineries shut down for maintenance prior to making the adjustments
from heating maximization to massive gasoline production, problems sometimes
develop. An Indiana refinery caught
fire last week, and more of these kinds of stories will surface in the next
month. A refinery in Houston
currently is completely shut down (that Indiana refinery was operational even
before the fire hoses were repacked).
Now, you do not need to build a
new complex to get more production out of refineries.
In the past three quarters, production in the U.S. petroleum and coal
sector expanded 4 percent. While
capacity utilization rose to 91.9 percent, well above historical norms, capacity
did expand near the 1.2 percent average of all capacity growth for all industry.
Nevertheless, the growth of
utilization indicates that little margin exists to absorb operational shutdowns,
fires or even shutdowns to change mix to comply with environmental protection
agency clean air requirements by locality.
Just as speculators last year
bet that the absence of crude oil production capacity would lead to some price
increasing conditions, they are betting today that high refinery utilization in
old facilities will lead to price surging disruptions.