Energy price outlook: Break from summer heat?

by Josh Sosland
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Reeling from the pressure of ingredient prices surging to levels not experienced in a generation, food processing executives may actually find a dose of good news in a review of the energy markets.

While prognostications of higher energy prices abound, fundamentals do not support such an outlook, said Amanda G. Kurzendoerfer, a commodity analyst with Summit Energy Services, Louisville, Ky.

"A lot of people proclaim doom and gloom for oil, but we don’t see it that way," Ms. Kurzendoerfer said. "Similarly, even for natural gas, the only problem in that segment you could see would be from a storm, and forecasts for the hurricane season have been moderating. That said, Hurricane Dean has just formed in the Atlantic."

Other analysis warns that markets remain vulnerable to any kind of disruption with stocks projected to remain reasonably tight.

While agreeing that the potential for market disruptions remains present, the downside potential for crude oil prices is considerable, Ms. Kurzendoerfer said, noting that prices recently reached a new all-time high of $78.70 per barrel (U.S. West Texas intermediate).

The road leading to the record for crude oil was somewhat confounding, since it appeared to be driven, in part, by weakening oil demand from refineries.

"Over the summer we had a large number of refineries taking downtime for maintenance," Ms. Kurzendoerfer said. "Much of the downtime was due to the aging infrastructure and could be described as an industry-wide epidemic not owing to anything specific. So, refinery utilization rates fell, bringing down gasoline stocks to record low levels. That put upward pressure on the underlying crude oil market. That aspect is counter-intuitive since the refineries were buying less oil, but when utilization rates are low, the market focuses on the future, expecting demand will increase at some point. It’s recognition of the pent-up demand that is building."

Capacity utilization rates improved more recently as maintenance projects wrapped up, hitting levels in line with the five-year averages for utilization, Ms. Kurzendoerfer said. While this development had been well anticipated, including a concomitant decline in crude oil stocks, oil prices still showed strength.

"This market tends to look for anything bullish, so even though they knew it was coming, the decline in stocks has contributed to additional upward pressure in the crude oil market," she said. "We recently reached a new high of $78.70 a barrel, up from $65.08 on June 1."

The $78.70 price eclipsed the $77.95 per barrel peak reached last year during the Israel-Hezbollah war in Lebanon, amid uncertainty over whether the conflict would result in a disruption of Mideast oil supplies.

"That was psychologically driven," Ms. Kurzendoerfer said. "This year’s is a little more fundamentally driven but is still overdone, we would argue.

"One of the other things that has helped drive the price upward recently was a major influx of speculative money. Some of that was prompted by an International Energy Agency statement that OPEC (the Organization of the Petroleum Exporting Countries) needs to increase production or we are going to draw down stocks in a big way."

The statement attracted strong speculative interest, building a record net long speculative position in crude oil futures, she said. This development could pave the way for a price break, she said, noting that prices already have declined from the upper $70s to a recent close around $72.

"Any bearish piece of news that could send the price lower, and there is a potential for the bottom to fall out of this," Ms. Kurzendoerfer said. "We’ve seen a little of that because of the sub-prime crisis. The thinking there is the weaker financial markets could lead to weaker economic growth, which leads to weaker demand for oil.

"Markets are vulnerable. I believe the market is overvalued. There is speculation that stocks need to be tapped later in the year, but even if so, stocks are above the five-year average, so that should be a cushion. Plus, we think that with prices at these levels, OPEC is going to be incentivized to increase production."

Leaving markets somewhat less vulnerable to upward shocks has been a gradual increase in the spare production capacity of OPEC. With production cutbacks, spare capacity has been estimated at 3 million barrels per day, up from less than 2 million in the past two years.

"Stock levels are still high," Ms. Kurzendoerfer said. "OPEC is incentivized to increase production. They already are overproducing but not at the historical level at which they overproduce."

While she expects a further break in crude oil prices, Ms. Kurzendoerfer is conservative in projecting a likely price range for the months ahead.

"I expect prices to fall to the mid-$60s, probably not lower," she said.

The cautiousness is underpinned by a tightening in recent weeks in world oil supply/demand projections. This tightening, which contributed to the price rally, reflected cutbacks in project world oil production and a larger projected Organization for Economic Cooperation and Development stock draw in the second half of 2007, according to the Energy Information Administration of the U.S. Department of Energy.

"This situation contrasts with conditions last year, when prices weakened in the second half due to slow consumption growth, rising global inventories, and the absence of hurricane-related oil supply losses," the E.I.A. said.

For 2008, the E.I.A. projected tightness, with higher consumption growth than in 2007, moderate growth in non-OPEC supply, increased demand for OPEC oil, and limited surplus production capacity, held mostly in Saudi Arabia.  

Looking further forward, the E.I.A. said, "These tight conditions leave the market vulnerable to unexpected supply disruptions, especially as oil inventories are reduced over the coming months."

Turning to natural gas, the effects of diminished tightness in the supply-demand picture has resulted in weakening prices, Ms. Kurzendoerfer said. More recently, though, prices have rallied.

While prices dipped beneath $6 (per million British thermal units) recently, the market has strengthened in recent weeks, returning above the $7 mark.

"The storage position was very favorable compared to last year," Ms. Kurzendoerfer said, explaining the weakness. "As we moved through the summer, injections (increases in underground natural gas storage) were larger. It looks as though we will go into the winter in a strong storage position."

Ms. Kurzendoerfer was wary of making price projections as the hurricane season gains momentum. The E.I.A. was similarly guarded.

"Current price projections remain vulnerable to potential storm-induced supply disruptions during that period," the agency said. "Taking into account E.I.A.’s current assumption about hurricanes, the Henry Hub spot price is expected to average $6.66 per mcf in the third quarter and $7.96 per mcf in the fourth quarter. For the year, the Henry Hub spot price is expected to average about $7.45 per mcf in 2007 and $8.06 per mcf in 2008."

This article can also be found in the digital edition of Food Business News, August 21, 2007, starting on Page 23. Click here to search that archive.

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