Over the last four weeks, prices for benchmark WTI crude oil have exhibited extreme volatility. On 31 July, the price of WTI surged to a record high of $78.16/b on news that US crude oil stocks had plunged 6.5 mb/d in the week ending 27 July, with inventories in Cushing declining for the 10th consecutive week. This was $1.20/b over the previous record set in August 2006. Over the same period, non-commercial net long positions on the Nymex crude market rose to a record high, while open interest broke above the 1.5 million mark to stand nearly 500,000 lots higher than the same period last year.
Then, in early August, WTI prices plunged almost 9% or $7/b. The fall was attributed to concerns about a possible slowdown in the US economy in the second half of 2007 following data showing a lower-than-expected expansion in the services sector — which constitutes about 80% of the economy — as well as a slowdown in job creation which pushed the unemployment rate slightly higher in July. The downtrend was furthered by the increasing fallout from the troubled US subprime housing sector which resulted in a correction in the financial markets in the US, Europe and Asia. Over the same period, speculators on the Nymex crude oil market trimmed net long positions while open interest volume also declined.
The easing situation in the downstream has also helped to moderate prices. Refinery utilization rates in the US rose to 93.7% in the week ending 27 July, the highest level in more than a year which helped build gasoline and distillate inventories. Indeed, the increase over the last few weeks has brought gasoline stocks up to just below the five-year average. Distillate stocks now stand at the middle of the range, while heating oil has improved but remains 15 mb below five-year range. With the approaching end of the US driving season, product developments no longer appear to be driving the market and the bearish sentiment has been reflected in the futures markets where open interest in both the gasoline (RBOB) and heating oil contracts has declined.
Another notable development in recent weeks has been the change in the shape of the forward market. For the first time since October 2005, the WTI market shifted into backwardation. With prompt prices higher than those further out, there is a reduced incentive to hold inventories and therefore the potential for a decline in crude stocks in the weeks ahead. However, the new market structure for WTI may prove to be a temporary phenomenon — as was the case for Brent, which briefly moved into backwardation before falling back into contango. Either way, with OECD total crude oil stocks at close to decade-highs and US inventories at particularly comfortable levels, crude oil stocks appear sufficient to meet the forecast demand levels and still remain above the middle of the five-year range.
There is no doubt that the above uncertainties have clouded the outlook for oil demand. The more bearish economic trend which has materialized in recent weeks could negatively impact demand growth in the second half of the year. Meanwhile, declining refinery margins—which have fallen by $10/b over the last few weeks — along with the end of the driving season and the start of autumn refinery maintenance in the Atlantic Basin in September may reduce the incentive to keep throughputs high, weakening demand for crude oil. Additionally, if the current shape of the WTI market were to persist, this may encourage stock withdrawals. As a result, careful monitoring of how these developments unfold will be necessary to determine the real market needs for the coming months.