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Oil Prices Likely to Recede by Year’s End

July 29th, 2009 Michael McDonough

Oil prices are likely to continue facing downward pressure as the year progresses, stemming from an oversupply amid weak demand.  The downward pressure placed on oil prices will probably be exacerbated later this year due to seasonal factors, which include the end of the summer driving season.

First off, I would like to point out that despite a significant decrease in demand for oil products US crude oil production has actually continued to rise (see chart).

Oil pro vs conSource: EIA

This probably implies that the excess supply is being stored in inventories, which in fact have been rising quite substantially (see chart).

InventoriesSource: EIA

Now here is what’s interesting, despite falling energy demand and growing supply, WTI prices have begun to experience a resurgence over the past several months (see chart).

WTISource: EIA

What does this mean?  It is my belief that oil prices are being bolstered partially by speculators, refiners’ overly optimistic purchases of crude oil stemming from what is typically higher seasonal demand associated with the summer driving season, and a weaker dollar.  But, a weakened labor market has subdued consumers’ willingness to spend, forcing consumers to rethink travel plans, and reduce gas expenditures. Thereby, putting us in the awkward position where we have a growing oil supply, without any offsetting increments in demand. Yet, oil prices have begun to rise.

It is hard for me to make a bullish case for oil in the near-term given the current environment, so I won’t.  Today’s crude inventory levels helped to support this view, it showed a significant and unexpected rise in US crude oil inventory levels and a decline in demand for gas. As the summer driving season winds down, bringing with it even further pullbacks in gasoline purchases,  refiners will likely trim down crude oil procurement.  This should effectively remove an important pillar of support for WTI prices at their current levels.  At the same time, this will likely chase a number of speculators away from the market.

Upside risks to this forecast would include a strong and sudden demand increment by US consumers, or a sudden drop in relatively sticky supply.  Of course capacity and other global factors could come into play for this analysis, but we will save that for another article.

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