Big users bet on more oil price falls

Posted on June 25, 2012

Oil Refinery...Refining towers are seen at the Zawiya oil refinery near Tripoli, Libya

Airlines, trucking companies and other big energy consumers are betting on further oil price falls, with many reluctant to lock in at current levels amid fears prices could plunge if the global economy weakens further.

Consumers are largely on the sidelines of the oil market in spite of a 30 per cent drop in price, from $125 in March to $90 now, commodities bankers said. The price of Brent crude hit an 18-month low last week.

    Oil consumers fear the current slide in prices – largely due to slower economic growth in China, the main engine of oil demand, and the eurozone sovereign debt crisis – is only the beginning of a major sell-off. Saudi Arabia has this year boosted production to a 30-year high, further subduing prices.

    “If the global economy continues to deteriorate, I will not be surprised if we see more downward pressure on oil prices,” Fatih Birol, chief economist at the International Energy Agency, the oil watchdog, told the Financial Times.

    Consumers’ wait-and-see approach does not bode well for future oil prices as it removes a key source of forward buying, bankers said. It also mimics the behaviour of big consumers in late 2008 at the start of the global financial crisis, when they moved to the sidelines as prices plunged from an all-time high of nearly $150 to a low of $45. It could yet backfire if oil prices rise on the back of the US and EU sanctions on Iran or if Saudi Arabia decides to cut its oil production.

    “So far we have seen light hedging activity,” said a senior New York-based commodities banker, echoing the view of many others in the energy market. “We expect some consumer buying if we [oil prices] go down another $10,” he said.

    Price could hang on Iran’s actions

    Oil prices are on a downward trend, but Iran could still reverse the trajectory, sending prices back to $100 a barrel.

    Iranian oil exports have fallen sharply in June as an imminent insurance ban on tankers carrying the country’s crude puts off buyers. The ban, implemented by the European Union from Sunday, will stop refiners from buying protection and indemnity insurance, known as P&I, in the London insurance market.

    Oil experts believe the ban will cut another 400,000 barrels a day of Iranian sales by July 1, on top of the roughly 600,000 b/d Iran has already lost due to other EU and US sanctions this year.

    Companies keep their hedging plans close to their chests, but anecdotal evidence confirms bankers’ views. Laura Wright, chief financial officer at Southwest Airlines, the largest low-cost carrier in the US, told investors earlier this year that the airline’s hedge protection for the second quarter was “minimal”.

    Lower oil prices could help boost company profitability. The recent drop in prices was already akin to a “tax break to consumers and businesses”, Mr Birol said. “Companies will improve their profitability.”

    Michael Glenn, executive vice-president at FedEx, the US package delivery company and a big fuel consumer for its fleet of trucks and planes, told investors last week that “certainly, lower fuel prices will help”.

    The price of Brent oil has fallen from a peak of roughly $125 a barrel in mid-March to $88.49 a barrel last week, the lowest since December 2010. On Monday in London, Brent crude settled at $91.01 a barrel, down 3 cents.

    Oil prices remain high by historical standards. Brent crude oil has averaged so far this year at $114.2 a barrel, the highest January-to-June average ever, surpassing the averages for the same period in 2008, when prices hit a record high, and in 2011, when the civil war in Libya cut oil supplies significantly.

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