The sharp rebound in the oil price this year has been inconsistent with underlying inventories and economics, neither of which supports such a strong run in the oil price based on demand fundamentals. This suggests a strong risk that the oil price might fall back, which would drag the oil and gas sector down with it, although to varying degrees. We examine which oil and gas shares are likely to be the most resistant to such a fall in the oil price, and which are most exposed to the downside.
What could move the price up or down?
There is currently a global glut of oil, including an awful lot of it still bobbing around on the seas in disused tankers as producers have looked to sell into higher-priced forward markets rather than at recent weaker spot prices. Research by consultants KBC Market Services shows that while crude oil stocks at sea have gradually declined from a peak of over 100 million barrels in May 2009 to just under 50 million barrels in July, floating stocks of oil products have soared from just 4 million barrels in March 2009 to over 60 million barrels in July.
What could drive oil prices up are supply disruptions, such as political turmoil in a major producing country, or further supply contraction from Opec (which left output unchanged at its September meeting), although in the short term, the supply side doesn't look like being a force in pushing up prices.
We're wallowing in oil
The US refining system is wallowing in oil and oil-related products. US crude inventories have been at 10-year highs nearly all year, reflecting the lack of demand from the refining system. Even more worrying for oil bulls, heating oil inventories also hit 10-year highs in the first half of 2009, but showed absolutely no signs of the expected seasonal drawdown towards the end of the winter.
The significance of this is that refiners generally build inventories from the end of May onwards for the forthcoming winter, as peak refining capacity cannot match peak demand. Inventories should, therefore, reach highs at the beginning of winter and be drawn down over the course of the winter. This year, heating oil inventories are already at peak levels, suggesting that the system is awash with oil, which will result in lower purchases of crude and further downward pressure on prices.
Marking the one-year anniversary of the oil recession, KBC sees "little boost to oil demand in the short term because unemployment continues to rise and we still cannot be sure that the worst of the economic crisis is over". It sees the only justification for the current oil price (Brent) of around $70 a barrel to be a market belief that "global oil demand next near is a rising tide that will float all boats". KBC concludes starkly that: "A break in the current sentiment towards better economic prospects and a postponement of the oil demand pickup could lead to a violent downward correction in oil prices led by the enormous stocks overhang."
Some "not too bad" economic data in recent months has led to talk of global economic growth and seen the oil price rise from a low of $35 a barrel on 24 December 2008 to around $70 a barrel now. Together with the wider recovery in equity markets since their low in early March 2009, this has caused a surge in many oil and gas shares.
However, many strategists believe the recent equity rally is overdue a strong dose of realism and that a sustainable recovery will ultimately adopt a W rather than V shape. A fall back in equity markets would also suggest a reversal for the oil price.
