Released on March 19, 2003
(Next Release on March 26, 2003)

As the Hour Draws Near
With the possibility of war with Iraq just days or even hours away, oil markets have ridden a wave of optimism over the last couple of days, as the anticipation of a quick war has led many traders to go “short”, expecting prices to fall following the onset of war. Believing that uncertainty over the war with Iraq and the decrease in Venezuelan exports were the main reasons prices had risen near $40 per barrel, many traders, and some analysts, expect that prices will fall well below $30 per barrel, now that Venezuelan oil exports are reportedly increasing and with the assumption that the war may be over soon with little damage to the infrastructure in Iraq and elsewhere. But even if this happens, which is arguable considering that oil prices rose over $30 per barrel last year prior to the strikes in Venezuela, OPEC remains a critical element to keeping prices below $30 per barrel.

Inevitably, comparisons have been made recently to the first Persian Gulf war back in 1990/91. Although some traders were too young to participate in the market back then, it is not so long ago that the history has been forgotten. Many people remember when the near-month WTI futures contract price fell more than $10 per barrel during the first trading day after commencement of the Allied air war campaign in January 1991. While very few people expect prices to fall that dramatically this time, the market does appear to be expecting a decline, as the near-month WTI futures contract has fallen by nearly $6 per barrel over the last week or so. However, there are a number of differences between now and then.

Of course, the major difference is the level of inventories. Inventories reflect the balance between supply and demand. When supplies are tight, inventories can be drawn down to meet demand, and when supplies are ample, inventories can be built so that they are available when demand picks up. Stock building usually happens in the April through September period globally. Although product demand globally falls in the second quarter, demand for crude oil remains high, as refineries need to run at high enough rates to build up product inventories while crude oil supplies also need to build. For the United States, with its seasonal peak driven by summer gasoline demand, this implies a lot of crude oil imports will be needed over the spring and summer months. And this year, the inventory build will need to be greater than normal as oil inventories are very low across the board, especially here in the United States. For the week ending March 14, U.S. crude oil, gasoline, distillate fuel, residual fuel, and propane inventories are all below the lower end of the normal range for this time of year, with some of these products (notably crude oil and propane) very near the lower operational inventory level.

This is somewhat different than the inventory situation just prior to the start of the air war campaign in January 1991. To illustrate, EIA’s Weekly Petroleum Status Report for the week ending January 11, 1991, shows that since the Iraqi invasion of Kuwait in August 1990, the situation had worsened considerably, particularly for crude oil. U.S. crude oil inventories, which were much higher than normal at the end of July 1990, had fallen to slightly below the lower end of the normal range by January 11, 1991. However, they were still 28 million barrels above what was thought to be the minimum operating inventory level, unlike today, when they are barely above the lower operating inventory level. The comparisons are mixed when looking at the major petroleum products. U.S. gasoline inventories as of the week ending January 11, 1991, were slightly below the lower end of the normal range, similar to the situation that currently exists. But the situation is much worse today than it was back on January 11, 1991 when it comes to distillate fuel, and especially, residual fuel. At that time, U.S. distillate fuel inventories, while low, were still within the normal range, while residual fuel oil inventories were close to the upper end of the normal range.

While efficiency gains since 1991 imply somewhat lower levels of inventory may be sufficient to maintain smooth operations, and perhaps to a greater degree than currently reflected in reduced estimates of minimum operating levels, oil demand has risen enough over the last decade, arguably, to reduce usable forward cover, compared with 1991 levels. What all this means is that inventories now are not as well stocked as they were in January 1991, by any measure, meaning a greater dependence on imported oil to meet demand. This puts the onus on OPEC to maintain supplies at sufficient levels over the next few months, not only to help inventories build at their normal rate, but above and beyond these rates so that inventories can return to more normal levels. Until this happens, there may be sufficient price pressure based on supply/demand fundamentals to support prices near $30 per barrel. Any movement below this price may reflect an expectation of an improving supply/demand picture, but if this improvement doesn’t occur as expected, then prices will rise. With the latest weekly data continuing to show U.S. crude oil imports closer to 8 million barrels per day as opposed to 9 million barrels per day, let alone the expected levels closer to 10 million barrels per day projected for this spring/summer, the next few weeks may be a critical period.

Recently, there have been numerous reports about Saudi Arabia chartering additional tankers to bring oil into the United States in May. This additional oil will be critical, especially if Iraqi oil exports have not resumed at normal rates. (And even if Iraqi oil fields remain undamaged, there is still some uncertainty as to the administrative procedures that will need to be in place before Iraqi oil exports resume at more than 2 million barrels per day.) But where will the oil come from until then? There are reports that Venezuelan oil production has been increasing. But doubt remains as to how fast production will continue to increase and how close to pre-strike levels their production will reach later this year. If Venezuelan oil production fails to increase much from current levels, and Iraqi oil production remains constrained while the administrative procedures are worked out, OPEC will need to maintain its high production levels for several months. Will OPEC continue along this path or will it look to curb production once prices start to fall? The answer to this question will determine how quickly inventories will return to normal levels. While we may just be hours away from the beginning of the end of this chapter on Iraq, we may still be weeks, or even months away from seeing retail prices return to levels consumers are used to paying, thus returning to a sense of “normalcy” in oil markets.

U.S. Retail Gasoline Price Increases Again
The U.S. average retail price for regular gasoline rose last week for the thirteenth time in fourteen weeks, increasing by 1.6 cents per gallon as of March 17 to reach 172.8 cents per gallon, which is 44.0 cents per gallon higher than a year ago. This price is 1.5 cents higher per gallon than the highest price in nominal dollars since EIA began recording this data in August 1990. While the outlook could go either way, strong gasoline demand ahead of the normal seasonal increase, extensive refinery maintenance, and still tight crude oil supply, may be pointing to added price pressure in the months ahead. Also, the effect of the possible war in Iraq is impossible to predict, as the length of the conflict and collateral damage to petroleum facilities, or the lack thereof, could push crude oil prices either way. Prices were up throughout most of the country, with the largest increase occurring in California, where prices rose 6.1 cents to end at 214.5 cents per gallon, the highest price ever in our survey, which for California goes back to May 2000. This is the third week in a row that California prices have been above $2 per gallon. Prices for the entire West Coast also breached the $2 mark, hitting 204.1 cents per gallon on March 17, and prices in PADD 5 appear to be an important driver in the increase of national prices.

Retail diesel fuel prices decreased for the first time in nine weeks, falling 1.9 cents per gallon to a national average of 175.2 cents per gallon as of March 17. This decrease comes after four successive weeks of record prices. Retail diesel prices were down throughout most the country, with the largest price decrease occurring in the Midwest, where prices fell 3.0 cents per gallon to end at 170.8 cents per gallon. Prices in New England remained the highest in the nation, losing 1.0 cent to 199.1 cents per gallon. California saw a slight price increase, with prices rising by 0.3 cent to end at 186.9 cents per gallon.

Heating Fuel Prices Continue to Decline
Residential heating oil prices decreased 5.1 cents per gallon for the week ending March 17, 2003, averaging 180.3 cents per gallon, but are 62.1 cents per gallon higher than last year at this time. Meanwhile, wholesale heating oil prices decreased 17.6 cents per gallon this past week, to 109.4 cents per gallon.

Residential propane prices decreased 7.2 cents per gallon to reach 158.2 cents per gallon, and are 46.2 cents higher than one year ago. Wholesale propane prices decreased 5.9 cents per gallon, from 80.4 cents per gallon to 74.5 cents per gallon during the week ending March 17.

These prices come from the last survey done for the 2002/03 winter season. Weekly retail and wholesale prices for heating oil and propane will restart for the 2003/04 winter season beginning in October 2003.

Propane Inventories Slip Below LOI
With the last vestiges of winter sweeping across the upper plains last week, U.S. inventories of propane fell nearly 0.7 million barrels, slipping about 0.3 million barrels below the Lower Operational Level (LOI) to end the week of March 14, 2003 at an estimated 18.2 million barrels. An inventory level below the LOI may be indicative of a situation where supply flexibility could be constrained, which some industry observers say is already occurring in some parts of the nation as inventories reach historically low levels. Reports of supply constraints were beginning to surface in the Mid-continent region in recent days as some storage operators and pipeline companies were in effect scrambling to maintain propane supplies to consumers in the region. Nevertheless, the Midwest region reported a 0.8 million-barrel stockdraw last week, indicating propane supplies are still flowing from primary storage. In contrast, East Coast inventories grew by more than 0.1 million barrels last week while Gulf Coast inventories remained unchanged during this same period.

Note: Text from the previous editions of “This Week In Petroleum” is now accessible through a link at the top right-hand corner of this page.