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Released on May 26, 2004 More Crude Oil Should Lower Prices Some oil analysts predict that the Saudis’ announcement will have little if any impact on prices. Several distinct arguments related to market expectations, the quality of incremental Saudi crude, refinery constraints, timing of supply, and the availability of spare capacity have been advanced in support of this view. EIA has also reviewed these factors, but reaches a different conclusion. We believe that the Saudi announcement could contribute to lower prices, particularly if the Saudis maximize the incremental supply of light crude and provide terms that will enable potential buyers to commit to the purchase of more oil without undue risk. As always, the devil will be in the details. On the issue of expectations, the increasing evidence that oil suppliers have previously misjudged the strength of demand is consistent with the view that the market may have considered a production increase likely even before the recent announcement by Saudi Arabia. However expectations are inherently uncertain, and the announcement should begin to increase confidence that additional supply will be forthcoming. Tangible evidence of follow through -- notably additional shipments commensurate with the planned production increase - would obviously be an important further signal that the markets will be watching closely. On the issue of crude quality, those who doubt any impact suggest that incremental Saudi supply would be mainly in heavier, and more sour (meaning with a higher sulfur content) than the market needs right now in the heart of the U.S. gasoline season. Their reasoning is that since this is not the ideal crude sought by the market, it is of little use. However, EIA believes that Saudi Arabia still has some light, relatively sweet crude oil (with a lower sulfur content) excess capacity, and that a reasonable amount of that spare crude could be included in this increased production. There are also smaller amounts of additional light, sweet crude oil potentially available from other OPEC producers should they want to follow the Saudis’ lead. Also, since not all refiners need high-quality crude oil, additional supplies of lower quality crude, while less desirable, can free up available high-quality crude oil for those who need it the most. The bottom line is that extra crude oil of any grade that is priced to sell will find buyers and help to alleviate current market tightness. On the issue of refining capacity, some analysts suggest that with U.S. refinery capacity utilization at 95-96 percent in recent weeks, there is little room for a significant increase in gasoline production. This is inaccurate - there have been times in the past when weekly refinery utilization has even exceeded nameplate capacity, much less reached the 98 percent utilization rate. An increase in the utilization rate of 2 percent equates to an increase in refinery production of about 340,000 barrels per day, and if half of that were gasoline, 170,000 barrels per day of additional gasoline would be available. This represents more than 5 million barrels in a month, a sizeable increase in such a tight market. Indeed, a boost of this size could offset the normal stock draw in July and August. Such a scenario is possible depending on how the Saudis implement their announcement and whether other unexpected refining problems or supply disruptions can be avoided. Moreover, while today’s markets and news stories are focusing on gasoline, inventories across all petroleum products, as well as crude oil, need to improve to insure more flexibility in the system, thus reducing price pressures. At a time of year when crude oil inventories typically fall, if imports increase enough to keep inventories above 290 million barrels, they would be near the middle of the average range by as early as September. If crude oil imports average 10.3 - 10.5 million barrels per day during July and August, it would minimize the usual crude draw during these months while helping to rebuild refined product inventories. Higher production now would also help to reduce the prospects for volatility in heating fuel markets this winter. On the timing issue, it would undoubtedly have been more beneficial had Saudi Arabia acted earlier. However, oil produced in early June can begin to start reaching U.S. refineries by mid to late July, provided, of course, that it is provided on terms that are attractive to those refiners. And, of course, knowing that more crude oil was on the way, refiners would be more willing to draw from their limited crude oil and gasoline inventories in the interim, thus improving the supply situation even before the crude oil arrives. Finally, some analysts point out that any increase in Saudi Arabia crude oil production would reduce the limited global spare production capacity that already exists. Using capacity that would otherwise be idle over the next several months provides the market with additional supply now, but does not make this capacity less available in the future. Also, Saudi Arabia will still have considerable additional capacity. If the Persian Gulf War from 1990-91 is any indication, Saudi Arabia may actually be able to produce more than the common wisdom suggests, at least on a surge capacity basis. Regardless, even if spare production capacity was reduced, strategic inventories in consuming countries would still be available should a real supply emergency occur. Thus, EIA analysis indicates that should crude oil supply from Saudi Arabia reach levels similar to their production last spring following the onset of the war in Iraq, prices for both crude oil and gasoline should be lower later this summer than they would be without this additional oil. More crude oil in the global supply chain, available on suitable terms, should help lower prices, both now and in the future, contributing to an improvement in storage levels that will provide additional security and flexibility should any problems arise in the future. Retail Gasoline Prices Gain Almost 5 Cents Retail diesel fuel prices actually decreased last week by 0.2 cent per gallon as of May 24 to a national average of 176.1 cents per gallon, which is 32.7 cents per gallon higher than a year ago. Retail diesel prices were mixed last week, with the West Coast seeing a decrease of 5.2 cents to hit 219.8 cents per gallon. California prices lost 7.4 cents to 226.6 cents per gallon, marking the eighth week California average diesel retail prices have topped $2 per gallon. Propane Build Returns 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. |
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