Released on August 25, 2004
(Next Release on September 1, 2004)

Start Value
Those of us who watched the recent gymnastics competition at the Olympics, have learned about the term “start value,” which is the point total assigned to each gymnast’s routine from which deductions are made to determine his/her final score. In fact, a controversy about the start value of a South Korean gymnast’s routine has been the talk of the competition. In crude oil markets, there has also been talk about the “start value” of crude oil prices, but in this instance dollars are being added to the “start value,” not subtracted. In other words, the discussion has centered on what would the price of crude oil be if it were solely based on global supply and demand. Estimates of the “start value” for West Texas Intermediate (WTI) crude oil prices are important in that many use this value to determine where oil prices will ultimately land once “non-fundamental” factors go away.

Some analysts have argued that the WTI crude oil price would now be close to $30 per barrel or even lower, not around $45 per barrel where it was yesterday, if it weren’t for “non-fundamental” factors. These analysts would argue that current estimates of global supply and demand point to large implied global inventory builds. For example, EIA’s global supply and demand balance for the second quarter of 2004 shows an implied inventory build of 2.2 million barrels per day, or about 200 million barrels over the whole quarter. Yet, the latest data from the International Energy Agency shows an increase of only 82 million barrels in OECD countries, whose demand represents about 60 percent of global demand in the second quarter of 2004. If the implied inventory build is correct, countries outside the OECD, which include many countries much poorer than those in the OECD, are stockpiling oil at a much greater rate than those in the OECD. With prices at such lofty levels, one might wonder why non-OECD countries would be storing oil at a much higher rate. And even if the implied growth in non-OECD inventory is discounted, given the recent history of repeated revisions towards a much tighter balance in the world oil market, some would argue for “fundamental” WTI prices near $30 per barrel based on OECD inventory levels alone.

While current market prices are undoubtedly being affected by non-fundamental factors, EIA and other prominent analysts believe that the “start value” for WTI in today’s market is above $30 per barrel. There are two main reasons for this analysis: 1) extremely low spare production capacity worldwide, and 2) forward fundamentals. Estimates on global spare crude oil production capacity vary somewhat, with EIA estimating it at between 0.5 and 1.0 million barrels per day and others estimating it slightly above 1 million barrels per day. However, all agree that spare production capacity is at or near its lowest level in many years. Considering that global production is around 83 million barrels per day, having spare production capacity of about 1 million barrels per day implies that oil production is running at nearly 99 percent of its capacity! There are many producing areas where a disruption in supply could occur that would exceed the amount of excess production capacity that could be brought online, thus magnifying the impact of such a supply loss. However, what may be a larger factor weighing on the market is the fact that global oil demand is expected to grow by 3 million barrels per day or more between the second quarter and fourth quarter of 2004, and with observed inventories at fairly low levels and limited means to increase production, there is concern regarding the source of these additional barrels. This leads us to the concept of “forward fundamentals,” which EIA first introduced in the November 20, 2002 edition of This Week In Petroleum.

While many analysts review the latest data on global supply and demand, which often lag by several months, even for countries in which the data actually is reported, the concept of “forward fundamentals,” as explained in the November 2002 report, argues that prices today are reflecting perceptions of the supply/demand balance expected in the not-too-distant future. The fact that the market is concerned about where additional barrels will come from if demand grows as currently projected puts increased price pressure on barrels today. With demand growing rapidly this year, and estimates that strong growth will continue into next year as well, there are concerns that production capacity, which is barely ahead of demand requirements, will struggle to even keep pace with demand growth over the next several quarters. If this is indeed the case, spare production capacity might even be lower next year than this year, leaving crude oil markets extremely vulnerable to any supply losses. Given this scenario, it is easy to understand why EIA might give WTI prices a higher “start value” than some other analysts.

Retail Gasoline Prices Increase By 0.9 Cent
The U.S. average retail price for regular gasoline rose by 0.9 cent per gallon from the previous week to reach 188.4 cents per gallon as of August 23, 13.7 cents higher than this time last year. This is the first time prices have increased in the last five weeks, and reflects the response of gasoline prices to the rise of crude oil prices over July and most of August. Retail regular gasoline prices rose in all areas except California, led by an increase of 1.9 cents in the Gulf Coast region to hit 180.2 cents per gallon. Prices in California remained the highest in EIA's survey, despite a drop of 0.4 cent to 205.1 cents per gallon.

Retail diesel fuel prices gained 4.9 cents this week to a national average of 187.4 cents per gallon, which is 37.1 cents per gallon higher than a year ago. The largest increase for retail diesel prices last week was in the Gulf Coast, which saw an increase of 6.8 cents to hit 183.3 cents per gallon. California prices remained the highest, rising 4.0 cents to average 215.3 cents per gallon.

Propane Build Continues Strong
U.S. inventories of propane continued the August stockbuilding rally with a 1.8-million-barrel increase last week that put inventories at an estimated 54.8 million barrels as of August 20, 2004. Since the beginning of the month, propane inventories have gained 5.7 million barrels, surpassing the 5-year average stockbuild for August by nearly 24 percent. Despite the strong August build so far, U.S. inventories of propane continue to trail the lower boundary of the average range for this time of year. Sharply higher imports contributed to boost inventories in the Midwest and Gulf Coast regions with respective gains of 0.6 million barrels and 1.3 million barrels last week, while East Coast inventories remained unchanged during this same time. Inventories in the combined Rocky Mountain/West Coast regions slipped lower last week with a 0.1-million-barrel loss. Propylene non-fuel use inventories moved higher last week to 2.9 million barrels, accounting for a larger 5.3 percent share of total propane/propylene inventories, compared with a 5.1 percent share the previous week.

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