Oil markets fear supply squeeze

Oct. 13  With prices holding near 10-year highs, the worlds oil market closed out its most hectic week in a decade, as traders feared that continuing Middle East turmoil could further jeopardize supplies. Consumers faced even higher heating oil prices, just as winter weather takes hold. And while investors in oil stocks saw the group pull back on profit-taking Friday, uncertainty remained about whether this weeks price spikes will accelerate already-robust profits of oil producers and refiners. OIL PRICES ENDED the week sharply higher touching $37 a barrel before pulling back Friday. November crude futures on the New York Mercantile Exchange, dropped $1.07 to close at $34.99 a barrel. Other energy prices, including heating oil and natural gas, also ended the week sharply higher. With oil supplies already stretched before the apparent terrorist attack on the U.S.S. Cole in Yemen Thursday, prices have moved steadily higher this fall, despite increased production by the Organization of Petroleum Producing Countries. Though crude prices eased somewhat Friday, the markets remained jittery following an explosion at the British embassy in the Yemen capital Sanaa, in what Yemen said was a power generator explosion and Britain said was a bomb. Click here for the latest on the turmoil in the Middle East. The markets were calmed somewhat by OPECs assurances that it has no intention of entering the fray with a replay of the 1973 oil embargo. But with the cartel now producing at near the limits of its capacity, the impact of any interruptions in supply would be severe.

Though analysts believe OPEC would like to manage oil prices back below $30 a barrel, the markets biggest fear is that a renegade member could upset the delicate balance of supply and demand. Iraqi leader Saddam Hussein, the U.S. opponent in the Gulf War, holds a trump card this time around, according to Dain Raucher Wessels analyst Stephen Smith. His 2.4 million barrels of exports now makes a difference, he said. If he were to stop exporting then the arithmetic on the balance of spare capacity becomes a very, very snug balance. Even if OPEC follows through on pledges to pump more oil to keep prices in a trading range below $30 a barrel, traders says the worlds oil supply is vulnerable to any interruption. In Venezuela, an oil-workers strike continued for a third day Friday after the state-owned monopoly Petroleos de Venezuela SA abandoned talks over wages. The company says its contingency plan can guarantee exports and production of about 3 million barrels a day for about a week. October 12, 2000 Oil analyst Jim Placke says the spike in oil prices should ease unless tensions in the MIddle East widen.

On top of that, demand for the energy needed to fuel the ongoing global economic expansion continues to surge. Demand for refined petroleum products hit a record 20 million barrels per day in September, thanks to record consumption of heating oil, gasoline and jet fuel, according to the latest figures from the Energy Information Administration. Despite the precarious balance of supply and demand, most analysts believe prices are eventually headed lower. The consensus estimate tracked by First Call/Thomson Financial pegs the average price of a barrel of West Texas Intermediate crude at $27.92 by the first quarter of next year. Thats because severely low inventories of crude are slowly being rebuilt, and the current surge in prices will cut demand, according to Bear Stearns oil analyst Fred Leuffer. Our belief (that) oil prices will fall hard next year has been strengthened, he wrote in a research note Friday. But that wont come in time to provide relief to consumers who, after paying higher gasoline prices all summer, now face big increases in the cost of home heating oil just as colder weather set in. With heating oil stocks some 50 percent below levels seen last year at this time, the only relief from high energy bills will come from warmer-than-usual weather. A cold winter will put further pressure on prices. Higher energy prices also threaten to spill over into other consumer goods. Surging fuel prices sent the producer price index in September up a much stronger then expected 0.9 percent. That measure of inflation on the wholesale level make it less likely the Federal Reserve Board will ease interest rates near term to help calm the financial markets, analysts said. October 13, 2000 Dow Jones oil markets editor Beth Heinsohn explains on CNBC Friday why consumers face higher heating oil bills this winter.

We still think they have to raise rates more, Joseph Carson, chief economist at UBS Warburg, told CNBC. Were in the minority, but we think theyll do it later this year, early next year because of the spillover effects from energy prices in the core inflation. Continued high oil prices also increase the likelihood of a global slowdown. The Organization for Economic Cooperation and Development, a multinational think tank, estimates that a sustained oil price of $33 a barrel would shave 0.3 percentage points off the growth of U.S. gross domestic product, 0.5 percentage points from Europes growth rate and 0.6 points in Japan. OIL STOCKS GAIN As the oil shock reverberated through financial markets, shares of oil companies initially shot higher, on the belief that higher crude prices will accelerate the already strong profit growth of major oil producers and refiners. Airlines stocks got hurt by the twin fears of increased exposure to terrorist attacks and the surge in oil prices  and the cost of jet fuel. If oil prices remain remotely near current levels Paine Webber airline analyst Sam Buttrick thinks across the board losses are likely in the fourth quarter. Buttrick is also concerned about the impact of a slowdown in business travel, as companies facing slowing earnings tighten their belts by reining in travel expenses. But there are also signs of increased supply that could ease the upward price pressure. Department of Energy figures this week showed crude oil inventories rising by 1 million barrels. The European Union met Friday to discuss, among other topics, the question of whether to follow U.S. in releasing strategic petroleum reserves. EU nations hold a 3 months supply of oil, but there is no clear mechanism for releasing them. STAGFLATION SPECTER LURKS The stock markets biggest fear: that a sustained surge in oil prices could touch off a new round of inflation. Together with a sharp economic slowdown, that could bring a return the stagflation of the 1970s that produced a prolonged bear market in stocks.

Energy prices have now moved over a critical level where the cost of doing business is rising much faster than business itself, so some companies are going to try to pass that along, said Carson.

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-- Martin Thompson (mthom1927@aol.com), October 13, 2000