In mid-afternoon trading today, WTI crude has fallen below $80/barrel and looks set to end the month down about -10%. Given all the dismal economic news that came out this month, it’s a wonder the price didn’t fall even lower. What happened to oil prices was pretty predictable. What happens next is less so. The impact on the top line results at integrated oil companies like Exxon Mobil Corp. (NYSE: XOM), Chevron Corp. (NYSE: CVX), and ConocoPhillips Corp. (NYSE: COP) should be moderated somewhat by the strength in their refining results. E&P companies such as Occidental Petroleum Corp. (NYSE: OXY) are more likely to take a bigger hit. Among the reasons for oil’s falling price are a stronger dollar, weaker expected demand in the US and Europe, and, most important, indications that China’s expected growth this year will fall short.
A rising dollar depresses oil prices, and the dollar rose by around 4% in September vs. the euro and by 6% against a basket of six currencies. Demand for crude in the developed countries of North America and Europe is also falling as these economies continue to falter. In the US, crude oil stocks at Cushing sit at 341 million barrels, nearly at capacity, but down by 16 million barrels from last year at the same time. The supply of refined products is down from a year ago as well, by -0.7%, and the gasoline supply was down -1.1%. Domestic prices for gasoline will follow crude down, but not as quickly primarily because the WTI-Brent crude price differential keeps the price to Gulf Coast and East Coast refiners high and refiners with access to WTI don’t lower their prices, they raise them to the market standard set on the two coasts. But relief for drivers should follow and that will make a few more dollars available to buy something besides gasoline.
Internationally, estimated 2011 demand for crude fell by 200,000 barrels/day in September and the downside risks to the global economy could lead to an even steeper drop. And as bad as the economies of the developed countries are, fears that the Chinese economy is cooling off have probably contributed more to the sell-off in crude. China’s manufacturing sector contracted again in September, the third consecutive month of slowing growth. The country is still expected to post GDP growth of 9% in 2011, and third quarter growth is expected to come in at 9%, somewhat slower than the 9.5% growth the country posted in the second quarter. Government efforts to fight inflation include trying to keep a lid on input costs, including energy.
Inflation fell last month and is expected to keep falling slowly through the rest of this year. China’s lowered manufacturing output reflects lost sales to the weakening economies of the developed world. With demand for Chinese goods slackening, demand for energy will also fall. How far it falls will have a large impact on crude prices for the near term. The key could be the differential between WTI and Brent crudes. That differential is about $23/barrel today.
If Brent prices close in on WTI as WTI prices continue to fall, that will indicate that global demand is taking a hit and that hit will be coming from China. When the WTI/Brent differential is half what it is today and the WTI price is say $10/barrel lower than it is today, that’s when demand from China and other emerging economies will have given up trying to save the world. At that point, anything can happen. And probably will.