Tropical Storm Gordon Helps Extend Oil’s Rally

Oil prices are extending the sharp rally began in the middle of August.   We discuss three supply concerns stemming from 1) the US embargo on Iran, 2) US inventory drawdowns, and 3) a Gulf storm.

 

 

A tropical storm is headed for the Gulf of Mexico, and this is helped oil prices extend last week’s 5.4% rally.   Light sweet crude oil for October delivered is about 1.6% higher at $70.80.  It has been up to $71.40.  The multi-year peak on the continuation futures contract was set in early July near $75.25.

The Gulf area accounts for about a sixth of US oil production and 45% of its refining capacity. Reports indicate that workers have been evacuated from several oil platforms.

Oil prices have steadily risen from the mid-August low near $64.40.  The drawdown in US inventories coupled with coming US sanctions on Iran have helped boost prices. Although the US embargo on Iranian oil does not come into effect for two more months, it is already having an impact.  South Korea’s oil imports from Iran reportedly fell 40% in July.  EU imports are off 45% since May.  India at first balked, but now is considering a 50% cut.  Even China’s oil imports from Iran appear to have slipped.   The US seems reluctant to grant exemptions.  To beat the early November deadline, purchases have to be made in this month and loadings can take place until mid-October.

US oil inventories in three of the past four weeks for a cumulative draw of 2.95 mln barrels through August 24.  The Bloomberg survey found a median forecast of a nearly 2.9 mln barrel drawdown in the week ending August 31.  The August inventory decline follows a 9.14 mln barrel drawdown in July and 16.63 mln barrels in June and 1.44 mln barrels in May.  It US oil stocks have not increased on a monthly basis since April.

The $76.55 area on the futures continuation contract represents the 6.18% retracement of the decline in oil prices from mid-2014 (~$107.75) to the February 2016 low just above $26.  The technical indicators are constructive, and initial support may be pegged near $69.50-$69.70.

Higher oil prices and weaker exchange rates will conspire to boost headline inflation around the world. Fed officials see higher oil prices as a headwind on consumption rather than a lift to inflation.  Headline inflation converges with core inflation, not the other way around.  While others, like the ECB and BOJ, do not formally target their local inflation measure excluding energy, policymakers do take it into account.