AFTER what seemed an inexorable upward trend, energy commodity prices have started to fall. The drop in the crude price is most notable; from record highs over the summer close to $80 per barrel, Nymex front-month crude contracts this week fell below 59 dollars. However, crude is not the only energy commodity to have fallen in price:

In the US, driven by a recovery in supply and mild summer and winter weather, natural gas prices, which unlike in Europe are largely decoupled from crude prices, have been trending downward since the beginning of the year. While there were peaks close to $8 per mmBtu (million British thermal units) in April for the Henry Hub month-ahead contract and again in July to about 8.60 dollars, the month-ahead price this week was below 4.5 dollars, testament to the veritable glut of gas in storage.

Meanwhile, having started the year with high expectations, US coal miners are now reporting expected 2006 production at the lower end of their forecast ranges. The US Energy Information Administration said in September that electric power coal stocks had risen by 1.9 million short tonnes from May to June, the sixth consecutive monthly rise and the first time since 1985 that stocks had risen at this time of year. With plummeting gas prices, softer coal prices and mild weather, power forwards across the United States have also been trending down.

In Europe, the fall in natural gas prices has been prompted by the recent drop in crude prices. The UK’s National Balancing Point saw its month-ahead contract in September drop to 35 pence/therm as new supplies of gas were expected on-stream from new continental interconnectors. On October 3, gas in the United Kingdom was being given away after a newly opened pipeline from Norway led to a surge in imports, pushing gas prices into the negative. Falls were also seen in continental European markets, where mild weather reduced the demand for air conditioning, but the winter heating season has yet to get underway.

World coal prices have also retreated from earlier highs. The average price for spot coal delivered into northern Europe was $71.02 per metric tonne (mt) CIF ARA in August, but fell back to just below

$66 in September. Again the milder weather has an impact on power generation demand, and coal stocks at the key export point of Richards Bay in South Africa rose to 5 million mt before dropping back to around 4 million mt.

Meanwhile, having crashed in May to a low below 10 euros/mt for EU Emission Allowances – a result of the release of verified emissions data by the European Commission showing member states had been over-generous in their allocations in the first phase of the European Trading Scheme – EUA prices had recovered to around 15-16 euros/mt in September. However, the drop in European power prices – led by weather and falling oil, gas and coal prices – renewed concern that the market for first phase EUAs is fundamentally oversupplied. EUAs lost around 20% of their value in the second half of September as a result.

The fall in the crude oil price reflects a market that has for months been in physical oversupply. The market has been in a contango for over a year, despite some major outages in terms of Nigerian crude and more latterly BP’s Prudhoe Bay in Alaska. Tanker chartering rates, which usually jump sharply in mid-September ahead of the winter heating season, remain very low. Far fewer tankers have been fixed for the October 11-31 period that at the same stage last year.

However, while the market may have been experiencing oversupply on the crude side, a sea change has also taken place in the products market, where inadequate refinery capacity had previously meant healthy margins, supporting the price of crude.

EIA data released on September 27 showed US commercial crude stocks falling 100,000 barrels to 324.767mn barrels – down 22.284mn over the last 14 weeks, but unchanged against the five-year average. However, gasoline stocks edged up 600,000 barrels to 207.554 million, distillates rose 4.1mn barrels to 148.67 million, and jet/kerosene inventories climbed 1.3 million barrels to 42.21mn, contributing to the sixth consecutive increase in total US stocks. Gasoline inventories are 12.15mn barrels above year-ago levels and 9.7mn barrels above the five-year average.

In Asia, Japan’s total refined oil products sales fell 6.2% on the year to 20.14mn kilolitres in August, according to preliminary data released by the Ministry of Economy, Trade and Industry in September. August sales were also down 1.3% from July. A key indicator of Japanese demand is kerosene, stocks of which were up 17.9% in August on a year earlier. Total products stocks were up 5.8% on August 2005. In addition, South Korean jet and kerosene stocks are about 10-15% above levels seen in September 2005.

Simple refining margins in Northwest Europe are reported to have fallen near break-even as gasoline cracks (profits from turning crude into gasoline) have declined sharply and distillate cracks continue to weaken. Even complex margins are sharply down, owing to the growing surplus of gasoline in Europe. High US inventories mean there is less prospect of moving European gasoline to the US market, while gasoil (diesel) has been moving from Asia and the United States into Europe. Outright prices for ultra-low-sulphur diesel and gasoline hit six-month lows towards end-September.

Rising oil prices over a protracted period appear to have resulted in demand destruction. While forecasters still see demand growth for crude of over 1.0mn barrels per day in 2006, and even higher in 2007, growth has flattened out in the OECD.

In addition, capacity creep in the refinery sector and enhanced ability to handle a wider slate of crudes has eased the bottleneck in products supply. This has created a hiatus that has contributed to the fall in prices across the energy complex, although if lower energy prices, or other factors such as extreme weather, spark a rebound in products demand, then the refinery bottleneck may again be tested, causing crude prices to rise on the back of improved margins.

While demand growth remains positive and above the expected increase in non-Opec supply, future movements in crude prices will depend on three key factors, namely:

r Opec, which as a group appears willing to defend a price of 50 dollars per barrel, or possibly higher;

r financial investors, and whether they view the current change in price trend as a watershed or temporary correction; and

r the geopolitical risk premium, which having cooled in recent weeks in certain key hotspots, remains no less flammable than before.

The price outlook depends largely on how demand reacts to the moderation in energy prices. Surplus capacity in both crude supply and refining capacity remains relatively small, while the causes of recent geopolitical tensions remain unresolved. – Oxford Analytica/www.oxan.com