Why Oil Prices Are Likely to Decline Further

Weak global growth is slamming oil prices, sending them nearly 10 percent lower in less than two weeks, with more declines likely.

Oil Storage Tank
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Oil Storage Tank

West Texas Intermediate crude futures lost more than 1.5 percent Wednesday to $89.98 per barrel, after U.S. government inventory data showed a drop of 8.7 percent in demandfor distillates, which include diesel fuel and heating oil. U.S. crude oil stocks fell by 2.45 million barrels, to 365.18 million barrels, according to the Energy Information Administration’s weekly report.

John Kilduff of Again Capital said the drop in demand for distillates was the worrying factor, after last week’s 10-percent drop in distillates demand, on a four-week average basis.

“Now we’re going to have to really watch it. If we get another two reports like this and it’s a full-month reporting period, then it’s clear we have a problem,” he said.

Kilduff said the numbers are reflecting the drop in economic activity discussed by transportation companies FedEx , in its earnings warning, and Norfolk Southern . (Read More: What Caterpillar's Profit Warning Means for Global Growth)

WTI oil fell through its 100-day moving averageof $99.25 Wednesday morning. “The next major number we are looking for is $88.85, which is a 50 percent retracement of the June to September rally,” said Kilduff. “Then you’ll have some support at $86 and then $82.” Brent, the international benchmark, was also lower, falling 0.4 percent to $110.04 per barrel.

Gasoline, meanwhile, rose on the Nymex after news of an explosion Wednesday morning at a refinery in Saint Johns, New Brunswick. The Irving Oil refinery later said it resumed normal operations. The gasoline market is extremely sensitive since supply is so stretched. Gasoline inventories in the Northeast have fallen to the lowest level since EIA records began in November, 1990, according to Dow Jones.

(Read More: Get Oil and Natural Gas Prices Here )

RBOB gasoline futures finished the day up 3.8 percent at $3.1068 per gallon. Gasoline demand was down 1 percent in the weekly EIA report, and gasoline at the pump saw its first decline in seven weeks this week.

But oil supply is not stretched, and absent a crisis in the Middle East, it has likely seen its highs of the year. Analysts have said the plentiful global oil supply, with OPEC pumping record amounts, is colliding with a decline in demand as global growth sputters.

“When I looked at crude this morning, my biggest concern was what is going on in Europe, and the economies over there,” said Andrew Lipow, president of Lipow Oil Associates. “You’re seeing it in the streets, in Greece and in Spain, and it’s just a telling sign of how bad the economy is. If you see how the world is so interconnected, a slowdown in Europe is going to affect both China and the U.S., and those are the type of things that are affecting the price of oil.”

“It probably gets those people who were enthusiastic going into the Fed week to reconsider it now and get out,” he said. Oil began its decline from its September high, shortly after the Fed announced its latest round of quantitative easing. Some traders say oil rose on expectations that QE or Fed asset purchases would be more inflationary, sending commodities higher.

The selling was also fueled by Saudi Arabia’s comments that higher oil prices were not justified and by its commitment to keep pumping at higher levels. Meanwhile, even as Iranian oil has come off the market due to sanctions against it, neighboring Iraq has been able to pump more. At the same time, the White House has made it clear that it will consider all options, including a release from reserves, if oil prices get too high.

U.S. oil production also picked up to 6.5 million barrels per day last week, the highest level since 1997, according to the EIA. U.S. imports of oil fell by 2.25 million barrels a day, the lowest level since December, 2011.

“Here’ in Texas, it’s getting to be like an 18 year high. We’ll probably get to over two million barrels a day by the end of the year,” said Lipow. “Texas oil production is up a half million barrels a day in the last twelve months. That’s amazing. That increase is about equal to the entire output of California or Alaska.”

Texas production is about 1.8 million barrels a day currently, he said.

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