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Morning Note: Oil Due For A Correction?

Civil war in Libya, Nigerian election violence, Bahrain State of Emergency -- just some of the threatening headlines out of North Africa and the Middle East this month fueling volatility in crude prices. Oil prices have risen to levels not seen since 2008 as traders have attempted to price in relevant supply risks. But is too much of a risk-premium now present in the price of crude?

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That was Goldman Sachs’ argument Tuesday morning. In an April 12 note, Goldman Sachs’ analysts David Greely and Jeffrey Currie called for a significant oil correction saying that the fundamentals did not support the recent run-up in prices. Brent crude hit a high of $127 per barrel yesterday. In their note, Goldman Sachs’ analysts argue Brent could return to $105 per barrel.

“Inventories and spare capacity are much higher now and net speculative positions are four times as high as in June 2008,” said Goldman Sachs’ commodity research team.

The team focused on Brent, which is sourced from the North Sea. Crude from Europe, Africa and the Middle East is priced relative to Brent. Oil inventories in that region have tightened due, in large part, to the loss of Libyan supply. Libya produced an average of 1.3 million barrels per day in 2010 and will remain shut down for “many more months,” according to the International Energy Agency.

WTI crude is a better barometer of oil supply and demand in the U.S., Canada, and Mexico. It has risen along with Brent, though not as fast or as high. WTI futures for May delivery hit an intra day high of $113 per barrel yesterday. That’s in part because of record oil supplies in the U.S. Oil inventories in Cushing Oklahoma hit a record 41.9 million barrels last week, according to the U.S. Department of Energy. Cushing inventories are up 35% due, in part, to an inability to move Canadian oil that flows into Cushing quickly to high demand areas in the U.S.

Both Brent and WTI were pulling back Tuesday morning after Goldman’s call. WTI crude dropped nearly 4%, falling near $106 per barrel. Brent crude fell more than 3% to $120 per barrel.

Chris Motroni, an oil broker with Heritage Energy, believes crude prices are still trading on headlines. In a Tuesday morning note to clients, Motroni wrote that IMF cuts to U.S. and Japanese growth forecasts were causing oil to weaken. But the pullback would likely be short-lived.

“The Middle East will remain the primary focus for anyone trading crude. I still think the developments in the Middle East will get much worse before it gets any better,” he wrote.


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