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What Just Happened With Crude?

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Energy markets got something of a double jolt yesterday, with API inventories showing the largest drawdown since records began. A little while later, the dollar was shaken up when Fitch downgraded the US sovereign rating to AA+ from AAA, the second agency to do so, ever. It’s been a wild ride in the markets lately, with crude especially affected.

The API report showed a drawdown of 15.4M barrels of crude last week, which is way more than the 0.9M bbl expected. It is so big, in fact, that it’s the largest number of records that date all the way back to 1982. That has lead to some serious speculation that it might be quickly revised.

It’s yet to be confirmed

The American Petroleum Institute (API) does a weekly survey of its members to estimate how much inventory the US has. This is separate from what the Department of Energy does in surveying inventories, which is seen as the “official” tally. For this reason, the API number is seen often as a “forecast” or “prediction” of what the DOE will say a day later. Although, the API survey is meant to inform its own members, and isn’t intending to try to predict what the DOE will report.

That’s why the market is still a little cautious following the API survey, since it isn’t the official number. However, the API report typically correlates with the actual state of inventories, and even if the DOE number is different, it can still affect the market. After all, what drives prices is supply and demand, not who is “official”. And, right now, there are indications that the market for crude is entering a little bit of an imbalance.

The market situation

Many analysts have been optimistic about crude prices recently, betting on a surge in demand from China. That includes Goldman Sachs, which recently said that it sees oil prices rising through the latter half of the year. The International Energy Agency predicts that demand will outstrip supply later this year, which would presumably also push up prices. That prediction is also based on increased demand from China.

However, China’s manufacturing PMIs just went into contraction, suggesting that the world’s second largest economy and the largest crude importer, is facing economic challenges. The thing is, China continues to import crude, but is building up stockpiles. The crude isn’t being sent to refineries to produce gasoline and diesel. The latter is crucial, because it’s important for transportation and industry. In fact, China is increasing its exports of diesel, suggesting that there is slowing demand in the domestic market.

So, why did the price increase?

Investors appear to be coming to the conclusion that the US economy is more resilient than anticipated, which means the largest consumer of fuel will keep doing so. The recent high price has led the US government to suspend buying to replenish the SPR, as the summer driving season has coincided with crude cuts by Russia and Saudi Arabia. The latter is expected to extend its cuts for another month when OPEC meets later this week.

But some analysts caution that the recent surge in demand might not last. The sudden decline in inventories included a surge in demand for gasoline as prices at the pump have gone up. It’s normal to have a seasonal increase in fuel demand in the summer. But with slow economic performance in Europe and China, that seasonal increase in demand could fade in the coming months and put a cap on crude prices.

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