Oil Prices Rally on Falling U.S. Supplies

NEW YORK (TheStreet) -- Oil prices were gaining Tuesday morning on signs of long-term tightening of supplies in the U.S.

West Texas Intermediate (WTI) light sweet crude oil for December delivery was spiking $2.22 to $93.49 a barrel as signs of a longer-term decline in domestic stockpiles, as well as a rebound in China's manufacturing sector helped render a breakout above the technically significant $90 level and made way for a rally just below $95. The U.S. dollar was trading flat against the euro Tuesday morning.

A Cameron Hanover report indicates that crude oil stocks in the U.S. are now 28.3 million barrels lower than a year ago and 6.2 million barrels lower than they were two years ago, amid draws at key U.S. oil trading hub Cushing, Okla.

"We believe WTI's excessive cheapness will fade away as crude by rail infrastructure is expected to expand very fast to meet the demands of increasing oil supply from Canada and Bakken fields. We are already seeing diminishing oil inventory in Cushing," said Natixis oil and gas analyst Abhishek Deshpande.

A Goldman Sachs analyst told Bloomberg last week that the steep discount at which WTI has been trading against Brent could narrow by up to 77%, by the end of 2012, as producers rapidly boost shipments by rail from the U.S. Midwest to refiners on the Gulf Coast.

BGC Financial director Roger Volz says if WTI prices are able to settle at $94.90 Tuesday, there could be further upside to price levels. At the same time, Schork report analyst Hamza Kahn says at this point he doesn't think it even matters where Brent settles, as almost everyone is now looking for a correction between the WTI and Brent spread.

"I'm not sure if we'll hit parity, but Brent will likely move lower, WTI will move higher and the inter-market spread will hold above its 200-day moving average of -17.198," he said.

Traders unwound their bets towards the WTI -Brent crude spread as WTI prices gained on evidence of a longer-term trend of falling supplies. The spread between the two fell to $17.40 Tuesday morning, below the typical $23 discount at which WTI has been against Brent.

"I smell hedge fund death," commented veteran energy trader Dan Dicker. "That spread has taken care more of a few good men," he added.

Brent crude oil futures for December delivery were falling 56 cents to $110.89 a barrel, reflecting global worries, including those that the eurozone is already plunging into its second recession in four years and that even the definitive plan that European leaders are expected to come up with this week to solve the debt crisis won't occur on time to prevent recessionary woes. Furthermore, increasing tensions between the top oil-exporting regions of Saudi Arabia and Iran are expected to exert some additional, mild pressure on Brent crude prices, given the power that Saudi Arabia has to raise production to a level that is counter to Iran's economic interests.

"Obviously the Saudis can produce more oil," says Cameron Hanover analyst Peter Beutel. "By producing more oil, the Saudis can get more money. But the Iranians would have to take it at a lower price. The Iranians can only produce to a point."

Beutel says although Saudi Arabia will "accept bids from anyone who wants oil," they would pare down production if they saw that prices were low to a point that they were starting to hurt African members of the Organization of the Petroleum Exporting Countries such as Nigeria, Algeria and Angola and Libya, who's still struggling to bring its oil production back to full recovery. "The only time Saudi Arabia was in favor of cutting was when prices started dropping, like in 2008 and 2009. They got to a point where producers other than Iran started suffering," the analysts pointed out.

But "they won't go out of their way to help Iran," he added.

Citi Futures Perspective's energy analyst Tim Evans agrees that while there's a "perpetual need to find something scary to use as a justification for a long position in crude oil, I don't see a Saudi-Iranian showdown as a high-probability bullish scenario."

"In fact, under a scenario where Saudi Arabia looks to punish Iran economically, they would maintain production at a high level to knock down prices, depriving Iran of income."

MF Global senior markets strategist Richard Ilczyszyn, on the other hand, is in the camp that believes the tensions between the two regions are leading to increased risk premium for oil prices -- and as tensions continue to escalate, the markets will see "shorts running for the hills. We can see risk premium added to the market as we speak," he said, pointing to the U.S. Commodity Futures Trading Commission's report that hedge funds increased net-long positions in energy and grains by 12% last week.

Natixis' Deshpande says "the tensions between the three nations -- U.S., Iran and Saudi Arabia that escalated further recently due to the alleged assassination plot is not likely to have any immediate impact on oil prices. However if the United Nations atomic agency's intelligence data report that is expected to be published in November confirms Iran's active nuclear program for military purpose, more sanctions on Iran by the U.S. and UN are possible. This could lead to further reduction in oil production as more oil companies would be prompted to leave the country, thereby reducing supply from Iran."

"This could push oil prices up," said Deshpande. "Oil production in Iran has fallen down since 2009, dropping by 1.4% and 2.5% year-over-year in 2009 and 2010, respectively."

Matt Smith, commodity analyst at Summit Energy, a subsidiary of Schneider Electric, takes a more cautious stance on the Saudi Arabia's powerful position in oil, saying that "they have a huge responsibility -- one that seemingly outweighs the current tension with Iran."

Despite the mixed views on Saudi Arabia-Iran's impact on oil prices, one thing everyone can agree on is that, as TAC Energy trader Mark Anderle emphasizes, Greece, Italy and the eurozone debt crisis will continue to be a dominant force in shaping oil price direction for some time.

"It seems pretty telling in how oil prices have become a financial vehicle over the past few years in that Greece and Italy are influencing oil prices more than Saudi Arabia and Iran," said Anderle.

Energy stocks were mostly falling. EOG Resources ( EOG) was tumbling 2.1% to $89.18; Apache ( APA) was tumbling 2.1% to $95.23; Anadarko Petroleum ( APC) was down 0.5% to $78.80; Chesapeake ( CHK) was losing 1.5% to $27.91; Kinder Morgan Energy ( KMP) was flat at $77.10; Suncor Energy ( SU) was falling 1.4% to $30.99; and Triangle Petroleum ( TPLM) was rising 0.7% to $5.45.

-- Written by Andrea Tse in New York.

>To contact the writer of this article, click here: Andrea Tse.

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