Hurricanes are ill wind for oil prices

Saturday, July 12, 2008

Bad weather can have a devastating effect on the fuel industry, writes Kristy Dorsey.

Amid concerns about record prices, levels of demand and the threat to production in areas of conflict, the oil market is adding another imponderable to its list of worries – predicting the weather.

Bertha, the first Atlantic hurricane of the 2008 season, waxed and waned during the past week on its slow drift towards Bermuda. Although forecasters determined early on that the storm was unlikely to threaten the Gulf of Mexico, home to about 15% of the world's oil supplies, her formation was a reminder that natural disasters can pose the same threat to markets as manmade ones.

It's a situation faced by the industry every year, with the hurricane season running from June to the end of October. While the last couple of years have been relatively benign in terms of damage and disruption to oil facilities, few have forgotten the devastation of 2005 when a record-breaking 28 tropical storms formed, including Hurricane Katrina.

In the wake of Katrina, oil prices jumped by about $10 per barrel. However, they remained around the $40-$50 level for most of 2005, a long way south of the current average of about $135.

Analysts emphasise that the ongoing turmoil in energy markets is grounded in the fundamentals of increasing demand and limited supplies. But just as sabre-rattling in the Middle East or conflict in Nigeria sends oil prices on an upward spike, the threat of a major hurricane heading into the Gulf would be another piece of news for speculators to seize upon.

"The market is very volatile and very nervous," says Angus McPhail, oil analyst with Alliance Trust in Dundee. "You do see that being reflected in the oil market, and also in equity markets right now."

McPhail, who inaccurately forecast that last year's hurricane season would be especially vicious, jests that it is generally unwise to try to predict the weather. However, having recently returned from a tour of tornado and hurricane damage in the US, he still believes this could be a year of particularly fierce hurricane activity. He highlights the record number of tornados that have ripped through the US Midwest this year, plus drought in Australia and other abnormal weather situations globally.

As such, McPhail says there is "definitely more potential" for major hurricanes in the coming months.

The 2008 Atlantic Hurricane Season Outlook issued through the US National Weather Service in May says it is most likely that activity will be near-normal or above-normal, as the area is still in an "active hurricane era" that began in 2005. This indicates the probability that between six and nine hurricanes will form, with between two and five of these being major hurricanes with sustained winds of 111mph or more.

"An above-normal season is most likely (65% chance), but there is also a 25% chance of a near-normal season, and a 10% chance of a below-normal season," researchers state in their outlook, which will be updated in August, the start of the peak months for the Atlantic storm season.

Despite the probability of ill winds ahead, McPhail dismissed talk that oil prices could jump to $200 per barrel. While a massive weather event like Katrina would certainly produce a knee-jerk reaction, he noted that natural disasters were "short-term things" that markets tended to quickly shake off.

"I don't see ($200 per barrel] being caused by just a hurricane," he says. "That wouldn't be enough.

"The futures curve is basically saying that by this Christmas we will be looking at $141 per barrel in terms of Brent."

David MacNair, oil analyst with Brewin Dolphin, agrees. He says that although markets were "very focused" on hurricanes while they were happening, the broader impact on prices was usually minimal. However, until demand for oil slows sufficiently, it is reasonable to expect that any major storms would push prices higher.

"The psychology of the market right now is to look for reasons why it might spike upwards, rather than go down," MacNair says. "Markets now are very volatile and very susceptible to even small changes in supply."

On Thursday, Opec warned of growing uncertainty over demand for its oil in the years to come, as European and US governments work to cut their oil dependence and promote alternative energy sources. The cartel's 2008 World Oil Outlook said demand for oil from Opec countries could fall to 31 million barrels per day (bpd) in 2012, below current production of 32.4 million bpd by Opec, which pumps about one-third of the world's oil and accounts for roughly three-quarters of the world's proven reserves.

This view was echoed by the International Energy Agency (IEA), the Paris-based adviser to 27 of the world's largest industrialised countries.

Its monthly report on the global oil market, also released on Thursday, slightly raised forecasts for total demand in 2008, the first upward revision by the IEA in seven months. Although the thirst for oil from developing countries such as China is expected to push overall demand a bit higher, the IEA noted that pressure on markets should ease next year as high prices cut consumption in the developed world.

"Given the economic slowdown in the US and the continued rise in international oil prices, transportation fuels demand is expected to decline (in the second half of 2008], thus adding to the bleak demand picture," according to the IEA.

MacNair says that until high prices sufficiently destroy demand in developed countries, upward pricing pressure would prevail. Despite some evidence that the fuel-ravenous US and other countries such as the UK were beginning to cut their consumption and reduce demand, he noted that such corrections take a long time to feed through.

"The hurricane season will be long gone before we see that," he says. "We are looking at the end of this year or the beginning of next year before that happens."

This story was featured on The Scotsman website.


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