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Lower-than-expected inventory draw means softer crude oil prices

Ingrid Pan, CFA

Oil inventory figures reflect supply and demand dynamics and affect prices

Every week, the U.S. Department of Energy (DOE) reports figures on crude inventories, or the amount of crude oil stored in facilities across the United States. Market participants pay attention to these figures because they can indicate supply and demand trends. If the increase in crude inventories is more than expected, it implies either greater supply or weaker demand and is bearish for crude oil prices. If the increase in crude inventories is less than expected, it implies either weaker supply or greater demand and is bullish for crude oil prices. Crude oil prices highly affect earnings for major oil producers such as Oasis Petroleum (OAS), Hess Corp. (HES), Chevron (CVX), and Exxon Mobil (XOM).

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part II))

Inventory draw was less than expected, a short-term negative

On August 21, the DOE reported a decrease in crude oil inventories of 1.4 million barrels. In contrast, analysts actually expected a crude oil inventory draw of 1.5 million barrels. The smaller-than-expected decrease in inventories was a negative signal for oil prices. WTI closed down on the day at $103.85 per barrel compared to $104.96 per barrel the prior day. Signals from the Federal Reserve also caused market volatility and could have contributed to the weakness in crude prices. A government report of Fed minutes from a July meeting revealed that members of the FOMC were generally comfortable with Chairman Ben Bernanke’s plan to taper stimulus measures. Markets react to signals like this, as they believe reduced stimulus measures will dampen economic growth and therefore oil demand.

U.S. crude oil production has pushed up inventories over the past few years

From a longer-term perspective, crude inventories had been much higher than they were over the past five years at the same point in the year (though they’ve recently closed in under comparable 2012 levels). There has been a surge in U.S. crude oil production over the past several years, and inventories had accrued because much of the excess refinery and takeaway capacity had been soaked up and it took time and capital for more to come online. This caused the spread between WTI Cushing (the benchmark U.S. crude, which represents light sweet crude priced at the storage hub of Cushing, Oklahoma) and Brent crude (the benchmark international crude, which represents light sweet crude priced in the North Sea) to blow out. However, over the course of 2013, this has closed in considerably, so that the two benchmarks trade almost in line again.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part III))

But lately, more takeaway solutions have come online

Midstream companies have been actively looking for solutions to transport U.S. crude oil out and have helped move crude out of hubs such as Cushing. New infrastructure projects also require “pipe fill,” which is a base level of crude to fill pipelines and move oil through the system. This has increased demand for U.S. light sweet crude. Plus, U.S. refineries have been running at higher rates, which has increased domestic crude oil demand. Consequently, the spread between WTI and Brent has closed in significantly. For more on that, please see Why the WTI-Brent spread remains tight.

(Read more: An Introduction to Oil and Gas Hedges: Collars)

This week’s smaller-than-expected draw in U.S. inventories was a negative short-term indicator for WTI crude prices 

WTI price movements and broader oil price movements affect producers of crude oil, as higher prices result in higher margins and earnings. Names with portfolios slanted towards oil such as Oasis Petroleum (OAS), Hess Corp. (HES), Chevron Corp. (CVX), and Exxon Mobil (XOM) could see margins squeezed in a lower oil price environment. Plus, oil price movements affect energy sector ETFs such as the Energy Select Sector SPDR Fund (XLE), an ETF that includes companies that develop and produce hydrocarbons as well as the companies that provide services to them.

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