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Why crude oil fell off highs despite a neutral inventory report

Ingrid Pan, Sr Energy Analyst

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 various 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 (negative) 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 (positive) 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: Bakken crude begins to trade at premium to WTI, benefiting North Dakota names such as Whiting)

Inventory draw was much larger than expected, a short-term positive

On July 24, the DOE reported a decrease in crude oil inventories of 2,825 thousand (or 2.83 million) barrels. Meanwhile, analysts actually expected a crude oil inventory draw of 2,800 thousand (or 2.80 million) barrels. As the actual inventory change was very close to expectations, it was largely a neutral indicator. However, crude prices tumbled on the day, as weak economic data came out of China and U.S. crude production showed strong growth. Please see Why surging crude supplies weigh down oil prices and China’s weak Purchasing Managers Index (PMI) data caps oil’s recent rise for further information. WTI closed on the day at $105.39 per barrel compared to $106.91 per barrel the prior day.

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 in 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, 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 spread has closed in considerably.

(Read more: Why another large inventory draw boosts oil prices, a short-term positive)

But lately, more takeaway solutions have come online

Midstream companies have been actively looking for solutions to transport U.S. crude oil 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), which has increased demand for U.S. light sweet crude. Consequently, the spread between WTI and Brent has closed in significantly. For more on that, please see Spread between WTI and Brent vanishes, lower relative U.S. oil prices.

This week’s close-to-expected draw in U.S. inventories was a neutral short-term indicator for WTI crude prices, though other data caused oil prices to fall 

WTI price movements and broader oil price movements affect crude oil producers, 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. Additionally, oil price movements affect energy sector ETFs (exchange-traded funds) such as the Energy Select Sector SPDR Fund (XLE), an ETF that includes companies that develop and produce hydrocarbons and the companies that provide services to them.

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

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