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Why a smaller-than-expected inventory build helped crude prices

Ingrid Pan, CFA

Oil inventory figures reflect supply and demand dynamics and affect prices

Every week, the US Department of Energy (the DOE) reports figures on crude inventories, or the amount of crude oil stored in facilities across the US. Market participants pay attention to these figures, as 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).

Smaller-than-expected inventory build: Positive for oil prices

On November 6, the DOE reported an increase in crude inventories of 1.6 million barrels compared to analysts’ expectations of a crude oil inventory build of 1.7 million barrels. The smaller-than-expected increase in inventories was a positive signal for oil prices.

WTI crude prices rose on the day, closing at $94.80 per barrel compared to $93.37 per barrel. Since early September, WTI crude oil prices have slid from ~$110 per barrel to currently trade at ~$95 per barrel.

Background: US crude oil production has pushed up inventories over the past few years

From a longer-term perspective, crude inventories had been much higher than where they were in the past five years at the same point in the year (though they had closed in under comparable 2012 levels for a period earlier this year). There has been a surge in US 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 US 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 closed in considerably, so that the two benchmarks traded almost in line again, as more takeaway capacity from the Cushing hub came online. Recently, however, the spread has widened back out (see Why the WTI-Brent spread is at its widest level since March for more background).

This week’s smaller-than-expected build in US inventories was a positive short-term indicator for WTI crude prices

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. 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 and the companies that service them.

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