Oil pricing loses the 'fear premium'


Oil producers have been hit by the biggest monthly price drop since the beginning of the Great Recession and see little prospect for a significant upturn, short of sharply escalating tensions in the Middle East.

Crude prices haven’t hit rock bottom as natural gas did earlier this year when producers faced financial losses and were forced to shut in production. But investors have pummelled oil company share prices in recognition that stellar first-quarter results will not be repeated.

Oil markets are being driven by increased anxiety about recession in Europe and an economic slowdown in China, as well surging North American production that has sent inventories to 22-year highs in the United States.

The near-month futures price for the benchmark West Texas Intermediate dropped 17 per cent in May, losing $1.29 (U.S.) a barrel to close out the month on Thursday at $86.53 on the new York Mercantile Exchange. WTI peaked in February at $110 a barrel.

Prices spiked earlier this year on fears that a U.S.-led effort to ratchet up sanctions against Iran over its nuclear program would lead to crude shortages, and perhaps even an effort by Tehran to disrupt shipments out through the critical Strait of Hormuz at the mouth of the Persian Gulf.

“That fear premium is basically gone and now we have fear in a different direction,” said Phil Flynn, commodity trader at Price Futures Group in Chicago. He pointed to rising concern that Spain could face default, dwarfing the bailout that was needed to avert a crisis over Greece.

“There is a concern that if we don’t get a handle on this European situation, the market could collapse … you could see oil at $50 or lower.”

The world has looked to China and other emerging markets to take up the slack from stagnant developed economies and boost global consumption of crude.

But China itself is stumbling, amid slowing demand from countries like India and Brazil. Independent analyst Paul Ting said there has been “across the board weakness in Chinese oil demand” in first five months of this year.

“In the near term, one is hard-pressed to find any bullish factors to cheer about,” Mr. Tong wrote in a report on Chinese oil demand.

However, Beijing is expected to pursue additional fiscal and monetary stimulus to ensure its economy grows by 7.5 to 8 per cent this year, and that rising demand should help underpin the price of crude, said Dina Cover, an economist with Toronto-Dominion Bank.

Ms. Cover said she expects the WTI price to average $95 a barrel in the second quarter, and slowly trend back up toward the end of the year.

Canadian oil producers should be comfortable with $85 oil, though the price slide has hurt their shares. Suncor Energy Inc. opened the month with a stock price around $32, and has seen it fall to close at $27.87 on Thursday. Canadian Natural Resources Ltd. fell from $34 to $29.66; MEG Energy Corp. dropped to $34.45 from $43, and Imperial Oil Ltd. sank to $41.51 from $46.

But the companies remain fundamentally sound, said Don Short, portfolio manager at QWest Financial Management Corp. in Calgary.

“The key is finding companies with decent cash flow and reasonable debt positions,” Mr. Short said. “And by and large, oil producers are still in better shape than natural gas producers.”

In a report released Thursday, DBRS Ltd., a Toronto-based bond rater, said the major oil producing companies entered 2012 with formidable strength, after record cash flow in 2011.

“The current price is still quite robust for them,” said James Jung, senior vice-president at DBRS. Companies typically make a fairly conservative price forecast in setting their capital budgets, he said, and he doesn’t expect them to begin cutting spending unless prices fall further and stay depressed.

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