FUTURES MOVERS - Oil price highest level since Gulf War - Effect of tight supply; plus, distillate inventory plummets

cbs.marketwatch.com By Myra P. Saefong, CBS.MarketWatch.com Last Updte: 4:24 PM ET Feb. 26, 2003

NEW YORK (CBS.MW) -- Crude futures prices rose Wednesday to their highest level since the Persian Gulf War, reflecting a tight U.S. inventory picture at a time of looming prospects of war with Iraq.

Crude for April delivery traded as high as $38 a barrel -- a level the futures market hasn't seen since the all-time high of $41.15 in October 1990.

The April crude contract closed at $37.70 a barrel, up $1.64, on the New York Mercantile Exchange.

"If inventories can't build now, they certainly won't build in the first two to three weeks of a military strike on Iraq," said John Person, head financial analyst at Infinity Brokerage Services.

In a wartime environment, oil shipments will be delayed due to security checks, he said, adding: "This is the real concern to address."

Heating-oil and gasoline futures also moved higher on Nymex, on the back of supply declines detailed in the latest industry data released earlier Wednesday.

Heating oil for March delivery closed at $1.155 a gallon, up 3.23 cents. Futures prices for the commodity briefly reached an all-time high -- $1.18 a gallon -- on Tuesday.

Meanwhile, March unleaded gasoline rose 1.05 cents to $1.0183 a gallon.

"We're seeing better-than-expected demand in gasoline, heating-oil demand that's gone off the map and crude inventories that stand at their minimum operating levels," said Phil Flynn, senior analyst at Alaron.com.

"It's not just Iraq," he said by way of explanation. "It's tight supplies."

Early Wednesday, the Energy Department reported a decline of 1 million barrels in crude inventories, while the American Petroleum Institute said stocks rose by 3 million barrels.

Flynn said the discrepancy was likely a correction from last week, with the API effectively catching up with the Energy Department's figures.

But total crude inventories of around 271 million barrels are quite near the 270 million barrels that the government set as the minimum stock level at which refineries can continue to operate normally. The stocks are 16.3 percent below where they stood a year ago.

Higher prices on tap

The low inventories have prompted many analysts to forecast higher oil prices in the run-up to a potential war on Iraq.

Based on the state of inventories among other factors, crude "remains susceptible for price increases," said Infinity Brokerage's Person.

Other factors include what seems an impending war in the Middle East, export reductions from Venezuela, refinery problems and severe weather conditions, he said.

John Vail, senior strategist at Mizuho Securities USA in Chicago, also sees higher oil prices in the short term.

"The inventory data is so worrisome that it may prevent a decline in oil prices in the short term until the Iraq situation is clearer," he said.

On the other hand, analysts believe that in the event of a quick U.S. victory against Iraq, oil prices will likely drop significantly. See Thom Calandra's StockWatch.

"Crude-oil prices will ease once markets are satisfied that there is sufficient progress in the military campaign against Saddam and that oil fields in Iraq and -- more importantly -- in neighboring countries are secured," said Economy.com oil economist Thorsten Fischer.

Near a three-year low

A closer examination of the latest supply reports showed that distillate inventories fell for a sixth-straight week -- to a level not seen in nearly three years.

The Energy Department reported a whopping 4.5 million-barrel decline in distillate inventories, which include heating oil. Total supplies of 99.1 million barrels are below 100 million for the first time since May 2000, the agency said.

Separately, the API pegged the drawdown at 3.2 million barrels, to 103.8 million. Research firm IFR Pegasus had expected distillates to fall by as much as 4 million barrels on the week.

Distillate inventories have dropped more than 20 million barrels since the week ended Jan. 17, according to Energy Department data. They're now 25 percent below their year-ago level.

Gasoline inventories also declined last week, falling by 3.1 million to 208.1 million barrels or by 792,000 barrels to 209.9 million barrels, according to the respective readings by the API and the Energy Department.

IFR Pegasus had expected gasoline supplies to be down by as much as 3 million barrels. Total stocks of gasoline are 5.1 million barrels below the year-ago level, according to the government data.

Gasoline demand fell last week, but only by 480,000 barrels to a level of 8.36 million barrels per day, said Tom Kloza, chief oil analyst at The Oil Price Information Service.

The two-week average demand figure of 8.6 million barrels per day "is a level which appears more logical for May than February," he added.

Natural gas in retracement

Natural gas for March delivery closed sharply lower following a jump to an all-time high on Tuesday.

The heating fuel has been driven higher by lingering concerns that cold weather throughout much of the U.S. will result in shortages.

March natural gas closed at $9.133 per million British thermal units, down 44.4 cents on the session. On Tuesday, it rose as high as $10.50, moving well past the previous record of $10.10 dating from December 2000.

Natural gas for April delivery, which became the lead-month Nymex contract at the session's close, rose by 80.6 cents to $7.39 per million British thermal units.

The Energy Department will issue its weekly update on supplies of natural gas Thursday. Inventories stood at 1.168 trillion cubic feet as of Feb. 14 -- 868 billion cubic feet below the year-ago level.

Analysts at Fimat USA expect a hefty drawdown in natural-gas supplies -- on the order of 138 billion cubic feet, although other market estimates are higher. A year earlier, supplies fell by 73 billion cubic feet.

Geopolitical backdrop

In war-related news, Turkey reportedly halted the movement of oil tankers through its border crossing with Iraq and told any tanker drivers already in Iraq to return to Turkey, said Person.

Meanwhile, Iraqi leader Saddam Hussein said he would rather die than go into exile, as some have suggested as an alternative to war. He made the comments during an interview earlier this week with CBS News. See Special Report: Countdown to War.

And chief U.N. weapons inspector Hans Blix indicated that Iraq is showing signs of better cooperation by reporting the discovery of two bombs, one of which could have a biological agent.

President Bush continued to urge the U.N. to support military action against Iraq, but British Prime Minister Tony Blair said that Saddam has "one further final chance" to disarm in compliance with U.N. demands.

Mizuho Securities' Vail believes that if Saddam blows up his own oil wells as some speculate, oil prices won't rise to the $80 level some analysts talk about because his supply is "not a major world factor now."

If Saddam doesn't destroy his own fields, "the initial reaction to a U.S. strike will likely force the oil price quickly lower," he said.

All-in-all, the progress of the war will determine whether oil prices and global economies recover or not," he said.

Comments from Energy Secretary Spencer Abraham pressured energy futures off their intraday highs on Tuesday. He indicated that the Bush administration would tap into the Strategic Petroleum Reserve in the event of a war-inspired disruption in Iraqi oil exports.

Vail suggest that the U.S. start releasing oil from its oil reserve because 600 million barrels of oil "should not just be sitting there."

"Combined inventories are too low and shortages are likely unless it is done," he said.

In the equities arena, most oil-service shares closed higher, with the Philadelphia Oil Service Index ($OSX: news, chart, profile) up 1.5 percent. See full story.

Also on Nymex, gold futures prices also closed higher amid a resumption of weakness in the broader stock market. See Metals Stocks.

The Reuters/CRB Index, a broad-based measure of the commodity futures market, closed at 245.2, up 1.1 percent, on strength in gold and petroleum futures. Myra P. Saefong is a reporter for CBS.MarketWatch.com in San Francisco.