There are several research upgrades and downgrades this morning that may feel meaningless in the overall scheme of things due to the international headlines coming from Japan and the Middle East. The idea is to look beyond today for the longer-term picture with high oil.  Goldman Sachs  raised Exxon Mobil Corp. (NYSE: XOM) to ‘Buy’; cut Occidental Petroleum Corp. (NYSE: OXY) from its ‘Conviction Buy’ list; and cut Devon Energy Corp. (NYSE: DVN) and Murphy Oil Corp. (NYSE: MUR) to ‘Neutral’. Bank of America Merrill Lynch also raised Chevron Corp. (NYSE: CVX) to ‘Buy’.

The upgrades are no doubt the result of higher valuations for the oil companies based on prices and announced reserves. The ink was barely dry, though, before prices took a serious turn southward, raising the question of when the decline would stop.

For the past month, oil prices have been rising steadily in response to fears of supply disruption in North Africa and the Middle East. Brent crude reached about $117/barrel and WTI topped $104/barrel. Fear probably contributed about $10/barrel to that price. The lack of a strong demonstration in Saudi Arabia was probably the single biggest reason for declining fears for supply from the Middle East.

What remains of the fear premium has now been almost wiped out by the events in Japan. Brent crude has fallen below $109/barrel and WTI has fallen below $98/barrel. Deteriorating demand from Japan contributes to the decline, as two refineries are still on fire and three others are shutdown. These five refineries have a combined daily capacity of 1.5 million barrels, nearly a third of the country’s refining capacity.

On top of that, the International Energy Agency has reported in its monthly report for March that crude supplies globally have reached an all-time high. The supply will only grow as refineries head into the spring turnaround and maintenance season. The IEA reported February supply reached an all-time high of 89 million barrels/day.

Libya’s 1.6 million barrel/day output has been effectively shutdown by the fighting between government and rebel forces. But supply from the other members of OPEC, particularly Saudi Arabia, have made up for the loss. Increased production from Alaska and Russia have more than made up the difference.

Demand for crude oil in Japan is not likely to reach pre-quake levels for some time. The extent of the damage to the burning refineries will determine demand recovery. In the meantime, refined products imports will have to increase at least somewhat to pick up the slack. That would include gasoline, diesel fuel, and heating oil.

Japan has lost about 7% of its total electricity generating capacity, and it will have to make this up with coal-, oil-, or natural gas-fired generation. The largest impact will be on the liquefied natural gas (LNG) suppliers, which could be called upon to boost shipments by as much as 1 billion cubic feet/day.

The abundance of crude supply and the capacity for refiners to ship products to Japan without strain probably point to an overall drop in crude prices to around $95/barrel for WTI and $105/barrel for Brent. It does not seem likely that the prices will dive another $5/barrel, but betting on the price of crude even a week in advance is best left to the professionals.

Paul Ausick

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