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August cover


Crude prices rise sharply over three-day period. Here's what happened:
Cost Management Solutions    
Cost Management Solutions
Crude prices surged over three trading sessions on Aug. 27, 28 and 31. We were not surprised by the jump on Aug. 27 as crude was overdue for a correction and there were a number of traders shorting crude. When traders short crude, they are committing to sell it for a certain price in the future, but they do not own the barrels they plan to sell. Instead, they are anticipating a fall in crude prices and plan to buy the crude later to fulfill their obligation. The amount the market drops from the time they commit to the sale to when they buy to cover the short represents their profit.

When prices fall, crude shorts are in a profitable position. The more prices fall, the more pressure there is to lock in profits. Markets are driven by fear and greed. When a trader is up on a short position in a falling market, he still hesitates to buy to cover when prices remain in a downtrend. In this case, the greed factor drives his decisions. However, as soon as crude prices start moving higher, his greed quickly turns to fear of losing profits. Then, the desire to buy crude to close his short position and protect the profits becomes very strong.

As we discussed last week, when the market becomes short on crude, as it had during this long downtrend that began June 24, the potential for a sharp price increase driven by short covering is present. A rebound in equities markets and a disruption in some of Nigeria’s crude exports were enough to push prices just high enough to trigger the fear necessary to begin the short covering rally on Aug. 27. Buying to cover short positions helped drive crude prices higher, which triggered more short covering that began to feed upon itself. At the end of the trading day on Aug. 27, we were not shaken or stirred because we had anticipated the movement well in advance.

On the morning of Aug. 28, crude prices began to retreat and things seemed to be progressing normally. We anticipated that crude prices would soon be back in their downtrend. We were stirred when crude prices suddenly took off again midmorning on Aug. 28. A rally in gasoline prices resulting from a spat of refinery issues, especially on the East Coast, seemed to be the catalyst for driving crude prices higher. Crude prices outpaced the gains in gasoline by the end of the day due to more short covering. The rally certainly caught our attention, but we were still sure it would falter once the excitement about the refinery issues faded.

We were shaken on Aug. 31, when the rally continued, quite strongly, into a third day. Traders had the weekend to calm down, but it appeared they hadn’t. By the time the smoke had cleared, West Texas Intermediate had touched a high of $49.33 after being traded to a low of $37.75 only five trading days earlier.

Crude prices gained a big boost Aug. 31 when the Energy Information Administration (EIA) released U.S. production data based off a new method of gathering and calculating production. The new reporting methodology resulted in a downward revision of what crude production had been reported. The new data showed a drop in production of slightly more than 300,000 barrels between the April and June reports. The result was a big boost to crude prices just when it looked like the two-day rally was fading.

Featured photo

The chart above plots U.S. production using the new methodology. The data shows U.S. production had fallen to around 5 million barrels per day (bpd) prior to 2008. Production began to rise after that point primarily due to production from shale formations. Production continued to increase until April of this year when it reached 9.612 million barrels.
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The new data shows production began falling in May with a 212,000-bpd drop. Production fell another 104,000 bpd between May and June. The total drop from the peak has been 316,000 bpd. The drop was more than markets were expecting. Indeed, if U.S. production is falling, the conclusion is that global crude supply and demand could balance out sooner than expected.

After a steep downward correction on Sept. 1, crude moved higher the next two days and appeared to regain the upside momentum. Fundamentally, crude still seems vulnerable with a lot of questions concerning demand. However, if this downtrend in U.S. production does not abate, crude traders could remain motivated to stay in buy mode. If so, this will provide more support for propane prices through the end of the year than we anticipated a few weeks ago. Crude markets remain very volatile, so crude’s price direction could go either way at this point. As propane buyers, we will have to keep a close eye on these developments.


A weaker-than-expected build in propane gave prices support. Crude eked out a higher week, which was kick-started by an EIA crude production revision on Monday, Aug. 31.

Our outlook for this week: Crude and propane remain in an oversupplied position. With the volatility of the week, we see no substantial trend to the upside, and a large amount of downside does not appear in the cards, either. That puts us in a neutral view of the markets this week.

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Last Week's Highlights
An EIA revision that crude production was not as high as previously reported gave a big kick to prices.
The market had time to completely digest the EIA production revisions and the market came away not as concerned, taking back some of Monday’s strong gains. A report from China’s manufacturing data showed continued slowing added to the weakness.
Propane inventories only showed a 620,000-barrel inventory gain – about half of what the industry was expecting. Propane prices managed to move a penny higher in Mont Belvieu and $1.75 higher in Conway on the inventory data.
Crude stayed in positive territory, mostly due to a higher equities market. As is normally the case, propane found its direction from crude prices, though it outpaced crude on a percentage basis.
Propane prices finally gave back some of the gains on the week, as crude and equities fell because job reports didn't seem to give the federal government any clear direction on potential rate hikes. The equities market didn’t like the federal government’s indecision and sold-off equities.

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