Crude Oil: It Is All in the Numbers; When Crude Hit Record Levels in 2006 Many Analysts Complained That the Supply/demand Fundamentals Did Not Justify the Price. Will Crude Prices Continue to Defy Supply Fundamentals in the Coming Year and What Impact Will Weather and Geopolitical Events Have on Prices in 2007?

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$78.40 is a fetching price tag for one barrel of the light, sweet crude oil that trades on the New York Mercantile Exchange (Nymex). Not only is that price a milestone because it is the all-time (front month) intra-day high hit July 14, 2006, but it's one that is likely to be short-lived as U.S. supply/demand balances tightened in the waning weeks of the year, making that an irresistible target to be challenged by energy enthusiasts in 2007.

Total U.S. petroleum inventories declined at one of the most rushed paces on record during the fourth quarter of 2006 while the Organization of the Petroleum Exporting Countries (OPEC) agreed to its first production cut in nearly two years. The cartel agreed to slash supply by 1.2 million barrels per day (bpd) in October at a special meeting in Doha, Qatar, effective Nov. 1. OPEC then agreed to another 500,000 barrel production cut at its Dec. 14 meeting in Abuja, Nigeria, this time effective Feb. 1, 2007, which is just enough time for the market to price in lower supply and to take the bullish edge off the cartel's decision.

While the world's largest oil producers agreed to remove some supply from global markets, America, the undisputed champion of global petroleum consumption, was undergoing a marked decline in inventories during what is typically the highest demand period of the year. Total U.S. petroleum inventories dropped 65.2 million barrels to 1,024 million barrels during the fourth quarter, leaving stocks 49.6 million barrels above the five-year average and 14.3 million barrels above year-ago levels, according to data from the Energy Information Administration (EIA). The bulk of the decline occurred in product inventories, which fell 56.16 million barrels to 704.3 million barrels during the third quarter and only in the final two weeks of the year was the trend arrested. High refiner throughputs while crude imports were at less-than-optimal levels allowed for a recovery in product output.

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However, if refiners were cranking out product, then they were using crude barrels to do so, and the proof was in a reversal in stock building during the fourth quarter that was evident by the 20 million barrel drop in crude inventories during the month of December. Crude inventories were 319.68 million barrels the week ending Dec. 29, the last set of data for 2006, leaving stocks 1.9 million barrels below year-ago levels, but 25.5 million barrels above the five-year average (see: "Reversing course," right).

By comparison, total U.S. petroleum inventories the week ending Oct. 6, which was the start of the fourth quarter, were 102 million barrels above the five-year average and 91.1 million barrels above year-ago levels. The last time total U.S. petroleum inventories were at a comparable level was the week ending May 19 when the active front-month crude contract on Nymex settled at $68.53 per barrel. The active front-month crude contract settled 2006 at $61.05 per barrel., which was a gain of 1 cents year-over-year, or 0.02%.

More important, a reporting error announced by EIA Jan. 3 suggested U.S. crude inventories may have taken a nose dive in the final weeks of 2006 with the data off by as much as 10.5 million barrels. Usually a reporting error works its way through the data over several weeks, but the upshot was U.S. petroleum inventories were not quite as plush as the plummet in prices would have had people believe.

The start of 2007 saw an onslaught of selling that sent crude prices plummeting nearly $6 per barrel in the first two trading days of the year despite fundamentals that had not undergone a structural shift. The same factors that sent petroleum prices surging through the past four years were still intact: a robust global economy provided the underpinning for demand for raw and industrial materials, which thus far has shown no signs of slowing; non-OPEC supply growth had failed to meet market expectations; demand growth has consistently surprised to the upside; and Iran and Western nations were still at a stand-off over the Islamic Republic's pursuit of nuclear capabilities. …