U.S. heating oil glut sets bull trap

In commodities, timing is everything. A smaller-than-expected rise in reported U.S. crude inventories and a sharp increase in refinery throughput has sent oil prices soaring to six-month highs as investors race to establish long positions ahead of an expected recovery and price upturn in the second half of 2009.

But prices risk getting ahead of reality. Bulls building positions ahead of an expected upturn could be forced to wait much longer than they expect, until well into 2010. In the meantime, the cost they pay to roll each month's futures contracts forward ("contango") will absorb most of any gains they make when prices do eventually rise.

The reported rise in crude oil inventories (600,000 barrels, bbl) was less than a fifth of the increase reported in the previous three weeks and the smallest weekly increase since February. Together with a sharp rise in the volume of crude processed by U.S. refineries (up 2.94 million bbl) the data have been interpreted as an early sign of market stabilisation.

Refinery operating rates jumped by more than 2.3 percentage points. For the first time since June last year, refinery operating rates are above year-ago levels.

With equity markets also rising amid hopes that the worst of the recession may be over and the banking sector may be stabilising, front-month oil prices have risen to the highest level since November 2008.

But a closer look at the data reveals worrying signs of weakness which will keep prices for both crude and refined products under pressure throughout the remainder of the year.

Demand remains exceptionally weak. U.S. consumption of refined products (refinery production + imports - exports) averaged just 18.212 million barrels per day (bpd) in the four weeks ending May 1, down 2.399 million bpd (11.6 percent) from the same four-week period last year. Usage is still falling. There are no signs of stabilisation, let alone recovery.

All petroleum products have been hit with falls in gasoline consumption (224,000 bpd), jet fuel (147,000 bpd) and residual fuel oil (319,000 bpd) reflecting reduced demand from transport (motoring, aviation and shipping) and power producers.

But the brunt of the downturn has been borne by middle distillates (diesel, home heating oil) where consumption has fallen by a huge 661,000 bpd (15.8 percent) against last year.

For the last 3 years, U.S. refiners have been exporting record volumes of distillate to Asia and Latin America to stem the rise in inventories and ease downward pressure on refinery margins, and the pace of exporting seems to have stepped up further this year as domestic demand has dropped away.

But even exports have not been enough to limit the build up of surplus inventory. Low and medium-sulphur distillate stocks are up more than 10 million barrels (11 percent) since early January despite a colder than average winter, and are almost 24 million barrels (28 percent) higher than at the corresponding point last year.

Distillate stocks look set to rise even further over the next four months as refiners produce more diesel and heating oils as an unwanted co-product of the summer gasoline campaign.

By September, the United States will be swimming in heating oil. The overhang will keep refinery run rates at low levels throughout autumn and the first part of the winter as refiners try to work down the excess with the result that any pick up in demand for crude oil is unlikely before the first half of 2010.

-- John Kemp is a Reuters columnist. The views expressed are his own --

By John Kemp

LONDON, May 7 (Reuters) -