Most observers see the drop in the oil price - which Thursday fell - as collateral damage from weakening consumption, itself driven by the credit crunch. But the link between the two may be more direct: The banking crisis is reducing financial flows that normally propped up the oil price.
Banks are either refusing or tightening up credit conditions in a long chain that starts in the ports of oil-producing Middle Eastern and African countries, goes through tankers and refineries and ends up in gas stations in Europe and the U.S. Less crude is being purchased while buying is increasingly being concentrated in the hands of a smaller number of companies - mostly oil majors and large retailers - that are able to bargain for lower prices.
"The credit crunch is putting on a brake at every level of supply," said Antoine Halff, deputy head of research at brokerage Fimat USA. "Levels of credit are evaporating, so producers and refiners are having a hard time selling -they want to make sure their customers are good for the money," Halff added.
"The oil trade relies on credit lines, so the freezing of credit is making the system less optimal," agreed Olivier Jakob, an analyst at Petromatrix.
Cash-rich majors are set to gain more bargaining power with national oil companies, as the latter are now less willing to deal with credit-starved smaller players, said crude traders and an oil industry banker. "Those who don't have their own oil (as possible collateral) are in trouble. Nobody wants to sell to them," said the banker. In contrast to pure traders who rely on letters of credit or credit lines for spot cargoes, oil majors are both buyers and sellers, meaning they have their own cash and crude reserves.
Shippers - who bring tankers from the ports to consuming countries - are also seeing a reduction of available credit, with some of them going under as a result. On Monday, For instance, well-known Swedish company Svithoid Tankers went into liquidation after facing an immediate liquidity shortage. Global shipping loans dropped 23% to $13.31 billion in the first half of 2008 from the same period last year, according to data from Reuters Loan Pricing Corp., leading to a scarcity of available capacity for shipping.
"Even with the credit crunch, there is still a capacity crunch," said Drewry Shipping Consultants Ltd. in a report last week.
To make matters worse, some of the major investments banks that are currently under stress - such as Morgan Stanley (MS) - are also an important part of the oil chain. "They hold storage, are active physical traders and some of them actively participate in the physical delivery process," said Petromatrix's Jakob. A large refinery such as U.K. chemicals producer Ineos Group Ltd.'s Grangemounth in Scotland relies on supply from Morgan Stanley. Earlier this month, Ineos itself faced speculation that the company could be close to breaching the covenants on its loan agreements, though the company has said this wouldn't happen.
Indeed, refiners appear to have been affected even more than traders. In a report last week, the International Energy Agency said refiners who rely on letters of credit to facilitate product exports are finding these "increasingly difficult to obtain," the Paris-based agency said, and that higher interest rates are reducing their ability to maximize the value of production. "Were such practices to become widespread it could potentially lead to some refiners cutting runs for financial reasons, despite apparently healthy product margins and demand for products," the IEA said.
Though consumers sometimes feel massive profits are being made at the pump, the credit crunch is also pushing many gas stations owners to the end of their tether and reducing their ability to buy refined products. Jeff Lenard, vice president for communications at the U.S. Association for Convenience and Petroleum Retailing, said "the challenges (of gas station owners) are now accelerated by the credit crunch." Many distributors are passing the impact of tightened credit conditions on to their clients.
In testimony before members of the House of Representatives in May, Bill Douglass, chief executive of Texas-based Douglass Distributing Co., said distributors servicing retailers are "running into their own credit limits in their efforts to keep their customers supplied with fuel" and as a result, have cut the time for making payments from 10 days to seven or fewer.
So far, Tim Rogers, owner of California-based distributor and retailer Tower Energy Group Corp., can consider himself lucky. Rogers said this week he expects to sign a new, $150 million credit line Friday. But it took longer than a previous line because it involved four banks instead of two and the interests will be higher - two points above the London interbank offered rate, or Libor, instead of 1.5 points before.
But when banks fail to renew credit lines, it can trigger a domino effect as experienced by Atlanta-based natural gas marketer Catalyst Energy Group Inc. earlier this month. Catalyst filed for Chapter 11 bankruptcy after its credit line with independent distributor Constellation Energy was suddenly ended. Constellation was a trading partner of Lehman Brothers Holdings Inc. (LEH), and its stock price collapsed with the fall of Lehman, precipitating its own sellout toBerkshire Hathaway's (BRKA) MidAmerican Energy Holding Co. Catalyst itself is now being sold to fellow retailer MX Energy Inc.
With smaller players diminishing in numbers - 6,000 gas stations have disappeared in the U.S. in the past two years - the largest of the survivors, such as Wal-Mart Stores Inc. (WMT), may have the upper hand in negotiations with sellers of products. Lenard said those large buyers, facing less competition, can "probably" negotiate lower prices. "If you can get more of the same product, you can get a discount," he said.
-By Benoit Faucon and Angela Henshall, Dow Jones Newswires; +44-20-7842-9266; benoit.faucon@dowjones.com
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