The week is starting off with a modest round of short covering as concern grows over the escalating situation between Russia and Georgia. The fighting has intensified even as the President of Georgia has signed a cease-fire pledge proposed by diplomats from the European Union. Originally there was talk of a major oil pipeline in Georgia being bombed but the Russian military indicated strongly they were not bombing or targeting any oil pipelines. As it looks right now, this situation does not seem likely to impact the flow of oil and as such should be a minor driver in the overall oil picture this week.
The other main drivers that may play out this week are:
The progress of repair to the BTC people, which could take longer than originally expected 15 days.
Nigerian militants issuing warning of new attacks.
Iran’s absolute rejection of the latest round of incentives from the West.
This week’s snapshot of the short term fundamentals. The market will not only get the normal weekly snapshot of oil inventories and demand but this week both the EIA and IEA will release their latest monthly oil market assessments. All are likely to impact price direction. The market will be looking very closely at all of the demand related information in each of the reports as many participants try to determine if the demand decline seen this year is temporary or more structural.
There are two tropical disturbances in the eastern Atlantic. Both have a moderate probability of strengthening over the next few days. It is way too early to determine their direction as they are both moving slowly westward and are still very far away.
The main driver last week and likely to be this week is the direction of the U.S. dollar.
Energy trading was dominated by the U.S. dollar last week especially on Friday. The dollar surged higher in its best one day performance in six years as traders are becoming extremely concerned over the evolving slowdown in countries other than the United States, in particularly Europe. Now that most of the bad news about the U.S. economy seems to have already been priced into the market concerns have switched to the slowing economies of Europe and Japan. As a result the likelihood of the European Central Bank (ECB) raising interest rates anytime soon is extremely low. Rather it now seems that the ECB may emerge on a path of lowering rates just as the U.S. Fed may be embarking on a path, later in the year, of raising interest rates. That all simply screams bullish for the dollar and thus bearish for oil and most other commodities. The dollar has breached several resistance levels versus the Euro over the last month or so and has clearly broken out of the trading range it has been in since earlier this year and is now trading at levels not seen since mid-February, 2008. The dollar peaked in mid-2001 and is now at the very end of the normal bullish/bearish cycles for the currency. The dollar may finally be in the very early stages of a long term strengthening pattern and thus bearish for oil.
The CFTC released their latest Commitment of Traders Report. The non-Commercial or Speculative sector held relatively steady with their net long position even as the EMI Composite Price index declined strongly last week (see chart below). As we discussed last week the current net long position of the spec community is now back to where it was in early Feb of 2007 when the price of the EMI Composite Price Index was about $65/bbl and as such price has lots of room to correct lower. Last week the price correction continued strongly also indicating that the Commercial or hedging community may have also been on the sell side. Even with the current downside correction to date price is still way over-valued versus the minimal size of the spec net long position.
The downside momentum is still strong enough to carry prices down to the lower end of the current trading range (see table at the end of the report). The correction will be interrupted with bouts of short covering as we are seeing this morning as the world remains susceptible to interruptions in oil flow from both Geopolitical events and natural disasters like hurricanes. For the moment the market sentiment is strongly bearish resulting from the firming of the U.S. dollar and demand restraint. All other drivers are being discounted for the moment but are helping to slow the down move a bit.
On the demand side the consumer has seen retail gasoline prices beginning to decline but not nearly as much as seen on the Nymex which is a wholesale price. The national average retail gasoline price has declined about 40% of the Nymex wholesale price so far. Or in other words the short term relationship between retail and wholesale gasoline prices is roughly at a rate of each $0.01/gal decline in the Nymex RBOB gasoline price the National Average retail price has decline $0.0040/gal. Barring any unforeseen events impacting the direction of the market we can expect to see retail prices fall at least another $0.40/gal which would bring the national average down to about $3.40/gal.
We are still bearish and believe prices have more to go on the downside as we also believe the dollar will firm further. The spec community should continue short side trading but very cautiously using tight trailing stops. Buy side hedgers should be looking for the market to stabilize before entering any new buy side hedges.
Currently prices are firm on the Georgian/Russian conflict while the dollar is trading either side of unchanged.
Current Expected Trading Range
Expected Trading Range
8/11/08
Change
Low
High End
From
End Support
Resistance
8:31 AM
Yesterday
Sep WTI
$116.26
$1.06
$110.00
$120.00
Sep HO
$3.1676
$0.0396
$3.0700
$3.3500
Sep RBOB
$2.9100
$0.0226
$2.8100
$3.0000
Sep NG
$8.368
$0.120
$8.100
$8.650
Euro/$
1.4989
0.0007
1.5290
1.5550
Yen/$
0.9133
0.0043
0.9200
0.9470
Dominick A. Chirichella
Energy Management Institute
dchirichella@mailaec.com
www.energyinstitution.org
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