Poor energy fundamentals take charge

In a New York minute

In a New York minute or is it minutes. That is how fast we can pop this economic earnings optimism bubble. The oil market that was previously caught up in the wave of good feelings generated by the Alcoa earnings in the beginning of the earning season started to get dragged down by the bummer reality thing. The first sign of trouble was the American Petroleum Institute report and then a lousy retail sales report followed by an Energy Information Agency supply report that was less then spectacular. The final straw seemed to be the Fed Minutes that wiped away a slew of economic good feelings. Now today you have a report of slower growth in China and a resurgent euro that makes oil traders wonder whether they should focus on weaker dollar or a weaker demand outlook for oil. Yet could big news out of China get oil rolling again?

What was it about the Fed Minutes that seemed to take away from the market besides the statement that the economy has softened somewhat? Well more than anything it was the fact that the Fed feels that they should be ready to consider additional steps to boost the U.S. economy if the economy took another turn for the worse. The thought that the Fed is even contemplating the possibility of even more stimulus is a reminder that despite some good corporate earnings we are still not out the economic woods just yet.

And despite a much bigger than expected drop in crude supplies, oil demand growth is not out of the economic woods just yet either. Oh sure the EIA reported that U.S. commercial crude oil inventories (excluding those in the Strategic Petroleum Reserve) decreased by 5.1 million barrels from the previous week but at the same time we saw a very bearish build in gasoline and distillates. The EIA reported that total motor gasoline inventories increased by 1.6 million barrels last week as gasoline output hit a record high while demand fell back after the holiday. Distillates surged by 2.9 million barrels on surging refinery runs and impressive output.

Yet demand fell flat. David Bird of Dow Jones says that U S total implied oil demand fell 4%, or 780,000 Million Barrels per day to 18.777 million barrels per day which is the lowest level since Apr 23 and the biggest drop since Mar 12. Demand for gasoline, the most widely used petroleum product, fell 3.9% in the week after the Jul 4 holiday, to 9.08 million barrels per day the lowest level since Apr 2. Demand for distillate fuel (diesel/heating oil) fell 422,000 barrels per day 10.7%, to the lowest level since Apr 16. The fall in distillate use was the biggest since Jan 9. And as Barbara Powell at Bloomberg points out despite the drop in crude supply the truth is that oil is still a whopping 7% above the five year average.

For products, in a weakening demand environment, gasoline is 4.3% above the five year average and distillate a gigantic 23.6% above the five year average. Not a very bullish outlook. Even OPEC is saying that we are well supplied. Dow Jones reports that Oil product markets are likely to remain well supplied throughout the summer driving season according to our friendly little oil cartel. "Given ample stocks for both distillates and gasoline, barring extensive unplanned supply disruptions, the risk of a product supply shortage during the upcoming peak season is very limited," OPEC said in its monthly oil market report. (Upcoming peak driving season?) "Additionally, by having 1.1 million barrels a day of new refinery capacity in 2011, it appears that spare capacity in the downstream sector remains relatively high in the short- to medium-term and the likelihood of market developments lifting crude pieces in the future is very marginal."

Of course I can almost hear them saying, what about China? What about China. Well China, as with the rest of the world, can chose to look at the barrel as half empty or half full yet new on their currency exchange rate may knock oil out of the doldrums. Bloomberg News reported that Chinese oil imports may decline from this month’s record high as waning energy demand reduces refining profits. China’s GDP fell more than expected which means slower demand. Right! Well hold everything! Now the Peoples Bank of China according its decision on June to end yuan's near two-year-long peg to the U.S. dollar--was an important step in reforming the country's foreign-exchange regime, and the current regime is in China's long-term and fundamental interests. Dow Jones says that the report suggested China must stick to its current exchange-rate regime even as it constrains monetary policy independence and flexibility. "Given the impossible trinity of achieving monetary policy independence, fixed exchange rate and free capital flow in an open economy, a managed floating exchange rate regime will help enhance the proactiveness and capability of macroeconomic management and the effectiveness of monetary policy, curb inflation and asset bubbles and contain macroeconomic risks," PBOC said.

Oil is also getting support from a successful Spanish bond auction that gave the euro a boost and put pressure on the dollar.

My major point being that you can be bullish or bearish but you should trade like a mercenary. Who needs to be a hero over the long-term when recently you would have more than likely been better off trading the range. We may break out to the upside at some point, yet I believe it will be to the downside and at the end of the day does it really matter? If you want to trade then take what the market is giving you. When the breakout comes there will be plenty of time to jump on the band wagon!

Phil Flynn is senior energy analyst for PFGBest Research and a Fox Business Network contributor. He can be reached at (800) 935-6487 or at pflynn@pfgbest.com

About the Author
Phil Flynn

Senior energy analyst at The PRICE Futures Group and a Fox Business Network contributor. He is one of the world's leading market analysts, providing individual investors, professional traders, and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline, and energy markets. His precise and timely forecasts have come to be in great demand by industry and media worldwide and his impressive career goes back almost three decades, gaining attention with his market calls and energetic personality as writer of The Energy Report. You can contact Phil by phone at (888) 264-5665 or by email at pflynn@pricegroup.com. Learn even more on our website at www.pricegroup.com.


Futures and options trading involves substantial risk of loss and may not be suitable for everyone. The information presented by The PRICE Futures Group is from sources believed to be reliable and all information reported is subject to change without notice.

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