Over supply of oil takes backseat to dollar

“Fortune knocks but once, but misfortune has much more patience.”

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EMI QuickView Short Term Market Overview

Impact on Energy Prices

Price Drivers

Crude

Gasoline

HO/Diesel

Nat Gas

Supply

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Demand

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N

Inventories

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N

US Dollar

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Global Equities

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10 Yr Treasuries

N

N

N

N

Geopolitics

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Technicals

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N

Market Sentiment

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Overall View

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N

Bias

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N - Neutral Bu - Bullish Br- Bearish CBu - Cautiously Bullish

CBr - Cautiously Bearish

The U.S. dollar influenced buying of oil continued throughout Tuesday’s session even as equities were on the defensive all day. As discussed in detail in yesterday’s newsletter oil is all about the externals and in particular the ongoing weakness of the U.S. dollar. At this point in the oil rally nothing else seems too much matter — not the fact that oil is strongly oversupplied or the fact that the global economy is slowing and oil consumption growth will also slow resulting in the current oversupply situation becoming even more oversupplied. In fact the main oil growth engine of the world, China, is projecting a slowing in crude oil demand during the third quarter as the slowing Chinese economy cuts into consumption of diesel fuel. According to China National Petroleum Corp’s research unit the economy is cooling as the government throttles back credit and pushes energy efficiency. This does not sound like a scenario that supports the current surge in oil prices.

In addition Wednesday’s round of U.S. economic data continued to confirm the slowing of the U.S. economy. Today U.S. factory orders declined by 1.2% in June compared with a projection for only a 0.5% decline. This is not only a negative for the economy but rings home very directly to the oil complex as factory orders decline so does the demand for transportation fuel to move raw materials to the factories as well as finished goods to the consumer markets. It has become a major divergence in my view that oil can continue to move higher unabated with literally little real support other than the lower dollar. Even equities were lower all day on Tuesday suggesting a weakening of the U.S. economy.

Also another point to consider with oil prices now trading at a three-month high is the price of oil is becoming more and more unattractive to the consumer market. There is no sheltering the consumer from the high price of oil as the United States not only buys its oil in U.S. dollars it also consumes it in U.S. dollars resulting in the threshold for elasticity of demand remaining constant. As such it will not take oil to move too much higher before the consumer who is already living and struggling through a fragile economic recovery once again starts to reduce their consumption habits for transportation fuels. In addition cost conscience oil intensive companies may rethink any expansion growth as higher oil prices negatively impact their margins. In a nutshell higher oil prices will also result in slowing oil consumption growth even further.

Although it is still a non-event, NOAA announced another new weather pattern forming in the Caribbean even as recently announced Tropical Storm Colin fizzled out overnight. At the moment the new pattern is a low probability weather pattern with just a 20% chance of developing into a tropical cyclone over the next 48 hours. The tropical storm season has been a non event so far and as such the hurricane risk premium has also diminished a bit, although one would not know that with oil prices trading around $82/bbl. Weather does not look like it will have an impact on oil prices in the very short term or at least for the rest of this week at a minimum.

The September WTI/Brent Spread has moved strongly in the direction of our recommendation of short WTI/long Brent as shown in the following chart. As I projected WTI is now trading at a discount to Brent as inventories are at record high levels in PADD 2 and Cushing, Ok. As is normally the case the spreads tend to follow not only the technicals but also the fundamentals...unlike the flat price market. The way WTI is surging one would expect the WTI/Brent spread to be moving in the opposite direction then what it is. However, rising inventories are much more of a factor than the perception that is driving the flat price market. I continue to expect this spread to deteriorate further. In fact in Tuesday afternoon’s API oil inventory report they showed Cushing stocks increased another 660,000 barrels while PADD 2 stocks rose about 550,000 barrels further supporting our bearish view for this spread.

The API oil inventory numbers are summarized in the following table along with a comparison to last year and the five year average for the same week assuming that the EIA data is in sync with the projections. The API reported a decline of about 800,000 barrels in crude oil stocks as imports declined by 1.4 million barrels per day offsetting the fact that refinery utilization rates decline by 0.7%. However, even if the EIA data is in line with the API data the overhang of crude oil inventory will remain in double digit figures compared to both last year and the five year average for the same week.

Projections

8/4/10

API

Current

Change from

Change from

Results

Projections

Last Year

5 Year

mmbls

vs. Proj.

vs. Proj.

Crude Oil

(0.8)

(0.5)

10.8

32.8

Gasoline

2.3

0.5

9.9

15.2

Distillate

1.1

1.0

7.0

31.1

Ref Change Level

-0.7%

-0.4%

5.7%

0.2%

Utilization %

86.7%

90.2%

84.5%

90.0%

On the refined product front the API reported a build in distillate fuel that was within the expectations while showing a gasoline build that was significantly higher than the projections. As has been the case many times this year each time we see a decline in crude oil stocks it normally results in a refined products inventory build far exceeding the crude oil decline. This was the case in the API report which resulted in yet another increase in total commercial stocks of crude oil and refined products raising the overhang even further.

I view the API report as bearish even though crude oil stocks declined as explained above. If the EIA data is in line with the API report it will also be bearish. However, it is a another matter as to whether or not the market will react to a bearish fundamental report as history (the last 17 months or so) tells us that if the dollar is falling and/or equities are rising the market will quickly discount a bearish inventory report and focus solely on the externals. The market all but ignored the bearish API report in Tuesday afternoon on two fronts...falling US dollar keeping oil prices firm and the normal concern that the more widely followed EIA data may not be in line with the API data. The more interesting situation will be to see how the market reacts to the EIA report if it too is bearish. Currently the externals are not supportive for oil prices in early trading.

On the external front Tuesday was all about the falling U.S. dollar. Equity markets declined but oil investor/traders pretty much ignored equities as well as the bearish economic indicators that come out on Tuesday. The US equity markets were lower across the board and that trend has carried over into the Asian and European markets as shown in the EMI Global Equity Index table below. The Index gave back some of the gains from earlier in the week (about 0.5%) but it is still up 1% so far with the year to date loss at 1.9%. Most equity market participants are starting to position themselves for several US employment related indices that start hitting the media airwaves this morning and culminating with the big on Friday morning.

EMI Global Equity Index

8/4/10

Change

Change

2010 YTD

2010

From

From

Change

6:46 AM

Yesterday

Yesterday %

%

US/Dow Jones

10,636

(38)

-0.36%

2.0%

Can/S&P-TSX

11,783

69

0.59%

0.3%

Lon/FTSE

5,326

(70)

-1.30%

-1.6%

Paris/Cac 40

3,723

(25)

-0.67%

-5.4%

Germany/Dax

6,273

(35)

-0.55%

5.3%

Japan/Nikkei

9,489

(205)

-2.11%

-10.0%

HongKong/HangSeng

21,549

92

0.43%

-1.5%

Aussie/SYDI

4,542

(30)

-0.66%

-7.0%

China/Shanghai A

2,765

12

0.44%

-19.6%

Brazil/Bvspa

67,997

(520)

-0.76%

-0.9%

EMI Global Equity Index

14,408

(75)

-0.52%

-1.9%

My individual market views are categorized in the table at the beginning of the newsletter. Everything remains the same for the oil complex but I will caution all that oil is very oversold and susceptible to a modest round of profit taking selling at any time. The market is starting to gear up for the big economic event of the week, U.S. non-farm payroll number and unemployment rate on Friday. Any deviation from the expectations will likely result in a strong swing in prices for both the financials and oil complex as Friday’s in August are typically low liquidity trading days. I strongly recommend that any long side flat price trader’s work with tight, trailing stops as a price reversal can happen at any time.

Currently the energy complex is lower on the back of a firming US dollar and weaker equity complex as equity futures are pointing to a lower open on Wall Street this morning.

Current Expected Trading Range

Expected Trading Range

8/4/10

Change

Low

High End

From

End Support

Resistance

6:46 AM

Yesterday

Sep WTI

$82.02

($0.53)

$76.80

$84.50

Sep Brent

$81.81

($0.87)

$76.00

$84.00

Sep HO

$2.1894

($0.0106)

$2.0000

$2.2000

Sep RBOB

$2.1819

($0.0116)

$2.0300

$2.1800

Sep NG

$4.665

$0.026

$4.680

$5.000

10 YR Treasuries

124.11

0.13

118.00

124.00

Dow Futures

10,571

(23)

10,150

10,850

US Dollar Index

80.76

0.076

80.150

82.550

Euro/$

1.3206

(0.0016)

1.2700

1.3100

Yen/$

1.1705

0.0052

1.1400

1.1650

Best Regards

Dominick A. Chirichella

dchirichella@mailaec.com

Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.

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Information and opinions expressed in this publication are intended to provide general market awareness. The Energy Management Institute and the Energy Market Analysis are not responsible for any business actions, market transactions, or decisions made by its readers based on information published in this report. Readers of the Energy Market Analysis use this market information at their own risk.

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About the Author
Dominick A. Chirichella

Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.

EMA has authorized Futures to publish its report once a week on Wednesday prior to the EIA release. For information on how to receive the report everyday look below.

PH: (888) 871-1207

Email info@energyinstitution.org

Subscribe here Free Trial Here

Information and opinions expressed in this publication are intended to provide general market awareness. The Energy Management Institute and the Energy Market Analysis are not responsible for any business actions, market transactions, or decisions made by its readers based on information published in this report. Readers of the Energy Market Analysis use this market information at their own risk.

This message and any attachments relate to the official business of the Energy Management Institute ("EMI") and are proprietary to EMI. This e-mail transmission may contain information that is proprietary, privileged and/or confidential and is intended exclusively for the person(s) to whom it is addressed. Any use, copying, retention or disclosure by any person other than the intended recipient or the intended recipient's designees is strictly prohibited.

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