Oil bulls optimistic on data from China

“A creative man is motivated by the desire to achieve, not by the desire to beat others.”

Ayn Rand

Tuesday’s trading saw oil prices trade in both positive and negative territory throughout the trading session as the financial markets also continued to flip-flop throughout the day. Equities started the day in the positive column while the US dollar was losing ground resulting in oil prices firming. However, by mid day the dollar had reversed and sent oil prices back on the defensive in what turned out to be a relatively lackluster trading session even though Gold closed at a new all time record high above $1,300/ounce. The financial markets are currently all about when the US Fed will intervene with a new round of quantitative easing (QE) and what will be the size of the QE. There are now two schools of thought...one expecting a full blown QE program like what occurred in the past and the other (based on a Fed official comment yesterday) expecting a scaled down version. In either case if the economy does not improve over the next few months the likelihood of the Fed intervening is very high. Barring a lot of earnings disappointments when third quarter earnings are released, the market is quickly viewing the Fed’s intention as sort of a put for the equity markets. As such the market sentiment is gaining strength in anticipation of equities continuing to firm which would result in oil prices remaining firm irrespective of the fact that the current fundamentals are still bearish.

Over the last twenty four hours the global equity markets were mixed, but as shown in the EMI Global Equity Index table below the Index has moved into positive territory for the first time since mid-April. The Index is higher by 0.3% for the year to date with Germany still holding the top spot on the leader board. Six of the ten bourses are in the winner column while only China’s Shanghai A shares are still hovering in bear market territory for the year. Most Asian markets gained ground overnight while Europe is starting the day on the defensive. However, the main storyline in the financials is the falling US Dollar. The dollar is currently below the last major support level and losing ground on a negative view of the US economic recovery coming from trader/investors as they focus on last week’s Fed statements.

With runs expected to only grow by 0.1% and demand slowly waning, I am expecting a modest build in gasoline stocks and a normal seasonal build in distillate fuel. Gasoline stocks are expected to grow by about 900,000 barrels as refiners continue to wind down from the higher demand summer driving season and turn their attention to the upcoming winter heating season. This week the gasoline year over year overhang is projected to widen again to around 15.5 million barrels while the surplus versus the five year average for the same week will be at 27.7 million barrels or almost 1 million barrels more than last week’s snapshot. The industry has to work off the surplus that has remained since the end of the driving season pretty quickly or we will see a very quick deterioration in prices followed by a sharp cut in refinery utilization rates.

Distillate fuel likely built by about 1.1 million barrels as economy sensitive diesel fuel implied demand continues to decrease and follow the slowly developing downtrend that has been in place since about May of this year, or around the same time the US economy began to slow down. Implied distillate demand peaked in mid-May at a tad over four million barrels per day and has declined about 10% since then. I would categorize this week’s oil inventory snapshot as biased to the bullish side if the actual EIA data is in sync with the projections. If the actual EIA data is in sync with my distillate fuel projection the surplus versus last year will still be close to five million barrels while the overhang versus the five year average will be near the 32 million barrel market. With early predictions for a mild start to the upcoming winter heating season along with near record high inventory levels, it is highly unlikely there will be any supply driven price surges in heating oil this coming winter season.

As usual do not overreact to the API data as more often than not it is not in line with the more widely followed EIA data. If the EIA report is within the projection I would expect the market to view the results as bearish. However, whether or not the market reacts at all to the report will be dependent on what is going on in the financial markets. If any combination of equities rising and the US dollar declining occurs, the market is likely to discount the inventories and focus more on the perception trade or what the fundamentals might be down the road. On the other hand if the financial markets are not supportive the market will be forced to look at and digest the current fundamentals, which are still simply bearish.

My individual market views are detailed in the table at the beginning of the newsletter. I remain in the neutral corner for oil and cautiously bearish for Nat Gas. I expect this to continue to be a volatile trading week, especially coming from the financial markets as we approach the end of the quarter with many fund managers under allocated to equities and thus likely to result in a modest level of equity window dressing on the week. In addition Nymex spot refined products contracts expire tomorrow which should add another layer of volatility.

Currently the markets are quietly mixed in early morning trading as shown in the EMI Price Board table below.

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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