Oil positioning ahead of FOMC and election

“Honesty is the first chapter of the book of wisdom.”

Thomas Jefferson

As I have been suggesting, the market is continuing to position itself ahead of next week’s two main events… the U.S. Fed FOMC meeting and the U.S. mid-term elections. The result is a modest round of dollar short covering which has resulted in oil and most other commodity prices weakening overnight and into this morning’s opening. Further adding to oil price pressure overnight is the significantly larger than expected crude oil build reported by the API last evening coupled with what looks like the beginning of the end of the French oil workers strike as about a quarter of the refinery workers agreed to go back to work yesterday. Although the market generally does not embrace the API data all that much, yesterday’s 6.4 million barrels build on top of non-supportive financial markets was enough to push oil investor/traders in Asia to focus on oil fundamentals which are still well supplied.

The U.S. dollar Index has been firm throughout the overnight trading period with the dollar/euro switch currently trading at a one week high as dollar short covering permeates throughout all of the currency markets. As I have been discussing for weeks, the direction of the U.S. dollar is almost entirely being driven by what the next round of quantitative easing will look like when the much expected announcement is made by the U.S. Federal Reserve FOMC committee next week. This morning’s move by the U.S. Dollar Index is far from a significant move to the upside as it is currently up by only 0.1% (as of this writing) strongly suggesting that what has occurred in dollar trading is all short covering and not yet the beginning of a definitive value reversal to the upside. Heading into U.S. trading, the dollar is mostly neutral to bearish for oil and the broader commodity complex at the moment.

On the global equity front the EMI Global Equity Index has held its ground over the last 24 hours as shown in the following table. The Index is still higher by 0.6% for the week resulting in a widening of the 2010 year to date gains to 2.9%. Most of the Asian markets lost ground today even after a marginally positive close in the U.S. on Tuesday. The view floating around Asia is next week’s expected Fed announcement may disappoint the market in that the magnitude of QE2 may be smaller than most investor/traders have been anticipating. As I said yesterday book squaring is already underway ahead of next week’s events. That said, trading in equities in Europe have been mixed so far with a better than expected earnings report coming from Germany’s biggest bank…Deutsche Bank. In addition U.S. equity Index futures are in negative territory suggesting a lower opening on Wall Street this morning. At the moment, the global equity markets are neutral to bearish for oil and the broader commodity complex which is consistent with the view coming from the currency markets.

Late yesterday afternoon the API released their latest inventory assessment. The API released a relatively bearish inventory report showing a surprisingly larger than expected crude oil inventory build of about 6.4 million barrels along with a larger than expected decline in gasoline stocks of just 1.8 million barrels while distillate fuel stocks built by about 800,000 barrels vs. most expectations calling for a decline of at least 500,000 barrels. The results of the API report are summarized in the following table along with my projections for this week’s inventory report and a comparison to last year as well as the five year average for the same week. So far the reaction to the API report has been biased to the bearish side and has contributed to the overnight decline in prices as both the U.S. dollar and global equity markets are non-supportive for oil prices.

The more widely watched EIA report will be released later this morning at 10:30 am EST. My projections for this week’s inventory report are summarized in the following table along with a comparison to last year and the five year average for the same week. I am expecting a mixed EIA report with a modest build in crude oil (as a result of refinery utilization rates declining marginally and imports still declining) and modest draws in both gasoline and distillate fuel. If the actual numbers are in sync with my projections for a crude oil build of about 500,000 barrels, it would be a bit concerning indicating that the destocking of late may not be taking hold. However, the declines to date have had a marginal impact on the overhang that has persisted in the U.S. throughout the entire economic recovery. As such, I would categorize this week’s crude oil inventory data as biased to the neutral side if the actual results are in sync with the projections as the year over year surplus will come in at 21.8 million barrel mark while the overhang vs. the five year average for the same week will be at 39.1 million barrel mark.

With runs expected to decline by only 0.2% and demand waning, I am expecting only a modest draw in gasoline stocks and in distillate fuel. Gasoline stocks are expected to decline by about 300,000 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 hold at around 10.5 million barrels while the surplus vs. the five year average for the same week will be at 18.6 million barrels. The industry seems to be starting to work off the surplus that has remained since the end of the driving season in an effort to at least put a floor on gasoline prices heading into the winter heating season.

Distillate fuel likely grew by about 0.5 million barrels as economy sensitive diesel fuel implied demand also continues to flat line even with agriculture demand for the harvest along with distillate fuel exports likely having increased as the arb is open and the U.S. dollar is weak vs. most major currencies that are likely recipients of U.S. exports of distillate fuel. If the actual EIA data is in sync with my distillate fuel projection, the surplus vs. last year will likely return to a small overhang of 1.8 million barrels after moving into a very small deficit after last week’s data was released. The overhang vs. the five year average will still be over the 30 million barrel level at 31.1 million barrels. With the U.S. dollar likely to remain on the defensive and the arb window still open, we can expect a continuation of distillate exports from the U.S. going forward which should result in the total inventory level at the end of the building season coming in pretty much in line with last year and possibly even a tad lower.

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 mostly neutral with a slight bias to the bullish side as total commercial stocks of crude oil and refined products are likely to have declined marginally for the second week in a row. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on in the financial markets. If any combination of equities rising and the U.S. 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 (as what currently is the case) the market will be forced to look at and digest the current fundamentals which seem to be improving but still surplus.

The tropical weather situation got a bit more quiet overnight as Richard completely dissipated in the Gulf while the storm in the eastern Atlantic has been downgraded to just a 10% chance of strengthening into a tropical cyclone over the next 48 hours as of this writing. At the moment, there are no other weather patterns in the tropics. With just about a month left to the official hurricane season it looks highly unlikely that the U.S. oil and Nat Gas producing region of the Gulf will be in jeopardy this year.