Oil turns bullish on supply and election

“Virtue does not come from wealth, but...wealth and every other good thing which men have... comes from virtue.”

Socrates

Event one came in as expected with the Republican party capturing the US House and making solid gains in both the Senate and governorships across the country. The American public clearly sent a message of no more politics as usual in Washington DC. The American people want a new direction as the current Administration policies have not produced jobs nor has it put the economy in a solid recovery. The vote clearly was a rebuke of big government, big spending and big bailouts as the US economy continues to face a very sluggish recovery and growing deficits. As much of yesterday’s historic election results (more House seats moved to the Republican side ...about 65 seats ... or the largest party turnover in over 70 years) were expected and priced into the market the actual results were directionally better than many of the polls indicated and should prevent much of a sell the fact day on Wall Street. The big question facing the US will be can a change in the mix in Washington DC be enough to get the economy moving in the right direction? Most analysts on Wall Street think it will certainly be enough to slow down or even stop the unpopular legislation that has occurred over the last two years and even possibly result in the repeal of the very unpopular and costly health care bill. As such the market has been viewing a takeover by the Republicans in the House as a positive for markets as less government intervention into the business mix is likely to be one of the main results going forward. Even a sort of gridlock has been viewed favorably as no new costly legislation is likely to emerge over the next several years.

In addition the next major event of the week hits the media airwaves at 2:15 PM EST today when the results of the US Fed FOMC meeting is announced. The market has priced in a new round of quantitative easing of around $500 billion dollars spread over a period of time (months). The Fed is likely to leave QE2 open ended with no definitive cap at this time other than it will continue as long as the economy requires it to continue. With the new mix in Washington DC the likelihood of any new fiscal stimulus program is highly unlikely and as such the only stimulus program that will emerge in the US will be QE2. Whether or not it jump starts the economy or just creates more inflation risk is a whole another discussion but for today it is likely to become a fact.

So far the global equity markets have viewed the US mid-term election results positively as the EMI Global Equity Index has continued to add value over the last twenty four hours as shown in the following table. The Index is now higher by 1.6% for the week resulting in a widening of the 2010 year to date gain to 4.2% or the largest gain for the year so far. Most of the Asian markets gained ground today with only China’s Shanghai A shares receding modestly on the day. With two more major events yet to hit the media airwaves this week’s equity trading has been cautious with a significant amount of cash still sitting on the sidelines looking for a window of opportunity to reenter the equity markets. I think it will once the sell the fact possibility is clearly behind the market. Most interestingly we have not seen any equity selling now that the US election is a known fact. At the moment the global equity markets are supportive for oil and the broader commodity complex which is consistent with the view coming from the currency markets as the US dollar remains marginally lower ahead of the Fed announcement this afternoon..

Late yesterday afternoon the API released their latest inventory assessment. The API released a strongly bullish inventory report showing a surprisingly larger than expected across the board build and a modest decline in refinery utilization rates versus expectations for a mixed report with more modest changes in inventories. The API reported a crude oil inventory draw of about 4.1 million barrels along with a large decline in gasoline stocks of just 3.2 million barrels while distillate fuel stocks declined yet again by a whopping 4.7 million barrels versus most expectations calling for a decline of about 900,000 barrels. The results of the API report are summarized in the following table along with my projections for this week’s EIA 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 bullish side and has contributed to the overnight gain in prices even though the US dollar and global equity markets are only marginally supportive for oil prices so far this morning.

As usual do not overreact to the API data as the more widely followed EIA data will hit the media airwaves at 10:30 Am EST today. 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 bearish side as total commercial stocks of crude oil and refined products are likely to have increased marginally. However, if the EIA data is more in sync with the API report we could see a strong surge in oil prices as total inventories would have destocked by over 12 million barrels on the week (sum of API inventory declines) and that is a very bullish outcome. With the election now in the history books and the Fed meeting results not due out until this afternoon this morning’s EIA report could play a larger than expected role in the short term price direction than originally anticipated.

The more widely watched EIA data is out this morning at 10:30 AM. As mentioned above with the significant surprises coming from the API data the market may be positioned to react more to the fundamental data than expected with the plethora of major events in the marketplace. However, the macros are still likely to be the main price drivers for the rest of this week at a minimum. My projections for this week’s EIA inventory report are summarized in the following table. I am expecting a mixed report with a modest build in crude a small build in gasoline stocks and another atypical modest decline in distillate fuel stocks. If the actual numbers are in sync with my projections for a crude oil build of about 1.5 million barrels it would be a bit concerning indicating that the destocking of late may not be taking hold. As such I would categorize this week’s crude oil inventory data as biased to the bearish side as the year over year surplus will be around 31.8 million barrels while the overhang versus the five year average for the same week will still come in around 45.1 million barrels.