Oil looking up on taxes and QE2

Yesterday the EIA released their latest Short Term Energy Outlook. The forecast remains overall supportive for the oil complex as shown in some of the main highlights of the report shown below.

Crude Oil and Liquid Fuels Overview. Gradual tightening in global oil markets continues to support world oil prices. Projected liquid fuels consumption growth of 2 million barrels per day (bbl/d) in 2010 is almost double the growth in supply from countries outside of the Organization of the Petroleum Exporting Countries (OPEC), which has led to rising demand for OPEC crude oil production and declining global oil inventories. While overall commercial oil inventories in the Organization for Economic Cooperation and Development (OECD) countries remain high, stock levels are unevenly distributed with some regions experiencing tightness in recent months. Both floating and reported on-shore inventories have been declining, and EIA believes that the projected continued reduction in OECD stocks over the forecast period should lend support to firming oil prices.

Global Crude Oil and Liquid Fuels Consumption. Projected world liquid fuels consumption increases by 2 million bbl/d in 2010, following declines in 2008 and 2009. As a result, total global consumption in 2010 should be close to the 2007 level. Global oil consumption growth slows to 1.4 million bbl/d in 2011. Non-OECD regions, especially China, the Middle East, and Brazil, represent most of the expected growth in world oil consumption next year. Among the countries of the OECD, only the United States is expected to show any significant growth in consumption volume in 2011 at about 0.2 million bbl/d.

Non‐OPEC Supply. EIA projects the total non-OPEC supply of crude oil will grow by just over 1.0 million bbl/d to an average 51.5 million bbl/d in 2010 - the largest year-over-year increase since 2002. The increase in total non-OPEC supply for the year is the result of higher production in the United States, Brazil, China, and Russia. However, non-OPEC supply falls by 280,000 bbl/d in 2011. The decline in non-OPEC supply in 2011 would be only the third time in the last 15 years that non-OPEC supplies fall year-over-year. Previous declines in 2005 and 2008 were primarily the result of supply disruptions in the Gulf of Mexico related to hurricanes.

OPEC Supply. EIA expects that OPEC crude oil production will increase by 0.3 and 0.4 million bbl/d in 2010 and 2011, respectively, similar to last month's Outlook, to accommodate increasing world oil consumption. Projected non-crude liquids increase by 0.7 million bbl/d in both 2010 and 2011. OPEC surplus capacity should remain close to 5 million bbl/d, compared with 4.3 million in 2009 and 1.5 million in 2008.

OECD Petroleum Inventories. Commercial oil inventories held by OECD countries at the end of 2010 are an estimated 2.73 billion barrels, equivalent to about 58 days of forward cover and roughly 94 million barrels more than the 5-year average for the corresponding time of year. OECD oil inventories decline through the forecast period, though days of forward cover should remain high by historical standards.

Late yesterday afternoon the API released their latest inventory assessment. The API released a mixed inventory report for the second week in a row. The API showed a strong decline in crude oil stocks and builds in both gasoline and distillate fuel inventories. The API reported a crude oil inventory draw of about 7.3 million barrels as refinery utilization rates surged by 4.2%. They also showed a huge build in gasoline stocks of about 4.8 million barrels while distillate fuel stocks also increased strongly by about 1.7 million barrels. The results of the API report are summarized in the following table. So far the reaction to the API report has been bearish as prices have continued to decline in overnight trading. In fact the API report is very bearish and if today’s EIA report is in sync with the API report it is likely to result in a strong round of profit taking selling.

My projections for this week’s inventory reports are summarized in the following table. I am expecting a mixed report for US oil stocks. I am expecting a modest decline of about 1.5 million barrels of crude oil inventories based on a modest increase in refinery utilization rates of about 0.5% as refineries begin to return back from fall maintenance. If the actual numbers are in sync with my projections the year over year surplus of crude oil would widen a bit to 22.1 million barrels while the overhang for the five year average for the same week will also widen to 33.9 million barrels. The overhang is still only slowly dissipating in the US as the direction of stock levels remains supportive for prices.

With runs expected to increase by 0.5% and with imports slowing I am expecting a modest increase in gasoline stocks. Gasoline stocks are expected to build by about 0.5 million barrels even 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 deficit is projected to widen to around the 5.7 million barrel level while the surplus versus the five year average for the same week will narrow to about 5.9 million barrels. Gasoline inventories have staged a decent recovery (recovery defined as destocking) as the overwhelming surplus situation that persisted throughout the entire summer driving season has virtually been eliminated with the overhang versus the five year average very manageable at this point in time.

Distillate fuel likely drew by about 0.8 million barrels as economy sensitive diesel fuel implied demand continues to remain steady and as the start of the winter heating season finally gets underway. The latest 6 to 10 day and 8 to 14 day NOAA temperature reports are still showing a large portion of the eastern half of the US likely to be engulfed in much colder than normal temperatures for the first half of December. The current forecasts are colder than what was projected about two weeks or so ago and this has given the heating oil bulls a bit of support. With the temperature forecasts projected to be colder than normal we could very well see HO net withdrawals starting to accelerate in the not too distant future. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 10.1 million barrels below last year while the overhang versus the five year average will drop to 19.6 million barrels.

As usual do not overreact to the API data as the EIA data will be available in a few hours. If the EIA report is within the projection I would expect the market to view the results as neutral as total commercial stocks of crude oil and refined products combined are likely to have decreased for yet another week. However, if the EIA report follows the API data this morning’s report will be viewed very bearishly as it would suggest that the destocking of inventories seen over the last month or so could be coming to an end. .

My individual market views are detailed in the table at the beginning of the newsletter. In the short to medium term I expect that we will see higher prices (by year end) and yes I do expect oil prices to breach the $100/bbl level at some point in time during the course of the winter heating season. There are still many more positives coming from the macroeconomic side than negatives that should be supportive for oil prices in the short to medium term. That said we are likely to be in the midst of a short term downside correction as prices have gotten a bit ahead of the data.

I remain cautiously bullish for Nat Gas in spite of yesterday’s round of profit taking selling. That said I also continue to believe prices will remain in the trading range until the weather pushes prices higher once again.

Currently most risk asset classes are stating the US trading session on the defensive as shown in the EMI Price Board table below.

Best Regards,

Dominick A. Chirichella

dchirichella@mailaec.com