Oil looking up on taxes and QE2

“Nature thrives on patience; man on impatience.”

Paul Boese

Yesterday’s trading activity was a bit of buy the rumor and sell the fact as most risk assets moved lower after the initial gains attributed to the announcement of the Obama/Republican agreements on extending all of the tax cuts. However, after the dust settled and it starting becoming clear that Obama’s own party was not in agreement with the dea,l most markets retreated on concerns that there was still a possibility that the deal could be derailed. One should never say “never” but I do not think the deal will be derailed and in the end it will be passed in the next week or so. As I said yesterday the deal is a game changer and very supportive for the economic recovery. This supply side stimulus coupled with QE2 should help to accelerate the economic recovery in the US and continue to inflate risk asset prices over the medium term.

Over the last 24 hours, global equity markets have drifted lower as shown in the EMI Global Equity Index table below. The US dollar has moved back into positive territory as many now think the tax cuts/QE2 combo will spur growth in the US and be a positive for the US dollar. As a result most commodity markets have retreated as have the equity markets. In addition there is a growing consensus that the Chinese government is likely to raise interest rates in the short term to continue its fight to mitigate a growing inflation problem…possibly over this coming weekend. If so it would be a negative for most all commodities as China is still the main commodity growth engine in the world. The EMI Index has lost 0.2% for the week narrowing the year to date gains to 3.3%...still well below the highs hit back in early November. Gains in the developed country bourses are still outpacing the emerging market bourses with last year’s big winner…China now this year’s main laggard as it sits at the bottom of the list with a year to date loss of 13.2%.

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