A pessimist sees the difficulty in every opportunity and optimist sees the opportunity in every difficulty.
Winston Churchill
Oil lost some of its upside momentum on Tuesday led by declines in the spot WTI contract with Brent crude remaining relatively steady on the backdrop of freedom protests around various Middle East countries. WTI has pretty much decoupled itself from the rest of the energy complex with Brent and refined products all trading with a risk premium associated with the possibility that oil supply could be disrupted as the freedom or democracy protests spread throughout the largest oil producing region in the world. As I outlined in yesterday's report the countries currently at risk are Bahrain, Algeria, Iran and Yemen where protests have continued. The total volume of oil from all of these countries combined is about 5.6 million barrels per day which exceeds the current EIA estimated surplus crude oil capacity of 4.65 million bpd in OPEC by about 500,000 bpd. Also as I mentioned yesterday the majority of the surplus crude oil capacity (3.76 million bpd) sits in Saudi Arabia which is also a potential hot bed as it is a ruling monarchy state. Whether or not the protests in any of these countries will continue to evolve or even spread to other areas like Saudi Arabia or Kuwait is a very big question. Oil prices…including WTI are back in positive territory in overnight trading on a combination of Geopolitics of the region as well as a surprise decline in US crude oil stocks reported in last night's API inventory report (see more details below on inventories).
As has been the case for the last several days the external markets have not been overly supportive for oil prices or the broader commodity complex. Overnight the US dollar has declined versus most major currency pairs with US Dollar Index now down about 0.3% and mildly supportive for oil and commodity prices. Most major currencies have been trading in a range for weeks and at the moment it does not look like this pattern will change anytime soon. As such I do not expect currencies to be a very strong or weak price drive over the short term.
On the equity front global equities have continued to add value in overnight trading as shown in the EMI Global Equity Index table below. The EMI Index has added another 0.1% in the last twenty fours and is now 1% higher for the week resulting in the year to date gain widening to 0.2%. Most equity bourses did not follow the downside correction seen in the US market on Tuesday with both Asia and Europe currently in positive territory. Brazil is now the only bourse still in negative territory for 2011 with the developed world markets still sitting on top of the 2011 winner's column. Market participants are treading carefully in most equity arenas as inflation is showing up in the developed world while it is clearly already impacting the emerging market world. Much like the currency markets discussed above I do not see equities being a very strong or weak price driver for oil and commodity prices in the short term.
The main price drivers for oil in the order of influence currently are:
· The evolving freedom movement protests in the oil rich Middle East
· Current fundamentals with inventories as the main gauge
· The view of the global economic recovery
· The impact of inflation fighting in the emerging market world especially its impact on commodity consumption
· Inflation risk in the developed world
As mentioned above WTI has mostly decoupled itself from the rest of the complex and it will continue to be influenced by the inventory situation in both PADD 2 and Cushing, Ok. At the moment both of these key locations are sitting with record high crude oil inventory levels with more oil on the horizon expected to flow from Canada. Last week there was a modest decline in stocks in this region but one week does not make a trend. In addition we are now entering the early stages of the spring refinery maintenance season which will result in a decline in refinery utilization rates and thus demand for crude oil. If this year is normal we can then expect to see crude oil stocks likely building further or at least not destocking strongly anytime soon. Bottom line WTI is likely to remain isolated from the rest of the complex and relatively bearish versus Brent and other major crude oil pairs.
On the other hand I would expect Brent and the rest of global oil complex to be primarily influenced by the evolving geopolitical situation discussed in detail above. In addition it will also be impacted by the other external drivers mentioned above. Everything other than WTI is likely to continue to carry a risk premium until investor/traders are convinced that the flow of oil will not be interrupted. At the moment one can't make that statement with any degree of certainty.
Late yesterday afternoon the API released their latest inventory assessment. The API released a mixed inventory report. The API reported a surprise decline in crude oil stocks (for the second week in a row), a build in gasoline stocks that was within the expectations and a draw in distillate fuel inventories that also came in within the expectations. The API reported a crude oil inventory draw of about 400,000 barrels even as refinery utilization rates decreased by only 2.7% to 80.8% of capacity. The API also reported a decline in crude oil imports. They also showed a build in gasoline stocks of about 1.2 million barrels while distillate fuel stocks declined by about 1.2 million barrels as the weather last week in the main heating oil consuming part of the US was modestly cold. The results of the API report are summarized in the following table. So far the reaction to the API report has been mildly bullish as prices have increased in overnight trading. In fact if today’s EIA report is in sync with the API report I would view it as neutral to modestly positive as both gasoline and distillate fuel stocks were within the market's projections the crude oil decline is definitely in the right direction in reducing the overhang that still exists in the US…especially in the mid-west region.
My projections for this morning’s EIA inventory report are summarized in the following table. I am expecting a mixed report for US oil stocks but yet another overall build in total commercial stocks of crude oil and refined products combined. I am expecting another strong build of about 2.3 million barrels of crude oil inventories mostly as a result of the industry continuing to readjust inventories after managing end of year stock levels as well as a modest increase in imports. If the actual numbers are in sync with my projections the year over year surplus of crude oil would come in at 12.9 million barrels while the overhang versus the five year average for the same week will be about 20.2 million barrels.
With runs expected to only decrease by about 0.2% and with imports expected to increase a bit I am expecting another strong increase in gasoline stocks. In fact I have seen estimates of around 300,000 tons (about 8 to 10 cargoes) of gasoline heading this way from Europe as the arb window has once again opened. Gasoline stocks are expected to build by about 1.6 million barrels which would result in gasoline stocks hovering around 20 years highs for this time of the year. This week the gasoline year over year surplus is projected to widen of around 10.4 million barrels while the surplus versus the five year average for the same week will widen to about 16.4 million barrels. Gasoline stocks will have built for eight weeks in a row if my projection for another build this week is in line with the actuals. If so gasoline stocks will have increased by about 21.6 million barrels over the aforementioned timeframe.
Distillate fuel is projected to decline modestly by 0.8 million barrels mostly as a result of the colder than normal temperatures we have been experiencing in the eastern half of the US. As has been the case for the last seven weeks or so it is only heating oil stocks that have been destocking as diesel fuel inventories have been rising strongly over the last two months as the US economy continues to grow very slowly. The latest NOAA weather forecasts are now calling for a return to not only normal winter temperatures but above normal temperatures for a good portion of the second half of February. With the vast majority of the winter heating season now in the history books the consistent decline in heating oil stocks may also start to perform much like diesel stocks have been over the last several months and that is to start into a premature inventory building pattern during the projecting moderation of temperatures during the second half of February. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 10.3 million barrels above last year while the overhang versus the five year average will be around 25.3 million barrels. Refiners are continuing to try to manage the overhang of crude oil by converting it into refined products and moving products into inventory. Net result the US continues to remain well oversupplied of just about everything in the oil complex with supply expected to remain robust for the foreseeable future.
As usual do not overreact to the API data as the EIA report is due out in a few hours and be cognizant that the API report is often not in line with the more widely followed EIA data.
My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view and bias at neutral as contagion is now something that has to be watched carefully in the Middle East. As discussed above my bias to WTI is more toward the bearish side while the rest of the complex is more supportive for all of the reasons presented above. Currently I do not see anything suggesting that the premium of Brent over WTI is going to collapse anytime soon. It is overdone and a correction is in order but that said this spread is not going to retrace back to normal historical levels anytime soon.
I am maintaining my Nat Gas view at neutral and my short term bias at bearish as the weather projections for the second half of February are simply not supportive for Nat Gas prices. With supply still very robust and the advent of a round of warmer than normal winter weather conditions prices have remained below the psychological and technical $4/mmbtu support level. Weather is still the main driver of price direction but the oversupply situation continues to dampen any upside enthusiasm that may come from above normal heating fuel demand.
Currently markets are firm as shown in the EMI Price Board table below.
Best Regards,
Dominick A. Chirichella
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