“Life is the sum of all choices.”
Albert Camus
Geopolitics around North Africa and the Middle East continue to dominate all financial and commodity markets, especially the oil complex. The perception that contagion around the Middle East will spread, coupled with a view that higher oil prices... to some degree... are here to stay for the foreseeable future, has completely turned the market sentiment to a risk off sentiment for just about everything with the word asset in it except for oil and precious metals. Over the last 48 hours, traders and investors around the world have shed risk by selling equities, most all commodities (again except oil and precious metals) and moved the cash into precious metals and bonds, but not so much into the US dollar which is actually on the defensive this morning. The selling of equities is based on a growing view that higher oil prices will eat into corporate profit margins as well as force many companies to raise the price of their goods and services, thus potentially reducing demand by the already nervous consumer. In addition higher oil prices will ultimately result in inflation and force the hand of the developed world to prematurely move from their easy money policies to a tight money policy via raising interest rates to mitigate inflation risk which will result in a slowing of the economy and thus a reduction in commodity consumption in general.
As market dynamics move to find an equilibrium between all of the views of what the markets may look like in the short- to medium-term prices for everything have been and will continue to be very volatile with the central theme of reducing risk in one's investment and trading portfolios while the commercial sector ponders adding hedges to reduce the exposure of even higher oil prices. At the moment, it does not seem to matter in the marketplace that there is ample supply of oil around the world with commercial stocks of crude oil and refined products still running at above normal levels, over 100 million barrels of oil in floating storage, a Strategic Petroleum Reserve in the IEA countries (which the US is part of) of around 1.6 billion barrels, an unknown volume of oil in China's SPR along with about 4.6 million barrels per day of surplus crude oil capacity in OPEC. Barring a spread of the discourse to Saudi Arabia with a resulting shut-in of production in Saudi Arabia, the world can easily handle a shut-in of production from Libya, Algeria and even Iran for a reasonable period of time without the consumer seeing a shortfall in oil supplies.
That said, even with all of the above cushions there is a substantial risk premium of someplace between $10 to $15/bbl already built into the price of oil (higher end of the range in Brent, lower end of the risk premium range in WTI...my estimate). As long as the protests continue in oil producing nations, the risk premium is not likely to recede anytime soon and if the market believes it will spread even deeper than it already has, the risk premium will increase even further.
Over the last 24 hours, Libya has declared force majeure on both oil and gas production as Gaddafi makes a stand and attempts to retain control of the country. As I said yesterday, I think the situation in Libya is beyond the point of no return and with little likelihood that things will go back to normal anytime soon. It is not obvious to the world what might yet transpire in Libya as reports indicate that the eastern region of Libya...where most of the oil is ... is not in the control of Gaddafi at this time. No one opposition group or individual has emerged as a likely leader in the country and as such the market views Libya as a high potential for civil war or in a state of chaos for the foreseeable future.
In Algeria, the government lifted emergency powers hoping that it would calm the populace a bit. In Bahrain the monarchy continues to attempt to survive and quell the protests by giving money to the citizens, releasing political prisoners and showing a willingness to talk. In Iran, the government continues to put down any attempts to protest while it sent two warships through the Suez canal to take the attention off of its own internal problems. So in a nutshell, the situation in North Africa and the Middle East is not any better today than it was yesterday and the amount of oil flow at risk is still substantial with the game changer...Saudi Arabia front and center in the minds of all traders and investors around the world.
The negative market sentiment has spread around the world quickly, as shown in the EMI Global Equity Index table below. With the exception of the China bourse all of the other bourses have declined over the last 24 hours with selling continuing in Europe this morning but the US equity futures markets indicating a slightly higher opening on Wall Street in a few hours. The Index is now lower by 2.3% for the week pushing the overall Index back into negative territory for the year to date. Needless to say the global equity markets are not very supportive for oil prices or the boarder commodity complex, but as described above, oil has pretty much decoupled itself from all price drivers other than the geopolitics of North Africa and the Middle East.
Interestingly, the US dollar has not yet seen any major inflow of cash as it has in the past during times of crisis. In fact the US dollar Index is in negative territory this morning (so far). Under normal times, the dollar move would be supportive to both oil prices as well as the broader commodity complex. But as I said above, all markets are primarily focused on the outcome of the most important oil region of the world.
I am not sure it will matter much to the direction of oil prices this week, but the weekly inventory cycle will get underway today as the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Thursday morning. My projections for this week’s inventory reports are summarized in the following table. I am expecting an across the board build for US oil stocks and yet another overall build in total commercial stocks of crude oil and refined products combined. I am expecting another strong build of about 2 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 10.4 million barrels while the overhang versus the five-year average for the same week will be about 17.9 million barrels.
With runs expected to increase by about 0.1% and with imports expected to increase a bit, I am expecting another strong increase in gasoline stocks. Gasoline stocks are expected to build by about 1.3 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 around 11.5 million barrels while the surplus versus the five-year average for the same week will widen to about 17.8 million barrels. Gasoline stocks will have built for nine 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 23 million barrels over the aforementioned timeframe.
Distillate fuel is projected to increase modestly by 0.3 million barrels, mostly as a result of the warmer than normal temperatures experienced last week. As has been the case for the last eight weeks or so, it is mostly diesel fuel inventories that have been rising strongly as the US economy continues to grow very slowly. The latest NOAA weather forecasts are now calling for a return to more normal winter temperatures for the upper portion of the US over the next several weeks. 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. In fact heating oil stocks actually built in last week's EIA report. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 8.9 million barrels above last year while the overhang versus the five-year average will be around 25.4 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 which will be released late today 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 modestly bearish as total commercial stocks of crude oil and refined products combined are likely to have increased for yet another week. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on with the evolving situation in North Africa and the Middle East as well as in the financial markets and how much the macro issues will offset any of the individual micro drivers like supply & demand.
My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view at neutral and my bias on the bullish side for all of the reasons I have been discussing over the last 48 hours. But again I raise the caution flag that prices are a bit overdone and susceptible to a correction.
I am maintaining my Nat Gas view at neutral and changing my short term bias to neutral as I think the Nat Gas market is due for a correction.
Currently markets are firm as shown in the EMI Price Board table below.
Best Regards,
Dominick A. Chirichella
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