The future belongs to those who believe in the beauty of their dreams.
Eleanor Roosevelt
Oil prices have been in positive territory since the beginning of the Asian trading session and for the first time since peaking (WTI) during the March 7 session. In fact most traditional commodity markets have rebounded a bit on overnight trading on the back of a positive day in the Japanese equity markets as participants continued to sort out what Japan's requirements will be for a whole basket of commodities in the short- and medium-term. The main difference so far this morning from the last few days is the massive selling of any and all risk asset classes has subsided and started to slow since yesterday afternoon's trading session in the US. Although the market sentiment is still decidedly bearish the amount of bad news emanating from the Fukushima nuclear facility has also started to subside indicating that the possibly that the worst may be over and the risk of a massive release of nuclear fallout could be also be starting to decline. However, the nuclear issue is still a big issue and one that will be impacting the direction of markets around the world for the foreseeable future That said the market is now placing more focus on the massive damage from the earthquake and the tsunami and what it will take to move Japan into a rebuilding and reconstruction mode. As the nuclear situation moves out of the headlines financial and commodity markets will likely being to stabilize.
With the ramifications of the Japanese disaster worked into the price of most risk assets oil investor/traders are starting to re-focus on the evolving situation in Libya and the greater Middle East. Since the Japanese disaster hit on Friday Gaddafi has retaken a major portion of the area that was under control of the opposition group while the US and the rest of the western nations continue to discuss the merits of establishing a no fly zone in Libya. However, irrespective as to whether the west gets involved and/or Gaddafi continues to remain in control, oil exports from Libya are going to be at a reduced level for months to come simply due to the damage at several of the oil ports from bombings related to Gaddafi retaking those cities as well as sanctions on Libya.
In addition to Libya, Saudi Arabia sent troops into Bahrain to try to stabilize the evolving situation in that country. Yesterday the Bahraini government imposed a state of emergency for three months which seems to set the stage for more aggressive action by the government and the Saudi troops against the protestors. Not that Bahrain is a large exporter of oil... it just happens to be in a strategic location in relationship to Saudi Arabia. If the Bahrain protests grow into an overthrow of the existing monarchy in Bahrain it could then spread to Saudi Arabia. It is that fear of losing supply from the largest supplier of oil in the world as well as the main source of surplus crude oil capacity that is starting to get the market back into worry mode once again.
A portion of the oil risk premium has been removed from the market as the world is not experiencing a shortage of oil anyplace in the world. In addition the Japanese disaster has resulted in Japan reducing their oil consumption for the foreseeable future and more than offsetting the loss of oil from Libya. So in the short-term, I do not expect the risk premium to surge, but I also do not expect it to be completely removed from the price of oil anytime soon. The risk in North Africa and the Middle East is far from over and as such oil prices will not only remain volatile but prices are likely to remain at elevated levels for the short- to medium-term. Recall before the Tunisian and Egyptian crisis the price of WTI was hovering around $85/bbl and on the verge of declining even further. Prices are now still hovering near the $100/bbl mark with Brent still trading well above the $100/bbl mark and that is after a portion of the risk premium has come out of the market over the last few days.
Global equities rebounded in Asia overnight led by about a 5% gain in Japan as shown in the EMI Global Equity Index table below. The Index has narrowed its weekly loss to 1.7% as well as its year to date loss to 2.6%. Seven of the ten bourses still remain in negative territory for the year to date with only the US, Canada and China still holding onto year-to-date gains. With the nuclear situation a bit more defined over the last 24 hours, investor/traders are now trying to analyze the impact of Japan on regional markets around the world.
Some of the questions yet to be answered is how much of an impact will the downturn in the Japanese economy have on the rest of the global economic recovery? How will the rebuilding and reconstruction of Japan help to stimulate the global economy in the medium-term? What will be the impact of repatriation of Yen by the Japanese government and individual companies (especially insurance companies) to pay for the rebuilding and reconstruction? Will Japan sell US Treasury bonds as well as hard assets around the world as part of the repatriation process and what will be the impact of such a strategy? What will Japan's requirements be for oil and all commodities for that matter in the short- and medium-term? These are just some of the questions front and center in investor and trader’s minds around the world and as one can imagine there are many differences of opinion as to the answer to these questions.
I certainly do not know all of the answers but like everyone else I certainly have a view. Excluding the nuclear part of the problem we can look at the aftermath of the 1995 Kolbe earthquake and get a bit of a feel for what evolved in Japan as far as the clean-up phase as well as the rebuilding and reconstruction phase. In the short-term, Japanese GDP is obviously going to decline for at least several months, maybe a quarter. During the clean-up phase, demand for hard industrial commodities like oil, copper, steel, etc. are likely to decline. Demand for foodstuffs like corn, rice etc. are likely to increase as major portions of the northern Japanese farmlands have been flooded and damaged with salt water. As they move from the clean-up phase to the rebuilding phase we can expect demand for all traditional commodities to increase significantly including not only oil but also LNG and coal as they move more of their power generation away from nuclear and into more conventional energy generation.
Many export companies will experience problems, especially manufacturers that are very reliant on electricity like auto, chips etc. This should be a short- to medium-term benefit to companies in China, Taiwan, South Korean and even Germany. Furthermore with the Yen likely to appreciate due to repatriation it will also be a negative for Japanese export companies and could result in Japanese government intervention into the currency markets. Overall from a macro viewpoint, the hit taken in commodity prices over the last few days has likely been overdone and an upside adjustment is likely in the short-term (as we have started to see this morning). How quickly Japan moves to the rebuilding and reconstruction phase will be very influenced by how quickly they can stabilize the Fukushima nuclear plant. I think the next three months will be the transition phase with price moves for equities and commodities likely to be very volatile and dependent on the 30 second news snippets hitting the media airwaves. During the second half of the year Japan will be well into the rebuilding and reconstruction phase.
Late yesterday afternoon the API released their latest inventory assessment. The API report was mixed. The API reported a crude oil inventory build of about 90,000 barrels as refinery utilization rates increased by 2.4% to 82.3% of capacity. The API also reported a huge decline in PADD 2 crude oil stocks of about 3 million barrels. They also showed a small draw in gasoline stocks of about 0.5 million barrels while distillate fuel stocks built by about 0.5 million. The results of the API report are summarized in the following table. So far the reaction to the API report has been mildly bullish for refined products as prices have increased in overnight trading but the vast majority of the gain in crude oil prices is more related to the turmoil in Libya and the Middle East. If today’s EIA report is in sync with the API report I would view it as neutral at best.
My projections for this week’s inventory reports are summarized in the following table. I am expecting a mixed report with a modest build in total commercial stocks of crude oil but a decline in refined products inventories as refinery runs likely declined marginally on the week. I am expecting crude oil stocks to build by about 1.5 million barrels. If the actual numbers are in sync with my projections the year-over-year surplus of crude oil would come in at 6.4 million barrels while the overhang versus the five-year average for the same week will be about 15.5 million barrels.
With runs expected to decrease by about 0.1% and with imports expected to hold steady, I am expecting a modest decline in gasoline stocks. Gasoline stocks are expected to draw by about 1.3 million barrels, which would result in the gasoline year-over-year surplus to narrow to around 0.6 million barrels while the surplus versus the five year average for the same week will narrow to about 5.2 million barrels.
Distillate fuel is projected to decrease modestly by 6.0 million barrels on a combination of some weather demand as well as a decline in production. The latest NOAA weather forecasts are now showing a significant portion of the US expected to experience above normal temperatures for the rest of March. The forecasts are a negative for heating oil especially after the last several weeks of less than bullish inventory reports.
With the vast majority of the winter heating season now in the history books, 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 as the latest weather forecast almost guarantees that the net withdrawals from inventory for the rest of the official winter heating season will likely come in at below normal levels. If so the inventory building season may get a bit of a jumpstart in starting to replace the volume consumed this year. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 6 million barrels above last year while the overhang versus the five0year average will be around 23.1 million barrels.
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. The major wild card for distillate fuel over the next three to six months will be how much additional diesel fuel is going to be required by Japan. It is likely that Japan's import requirements for diesel fuel will increase strongly once the nuclear situation is stabilized and the country enters into the rebuilding and reconstruction phase especially with a large percentage of the refining capacity in Japan shut in.
As usual do not overreact to the API data as the EIA report will be released in a few hours. The API report 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 neutral as total commercial stocks of crude oil and refined products combined are likely to have decreased only marginally. However, if the EIA data is more in line with the API data the market will likely view it as neutral or non-event from am macro overview and a negative for WTI versus Brent. Whether or not the market reacts at all to the inventory report will be dependent on what is going on with the Japanese disaster as well as the evolving situation in North Africa and the Middle East 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 view at neutral and my short term bias at cautiously bearish even as the market experiences a bit of a short covering rally so far today. Barring an uprising in Saudi Arabia oil prices may have peaked for the short term as the risk premium slowly declines.
I am maintaining my Nat Gas view and bias at neutral as I still think the Nat Gas market is still range bound as the market navigates through the rest of the winter heating season.
Currently most all asset classes are firm as shown in the EMI Price Board table below.
Best Regards,
Dominick A. Chirichella
Energy Market Analysis is published daily by the Energy Management Institute 1324 Lexington Avenue, # 322, New York, NY 10128. Copyright 2008. Reproduction without permission is strictly prohibited. Subscriptions: $129 for annual orders. Editor in Chief: Dominick Chirichella, Publisher: Stephen Gloyd, Editor Sal Umek.
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