If today was the day you were finally going to win, did you show up?
Unrest in the Middle East, a view that Yemen may slip into civil war, ongoing operations in Libya, a view that the fighting will last for an extended period of time in Libya, rising consumption in China and a smaller than originally expected decline in Japanese oil consumption has all contributed to pushing oil prices back to levels not seen for a few weeks. Now that the spot WTI contract is back over the $103/bbl market the next technical stopping point is around the $110/bbl level. That said the oil market is not a technically driven market rather it is being driven by the geopolitics of the North Africa & greater Middle East region and will continue to drive prices until both the commercial and non-commercial sectors are convinced that there will not be a supply disruption of significance down the road.
I say down the road because even with Libyan production mostly shut-in there is still not a shortage of oil anyplace in the world due to supply issues (Japan is the exception due to shut-down of refining capacity from the earthquake). The market is well bid as participants from all ends of the infrastructure view the drive to democracy eventually working its way to Saudi Arabia which could then result in a very significant impact on the flow of oil from the region. That is why prices are where they are today and that is why prices are likely to move higher if the tensions in the region continue to grow resulting in an increase in the fear side of the oil equation. Oil prices are driven by two main factors…supply & demand (over various timeframes) and fear. Today it is fear that is the main driver and it is attracting buyers into the complex. Things like the huge decline in gasoline inventories (see below for more detail) reported by the API in tier report on Tuesday evening only contribute further to the fear factor as we get closer to the summer driving season.
So where do oil prices go from here? Over the medium-term I would expect to see higher oil prices as a result of either a significant supply disruption (lower probability) and/or just an increase in demand as the global economy continues on its road to recovery. Supply and demand balances are slowly returning to pre-recession levels as demand continues to outstrip current supply flows. Although total stocks are still above normal, the overhang is now only marginal compared to where it was about a year or so ago. So even without a significant supply disruption I would expect prices to gradually rise over the next three to six months. If the unrest spreads to the larger oil producers in the Gulf, than all bets are off as oil prices will surge irrespective of what the current supply & demand balance looks like. If stability emerges quickly in Libya, Yemen and Bahrain, then I would expect oil prices to retrace strongly in the short-term with WTI likely falling back below the $100/bbl mark for a period of time. IF it does I would strongly suggest that it would be a buying opportunity as we now seem to be in the mode of buying the dips rather than selling the rallies.
Late yesterday afternoon the API released their latest inventory assessment. The API report was mixed but biased to the bullish side. The API reported a crude oil inventory build of about 1 million barrels even as refinery utilization rates increased by 0.3% to 82.6% of capacity. The API also reported a modest increase in crude oil imports which offset the increase in refinery run rates. PADD 2 stocks declined modestly by about 450,000 barrels after the previous API report showed a huge decline in stocks in that region. They also showed a huge draw in gasoline stocks of about 7.9 million barrels while distillate fuel stocks declined by about 0.6 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 bullish.
With the events well priced into the market already this week's round of inventory reports may matter as to the short term direction of oil prices as the more widely watched EIA data hits the media airwaves this morning. My projections for this week’s inventory reports are summarized in the following table. I am expecting another 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 1.9 million barrels. If the actual numbers are in sync with my projections the year-over-year surplus of crude oil would come in at just 1.2 million barrels while the overhang versus the five-year average for the same week will be about 15 million barrels.
With runs expected to decrease by about 0.2% and with imports expected to hold steady I am expecting a decent decline in gasoline stocks. Gasoline stocks are expected to draw by about 1.8 million barrels which would result in the gasoline year-over-year surplus switching to a deficit of around 1.4 million barrels while the surplus versus the five-year average for the same week will narrow to about 3.1 million barrels.
Distillate fuel is projected to decrease modestly by 1.2 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 below normal temperatures for the next several weeks. The forecasts are a positive for heating oil especially after the last several weeks of bullish inventory reports.
In spite of the forecast for cooler temperatures, it is now spring and low temperatures are not nearly as severe as they are in the heart of the winter and as such I do not expect any large increase in heating oil consumption that would result in a very above normal draw from inventory. 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 five-year 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 bullish from am macro overview and a marginal positive for WTI versus Brent spread. Whether or not the market reacts at all to the inventory report will be dependent on what is going on 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 bias at cautiously bullish as the market is still focused on the geopolitics of North Africa and the Middle East. I am leaving my view at neutral for the moment as I think we could see a bit of easing in oil prices in the short term but we are once again in the mode of buying the dips as a strategy that will likely have the highest probability of success.
I am maintaining my Nat Gas view and bias to cautiously bullish as Nat Gas prices broke out of the trading range it has been in since January. The price of Nat Gas surged higher on Thursday after a bullish inventory report and is now trading above the upper end of the trading range that has been in place since January. If prices remain above this level the next technical resistance level will be around the $4.30/mmbtu level.
Currently asset classes are mixed as shown in the EMI Price Board table below.
Dominick A. Chirichella
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