Quote of the Day
“You cannot find peace by avoiding life.”
Virginia Woolf
After starting Tuesday's session in negative territory oil prices staged a reversal rally and ended the day with modest gains. The recovery has continued in overnight trading pushing prices well above the $107/bbl (basis WTI) support level and signaling that oil is still trading within the uptrend it has been in prior to Monday's sell-off. In fact, as of this writing the spot WTI contract is within $0.50/bbl of recovering all of Monday's losses. Just about every indicator/price driver that was pointing to lower oil prices earlier in the week all reversed and are now supporting firmer prices. Recall in yesterday's newsletter I warned that selling could end very quickly...if the financial markets turn around coupled with the fact that this is a shortened trading week with most markets closed on Friday. Well that is pretty much what happened yesterday and the turnaround in financial markets, especially equities, has continued through Asian and European trading hours so far. Looking back at Monday's trading activity we can now begin to categorize it as an overreaction to the S&P downgrade as the market has now pretty much discounted the news.
Further support is coming from the global equity markets and the US dollar which has plummeted over the last several days. The US Dollar Index (USD against a basket of six major currencies) has now solidly breached this year's low and is quickly approaching the lows made back in December of 2009. The falling dollar is very supportive for oil prices as well as the broader commodity complex. The following chart highlights the relationship between what I call the big three...oil, equities and the US dollar. In spite of all of the events that have been driving oil prices, the correlation between equities and oil has remained in place as has the inverse correlation between the direction of the US dollar and oil prices. As shown on the chart the dominant relationship that has been in play and continues to be in play is the inverse relationship between the US dollar Index and WTI & Brent. For now we have to respect this relationship and as long as the US dollar continues to head lower we can expect oil prices to advance or at least remain firm at a minimum.
The US dollar has been on the defensive throughout most of this year with the US dollar Index declining around 5.5% for the year to date. The US dollar has been under siege as all signs point to the US Central Bank remaining in an easy money mode well beyond other major economies. The emerging markets have been raising interest rates for almost a year in the fight against inflation while the EU entered the fight earlier this month with their first short-term interest rate increase. The US continues with a policy of exceptionally low interest rates and quantitative easing until at least the end of June. Since the main fundamental driver of currencies is interest rates, one can quickly see the USD is at a strong disadvantage to most other major currencies and thus the selling pressure that has continued on the US dollar. One further note, a weakening US dollar is also inflationary and tends to contribute to higher oil and commodity prices from that perspective.
Global equities have staged a decent rally over the last 24 hours regaining a modest portion of what was lost earlier in the week as shown in the EMI Global Equity Index table below. The EMI Index has gained a tad over 1% over the last twenty four hours with the rally starting in Europe yesterday morning and continuing through the Asian & European trading hours so far. In addition, US equity futures markets are all solidly higher as of this writing and are thus pointing to a higher opening on Wall Street this morning. The Index is now down 0.6% for the week and 0.7% for the year to date. London moved back into the winner's column with only Japan and Brazil still showing modest losses for 2011. China remains on top of the leader board for the year with the US Dow holding the second spot. As I have mentioned a few times, both of these markets are being driven by two different policies. Market participants have become comfortable with the Chinese government's fight against inflation while participants continue to buy US equities as the easy money policy continues to bolster asset values like equities. For today, the global equity markets are supportive for higher oil and commodity prices.
Although the markets have been focused on the financial drivers, the geopolitics that are responsible for the vast majority of the last $20 to $25/bbl increase in oil prices are still evolving...albeit there has been nothing new suggesting another oil supply interruption is imminent. The evolving civil war continues in Libya with way too many innocents getting killed and displaced from their homes. Diplomacy is continuing, but so far there does not seem to be anything close to ending the conflict. The vast majority of Libyan oil production remains shut-in and will likely remain shut-in for an extended period of time.
In both Yemen and Syria, the protests have continued even as initiative are evolving to try to appease the protestors. Unfortunately in both countries the protests have been and continue to be bloody. In Yemen the diplomacy is directed at removing the current President and moving to free elections. In Syria the protests are calling for the removal of Assad but so far the movement in Syria is well behind that of Yemen. Although Mubarak is long gone from Egypt the situation in Egypt is far from stable and how it all turns out is still a big unknown. The Egyptian powers have now recognized Iran and announced that Iran is opening up an Embassy in Egypt for the first time in about 30 years suggesting that direction this country may be taking. Although none of these countries are oil producers, they do impact the overall price of oil or at least the fear premium as what is going on in all three of these countries continue to have broad implications for the region, in particular the Israeli/ Palestinian balance of power.
Finally the next hot spot to watch in the region is Algeria once again. Unlike Syria, Yemen and Egypt, Algeria is a major OPEC producer who exports high quality crude oil. Protests are once again emerging in Algeria after a quiet period for the last month or two. Algeria's largest minority group, the Kabyles who number up to 10 million, is demanding that their government hold a referendum on autonomy. This is also to be followed by planned demonstrations which some are concerned could spread and turn out to be something more widespread. We will have to watch what goes on in Algeria over the next few days.
Although there is nothing imminent that will result in a shut-in of oil supply in the very short-term, the geopolitics of the region continue to create an umbrella of uncertainty that is feeding and supporting the fear or risk premium in the price of oil. As I have said before, we may see a receding of the risk premium from time to time (as we saw earlier in the week), but by no means is it going to be eliminated anytime soon. Geopolitics will likely play a role in the price of oil for at least the rest of this year.
Late yesterday afternoon the API released their latest inventory assessment. The API report was mixed and modestly biased to the bullish side. The API reported a crude oil inventory build of about 0.7 million barrels as refinery utilization rates surged by 2.4% to 81.3% of capacity. The API reported a decrease in crude oil imports. PADD 2 stocks were marginally lower after holding steady in the previous API report. They showed large surprise declines in inventory for both gasoline and distillate fuel stocks. Gasoline stocks declined by about 1.8 million barrels, while distillate fuel stocks were lower by 3.4 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 although prices are in the midst of adjusting after the slide over the last two sessions. If Wednesday’s EIA report is in sync with the API report I would view it as biased to the bullish side.
My projections for this week’s inventory reports are summarized in the following table. I am expecting a somewhat bearish report with a modest build in total commercial stocks of crude oil and refined products inventories as refinery runs are likely to increase marginally on the week. I am expecting crude oil stocks to build by about 1.0 million barrels. If the actual numbers are in sync with my projections, the year-over-year surplus of crude oil would come in around 4.4 million barrels while the overhang versus the five-year average for the same week will also narrow to 15.9 million barrels.
Even with refinery runs expected to increase by about 0.2% and with imports expected to hold steady, I am expecting a modest draw in gasoline stocks. Gasoline stocks are expected to draw by about 1 million barrels which would result in the gasoline year-over-year deficit widening to 16.2 million barrels while the surplus versus the five-year average for the same week will narrow to 1.2 million barrels.
Distillate fuel is projected to increase modestly by 0.5 million barrels on a combination of minimal weather demand as well as an increase in production. The latest NOAA forecast is projecting above normal temperatures across portions of the US for the next several weeks, thus reducing any hopes for a continuation of atypical spring heating related consumption. The forecasts are a negative for heating oil especially after the last several weeks of bullish weather reports. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 2.5 million barrels above last year while the overhang versus the five-year average will be around 25.6 million barrels. With the beginning of the inventory injection season about to start for heating oil and with total distillate fuel inventories already at very comfortable levels, there are not likely to be any supply issues anytime soon.
Net result, the US continues to remain well supplied of just about everything in the oil complex and stocks are not yet in a sustained destocking pattern in general. 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 this morning. The API report is not in line with the more widely followed EIA data more often than not and as such it is always prudent to verify the API results by waiting a few more hours for the EIA data to be released. If the EIA report is within the projections I would expect the market to view the results as neutral. If the EIA data is more in line with the API data the market will likely view it as biased to the bullish side from a macro overview and a mild positive for the WTI versus Brent spread. Whether or not the market reacts at all to the inventory report will be dependent on what is going on with the events of the day.
My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my view at neutral, but upgrading my bias to cautiously bullish as Brent and WTI are both now trading well above the latest technical support level. This is a reversal from my adjustments from yesterday and symptomatic of the high volatility market environment that has engulfed the oil complex.
I am maintaining both my Nat Gas view and bias at neutral with s short-term upside bias as prices are likely to remain mired in a range for the foreseeable future.
Most all markets in the US and in many other countries will be closed on Friday in observance of Good Friday. Liquidity and activity will likely begin to decline by mid-week. I will not be publishing the Energy Market Analysis on Friday.
Currently asset classes are mostly higher as shown in the EMI Price Board table below.
Best Regards,
Dominick A. Chirichella
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