Quote of the Day
A man, who has committed a mistake and doesn't correct it, is committing another mistake.
Yesterday was certainly a risk off day in the oil complex as profit taking selling dominated Tuesday's trading session. The oil complex has been under pressure for the majority of the week so far with selling starting right from the opening on Sunday night after China's lower than expected manufacturing index number was released earlier in the day. The selling accelerated on the Bin Laden news and has returned yesterday after modest gains the day before. So far on the week the spot WTI contract has shed about 2.6% of its risk or fear premium or almost $3/bbl while the spot Brent contract declined by 1.9% or $2.43/bbl. Not a very deep downside correction considering the price of WTI was trading below the $100/bbl just five weeks ago.
The sell-off on Tuesday was a result of a bit of US dollar strengthening as well as a growing concern that higher oil prices are starting to impact demand (as discussed in detail in yesterday's newsletter). Overall not much has changed this week vs. last week. The geopolitics are mostly the same as fighting continues in Libya and oil remains shut-in while the market continues to price in a potential supply disruption from other areas of the Middle East as contagion has spread to several countries already. The democracy revolution continues.
On the economic front we have seen manufacturing numbers from around the world over the last few days all of which were a tad lower than the previous month but all (including China) were still above what is considered the threshold level indicating growth in manufacturing and thus mildly positive for oil and commodities. Higher oil and commodity prices are still fueling the inflation pipeline and as discussed many times in this newsletter many countries have already switched monetary policy to mitigate the impact of inflation…most noteworthy has been China which is also the main growth engine of the commodity consuming world. Even the EU Central Bank has already increased short-term interest rates last month and is meeting today and tomorrow to determine their next move. Many are expecting them to sit tight this month with another rate increase in Europe not expected until about July. Their decision could be a market mover tomorrow.
In any event the US seems to be the lone player still operating with an easy money policy and not likely to begin tightening until later in the year at the earliest. As such the fundamentals of the US dollar…basis interest rate differentials…is likely to remain a negative for the US dollar with all signs still suggesting that the US dollar will make an attempt to test the all time low (basis the US Dollar Index) sometime in the short- to medium-term. There is nothing supporting a sustained trend reversal in the US dollar at this point in time other than bouts of short covering from time to time. As such the dollar environment should remain a positive supporting the oil and commodity complex over the aforementioned timeframe.
Today starts the monthly employment data watch in the US with the release of the AP private sector job survey at 8:15 am EST, weekly initial jobless claims on Thursday morning and culminating in the main market mover…the monthly US employment report on Friday at 8:30 am EST which is expected to show a jobs gain of about 180,000 jobs with the headline unemployment rate hovering around 8.8%. Any deviations from the consensus will result in a strong and quick move in the currency, equity and commodity markets.
In addition to the sell-off in oil on Tuesday the global equity markets were also hit with selling as shown in the EMI Global Equity Index table below. The Index has lost 1.4% of its value so far this week resulting in the year to date moving solidly into negative territory for 2011 by 1.5%. Brazil has clearly locked up the bottom spot in the loser's column as inflation continues to plague this emerging economy while its commodity dependent economy gets a hit each time we see a downside correction in oil and other commodity values. The US Dow remains on top of the leader board as one benefit of the easy money policy of the US Central Bank has been to fuel the equity asset class. Japan remains the other bourse in negative territory but has been closed all week and will remain closed for the rest of the week for the Golden Week holiday. Equities have not been very supportive for oil or commodity values this week.
Late yesterday afternoon the API released their latest inventory assessment. The API report was mixed and mostly neutral with a slight bias to the downside. The API reported a crude oil inventory build of about 3.2 million barrels even as refinery utilization rates only increased by 0.6% to 82.2% of capacity. The API reported a big decline in crude oil imports. PADD 2 stocks were marginally higher for the second week in a row. They showed large surprise declines in inventory for distillate fuel but a larger than expected build in gasoline stocks. On the week, gasoline stocks increased by about 680,000 barrels while distillate fuel stocks were decreased by 1.5 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 although the market is in quiet mode ahead of all of today's macro events. If Wednesday’s EIA report is in sync with the API report, I would view it as neutral to marginally bearish.
My projections for this week’s inventory reports are summarized in the following table. I am expecting a mildly bearish report with an across the board build in all components of the complex as well as in total combined commercial stocks of crude oil and refined product inventories. I am even expecting a small build in gasoline this week. I am expecting crude oil stocks to build by about 1.6 million barrels. If the actual numbers are in sync with my projections the year-over-year surplus of crude oil would come in around 4.2 million barrels while the overhang versus the five-year average for the same week will widen to 14.7 million barrels.
Even with refinery runs expected to increase by only about 0.2% I am expecting a small build in gasoline stocks as demand likely slipped and imports increased on the week. Gasoline stocks are expected to build by about 0.2 million barrels which would result in the gasoline year-over-year deficit still widening to 19.2 million barrels while the surplus versus the five-year average for the same week will also widen to 3.8 million barrels.
Distillate fuel is projected to increase modestly by 1.0 million barrels on a combination of minimal weather demand as well as an increase in production. The latest NOAA forecast is projecting below normal temperatures across portions of the US for the next several weeks thus marginally suggesting that there could be some residual heating related demand…but not anything very significant. The forecasts are a neutral for heating oil especially for this time of the year. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 4.9 million barrels below last year while the overhang versus the five year average will be around 19.9 million barrels. With the beginning of the inventory injection season now underway 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 but with the below normal inventory levels in gasoline stocks the fundamentals are becoming more of a supporting factor for the first time in several years.
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 neutral as total commercial stocks of crude oil and refined products combined are likely to have not changed very much from last 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 view and bias at neutral as it is starting to look like the market may still experience a further correction to the downside. I am remaining to sidelines for today.
I am maintaining my Nat Gas view but moving my bias to cautiously bullish with short term upside objective of $5/mmbtu. I would also adjust the trailing stop as discussed above.
Currently asset classes are mixed as shown in the EMI Price Board table below.
Dominick A. Chirichella
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