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Yesterday the oil complex gained ground in the midst of a risk asset short covering rally that carried WTI back over the $99/bbl level and the soon to expire July Brent contract over the $120/bbl mark. The main event in the oil market was the surging of the Brent /WTI spread which hit yet another new all time record high. As I discussed in detail yesterday the spread blowout is more about what seems to be a physical squeeze in the expiring Brent contract combined with the loss of Libyan oil and the recent force majeure of Nigerian Bonny Light crude oil (due to damage to a pipeline) and less about the overhang of crude oil in the mid-west region of the US. In fact in last night's API oil inventory report they showed a huge crude oil draw in PADD 2 of about 3 million barrels as well as decline of about 1.7 million barrels at Cushing, Ok...certainly not a negative for the WTI side of the spread. The spread remains very overbought and susceptible to a downside correction...possibly after the July spread expires tomorrow.
Yesterday's equity rally which accelerated after a positive retail sales report in the US was the main external driver to support oil prices as well as the broader commodity complex on Tuesday. With equities having been under pressure for the last six weeks or so a major portion of yesterday's move to the upside in the US was also a lot to do with short covering. In fact the positive retail data was enough to offset the news that China continued to tighten by raising it bank capital requirements yet again after the latest inflation data out of China continued to show that inflation is still one of the biggest risks to China's economy. On a global basis the EMI Global Equity Index (table below) saw its weekly loss narrow to just 0.1% leaving the year to date loss at 5.4%. That said the equity rallies in the west were not carried over into the Asian markets at this point in the Asian trading session dampening some of the enthusiasm from yesterday's activity in the US. The latest tightening measure by the Chinese government has cast a negative umbrella over equities today which is spilling over a tad into the oil complex (oil prices are slightly negative as of this writing). So far we can only categorize yesterday move in equities as a short covering rally and certainly not yet a clear signal that equities have bottomed. As such we have to be cautious in reading too much into the rally insofar as ongoing support for oil prices are concerned. Seven of the ten bourses remain in negative territory for the year to date with Brazil still showing a double digit loss for 2011.
On the currency front the US dollar is mildly positive in overnight trading as concerns continue to grow over the ability to solve Greece's current debt crisis in the short-term. So far EU ministers have yet to resolve all of the issues brought forth by Germany insofar as sharing the cost of the new aid plan with private bondholders. That said work is continuing to reach a common ground, As I have mentioned I wholly expect a new plan to be agreed to and implemented in Greece sooner than later. When the market gains more confidence that it will happen we will see a short-term rally in the euro resulting in the US dollar losing ground and supporting oil prices. For today (so far) the US dollar is marginally higher resulting in a bit of pressure on oil prices.
The API report was mixed but biased to the bullish side on a much larger than expected decline in crude oil inventories and a modest draw in distillate stocks. Distillate fuel inventories resumed their decline (after a one week build) for the indicating that the market may not yet be ready to return to a more normal building season for HO / diesel fuel. The API reported a crude oil inventory draw of about 3 million barrels even as refinery utilization rates decreased by 0.2% to 84.5% of capacity but imports increased modestly. The API reported a big draw in crude oil stocks in PADD 2 of about 3 million barrels and a 1.7 million barrel draw at Cushing, Ok. Crude oil stocks in the mid-west are still high but have declined back to level from February of this year. They showed a draw in inventory for distillate fuel and another build in gasoline stocks. The market was expecting a modest build in gasoline stocks and a modest build in distillate fuel inventories this week. On the week gasoline stocks increased by about 1.1 million barrels, while distillate fuel stocks were lower by about 0.4 million barrels. The results of the API report are summarized in the following table. So far the market is not reacting much to the API report as the industry awaits the EIA report later this morning. If today’s EIA report is in sync with the API report I would view it as mildly bullish especially for crude oil and distillate and it could result in some support coming into the market.
With the markets looking for oil price direction we may see the weekly inventory reports have a directional impact yet again this week. At the moment with all of the financial uncertainty permeating around the global markets it is difficult to say when this week's report will impact the market (if at all). The EIA data will be released later this morning at 10:30 AM (EST). My projections for this week’s inventory reports are summarized in the following table. I am expecting mixed report with a modest decline in crude oil stocks as a result of an increase in refinery utilization rates. I am expecting a modest build in both gasoline inventories and distillate fuel stocks. I am expecting crude oil stocks to decline 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 narrow to around 4.9 million barrels while the overhang versus the five year average for the same week will also narrow to 26 million barrels. My projection risk for crude oil is to the upside as stocks could have actually built depending on the combination of how much additional crude oil came through the keystone pipeline versus the level of refinery runs in PADD2.
With refinery runs expected to increase by about 0.3% I am expecting a modest build in gasoline stocks as demand likely decreased while imports possibly increased. Gasoline stocks are expected to build by about 0.8 million barrels which would result in the gasoline year over year deficit narrowing to about 3 million barrels while the surplus versus the five year average for the same week will widen to about 5.9 million barrels. All eyes will be focused on the gasoline number once again this week after last week's surprise build in stocks for the fourth week in a row. Gasoline demand is definitely on the defensive even as last week's implied demand number increased marginally.
Distillate fuel is projected to increase modestly by 1.1 million barrels on a combination of no weather demand as well as an increase in production. The weather 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 14.6 million barrels below last year while the overhang versus the five year average will be around 8.3 million barrels.
The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year saw across the board builds in inventories for everything other than gasoline stocks versus this week's projected mixed report. In fact the builds last year are much greater than this week's projections so in general the fundamentals may gain some ground versus last year.
As usual do not overreact to the API data as more often than not it is not in line with the more widely followed EIA data. If the EIA report is within the projections I would expect the market to view the results as mostly neutral. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on in the financial markets.
My individual market view is detailed in the table at the beginning of the newsletter. For today I am continuing to remain neutral for my oil view and bias. The oil complex remains very choppy and is likely to remain choppy as it looks to settle back into a trading range. That said I also do not expect much of a push to the downside either and I think going forward we may be back to moving into a buy the dip mode. At this point I am still not sure where the dip is just yet. For today I am still remaining on the sidelines until all of the events have been fully digested by the market.
I am keeping my Nat Gas view and bias at neutral and still with an eye toward moving into the cautiously bearish category once this week's trading activity is fully digested by the market. I currently am sidelined and have no long side exposure in this market at the moment.
Currently asset classes are mostly lower as shown in the following table.
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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