Quote of the Day
The road to success is always under construction.
Lily Tomlin
The word debt played a major role in yesterday's action in both the financial and commodity markets and that word has carried through the overnight trading session and into this morning as well. The big boost came mid-day when a bipartisan group in the US Senate revitalized a debt plan that is now starting to get legs all the way through to the President. The markets picked up on the talk as a sign that the US politicians may be able to put together a debt and deficit ceiling deal by the August 2 date when the US government is supposedly going to hit its legal limit. The next few days will be critical to see if there is enough support in the Senate to pass a bill and then if the US House of Representatives will go along with the plan. Irrespective of one's view of what a plan should look like the markets are clearly saying they want to see a plan to raise the debt ceiling and not a default as demonstrated by the positive reaction in the markets from yesterday's lose comments concerning the Senate initiative under way.
On the other side of the Atlantic the evolving sovereign debt problems are starting to look more and more like a resolution may be forming as the EU leaders get ready for their summit on Thursday. The EU leaders need to come up with a plan to avoid a contagion to other southern EU member countries like Italy and Spain. The markets are starting to view a solution from the EU as a bit more likely with many old and some new options now on the table for the meeting.
Much like the US problem the markets want a resolution and not a default as even an imperfect resolution to both the US and EU debt problems will be better than a default (from the markets perspective) which is likely to result in a chaotic situation much like what occurred when Lehman Brothers collapsed in 2008. I do not think the politicians and leaders in both of these regions want a default either and as such I still believe there will be an agreement of some sorts in both the US and the EU.
How the markets ultimately react to a solution is still a bit of an unknown. Right now any signs that an agreement has been reached in the EU and the US will result in a short covering rally in global equities with at least some follow through into many of the commodity markets like oil. How sustainable this move could be will be directly dependent on how much of the agreements are smoke and mirrors type solutions or actual deep rooted solutions to the debt exposure in both the US and EU. That we will have to wait and see how it evolves over the next several days. But a global equity rally is certainly a positive for oil prices.
A solution in both regions may result in the currency markets going back to more fundamentally driven relationships based on yields and short term interest rates in each region. A solution in Europe will take the downward pressure off of the euro as the flight of cash to safety (to the USD) would end and market players would quickly revalue the euro based on the fact that the ECB is already raising interest rates while the US is stuck in an easy money policy with no intention of raising interest rates for an extended period of time. The euro would strengthen and the US dollar would likely weaken...yet another positive for the oil complex as well as the broader commodity markets.
Thus the next few days into next week will be critical as to the next directional move for the financials as well as the commodity markets. Eliminating the word “debt” from the media airwaves in both Europe and the US will likely result in market participants starting to slowly come back to a risk on trading mentality. Many players who are already of the view that the global economic recovery is going to pick up steam later in the year will likely not only close down shorts but probably start to buy into the perception trade for equities and commodities much as they have over the past several years...ignore the current situation and invest & trade based on what the conditions and fundamentals may be like six months from now. That is what I view as starting to permeate throughout the market sentiment for oil and equities.
On the oil fundamental front, last night's API report was mixed in my view with crude oil strongly bullish while refined products were mostly bearish. The API data was mostly outside of the market expectations showing a huge decline in crude oil inventories, an above expected build in gasoline stocks and refinery utilization rates with distillate fuel stocks building within the expectations.
The API reported a crude oil inventory draw of about 5.2 million barrels as refinery utilization rates soared by 1.2% to 86.1% of capacity while imports increased only marginally. The API reported a modest build of about 1.1 million barrels of crude oil in PADD 2. Crude oil stocks in the mid-west are still high and even with this week's increase they are around the level they were at back in the first quarter of this year. They showed a build in inventory for distillate fuel and gasoline stocks. The market was expecting a small build in gasoline stocks and a modest build in distillate fuel inventories this week. On the week gasoline stocks increased by about 2.0 million barrels while distillate fuel stocks were higher by about 1.1 million barrels. The results of the API report are summarized in the following table. So far the market has reacted positively to the API report...especially for crude oil... 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 modestly supportive.
At the moment with all of the financial uncertainty permeating around the global markets (as discussed in detail above) it is difficult to say when this week's report will impact the market (if at all). My projections for today's EIA inventory report is summarized in the following table. I am expecting a mixed report with a modest decline in crude oil stocks as a result of another week of reduced imports and a small 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 will narrow to about 1.0 million barrels but the overhang versus the five year average for the same week will also narrow to 18.5 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 oil came into the US versus the level of refinery runs in PADD2 and PADD3.
If the inventories are in line with the projections, I would expect to see a decline in both PADD 2 and Cushing crude oil stock levels which could potentially impact the Brent/WTI spread. Since peaking and setting another new record high last week the spread has narrowed about 10% since then but is still trading at an atypically high level at close to $20/bbl premium to Brent. As I have discussed over the last month or so I still expect the spread to narrow but not until North Sea oil production returns to more normal levels after the August turnaround season is over. However, with US refiners gradually increasing refinery utilization rates... inventories in this region are looking like they could be entering a destocking pattern. PADD 2 stocks are now back down to earlier year levels when the spread was trading in a range of $12 to $14/bbl premium to Brent. If stocks continue to decline I would expect the low double digit level as the next target for the spread during what looks like will be a correction phase when it finally begins (not likely until early fall or sooner if a resolution emerges in Libya before that).
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 0.2 million barrels which would result in the gasoline year over year deficit coming in around 10.3 million barrels while the surplus versus the five year average for the same week will narrow to about 3.0 million barrels. All eyes will be focused on the gasoline number once again this week after last week's surprise decline in stocks for only the second time in months.
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. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 20.4 million barrels below last year while the overhang versus the five year average will be around 4.0 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 experienced an across the board build in stocks so based on my projections the comparison to last year will deteriorate a tad in that this year's level will lose ground versus the same week last year. As such I do expect a noticeable change in the year over year status if the actual numbers are in line with my projections.
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. If the EIA report more nearly lines up with the API data I would expect the market to act more favorably to the numbers. 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 and that very important word...debt.
For today I am maintaining my oil view at neutral and keeping my bias at neutral also. I currently see nothing compelling to make me want to invest in the oil complex from a flat price position trading perspective in either direction or at least until there is more clarity on the financial issues in both the US and EU as any and all statements coming from either front is likely to result in unexpected intraday price reversals.
I am maintaining my Nat Gas view at neutral and keeping my bias at neutral. The market made a strong recovery after last week's sell-off suggesting that prices may continue to move higher in the short term. The heat wave has offset last week's bearish weekly snapshot while the projections for the upcoming inventory report are not coming in as aggressive as I first thought. Also, the technicals are disappointing and moving me solidly back to the sidelines until I get more clarity as to how much of an impact the current heat wave has had on the supply and demand balances.
Currently most risk asset classes are higher as shown in the following table.
Best regards,
Dominick A. Chirichella
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