Quote of the Day
Remember the difference between a boss and a leader; a boss says "Go!" - a leader says "Let's go!".
The downside correction in oil prices continued for a second day on Tuesday but has stabilized so far in overnight trading. I am not sure this is the end of the correction but if it turns out to be it will have proved to be shallow and short as I have been suggesting over the last several days. Oil is being driven by two main catalysts in my view...first and foremost by the ongoing geopolitical risk in the Middle East and Africa...especially Iran. The second driver is the massive amount of liquidity the Central Banks have been and continue to put in the market in variations of quantitative easing. Neither of these price catalyst are going to disappear anytime soon and as such I still expect oil prices to experience shallow and short duration downside corrections like we have seen (so far) with the correction that has occurred this week. Both of these price drivers are acting as a so called "Put" in the market and will prevent prices from declining precipitously until it becomes clear that either one or both of them have begun to disappear.
Speaking of liquidity, the European version of TARP, called LTRO, announced that the European Central Bank's massive loan program to the banks was higher than expected at about $713 billion USD (€529.5 billion). The loans were three years in duration at record low interest rates. 800 banks took advantage of the cheap money versus the last round of funding offered by the LTRO program. The markets have viewed the outcome of the LTRO as a positive for most risk asset classes...especially European equities. As each week goes by the market is placing less and less risk on the Eurozone region as the sovereign debt risk moves toward the background and market participants are focusing more on normal price drivers for global risk assets and less on catastrophic event risk that had engulfed most of the markets for the majority of last year. Also as discussed above with billions of dollars of funds continuing to be periodically injected into the global economy along with the perception that more may be coming (via a possibility for a QE3 from the US Central Bank) is very supportive for most risk asset classes including oil...the liquidity or soon to be inflation "Put".
With the developed world economies doing all they can to inflate their way out of the malaise that has engulfed these economies along with the potential for more stimulus like programs and a switching to more accommodative monetary policies in the developing world it is looking like risk asset markets...both equities and commodities are poised to continue in the uptrend that has been in place for the majority of this year. I am not saying that these markets are only going to go higher rather I am suggesting that we are in an uptrend that will experience downside corrections from time to time but when the dust settles at the end of 2012 all of the current signs and signals (that are in view at the moment) suggest that most risk assets values will be higher or above where they were at the end of 2011..incluidng oil. How much higher is a whole different issue that I can honestly say I have no way of forecasting but I do currently believe that they will be higher.
Oil is a bit different than most of the other risk asset classes in that is has a second catalyst impacting its price...geopolitics or better said the possibility for an interruption in the supply of crude oil due to unpredictable events in areas where the majority of the crude oil is produced and exported from. Absent these evolving risk zones the price of oil would be lower than it is at the moment but still clearly in an uptrend like most of the other risk asset classes. The last $10 to $15/bbl (WTI or Brent) of risk premium that has been embedded in the price oil came about after the EU announced their embargo on Iranian crude oil purchases raising the stakes in an already high stake game of "Middle East Hold-em oil poker." As I have mentioned on many occasions there is no shortage of oil anywhere in the world due to Iran. The market is trading on a perception that a supply interruption may occur at some point in time in the future.
There are three scenarios that can occur in my view. There are many variations of the scenarios I will present but I believe my three scenarios cover the range of events that can occur and what the impact might be on the price of oil. The first scenario is everything continues as is...a war or words going back and forth from both side but nothing happens insofar as impacting the supply of oil. Eventually this scenario will begin to be discounted by the market (especially if inventories remain stable and/or build) and some of the risk premium embedded in the price of oil will slowly start to recede.
The second scenario involves more talk of potential military action occurring either by the Israeli's striking Iran and/or the Iranian's undertaking a pre-emptive strike...mostly like against Israel. This will result in the risk premium widening as the market will become more convinced that a supply disruption will occur. This could bring oil price to the $115 to $130/bbl level (WTI or Brent).
Finally the last scenario does result in being the worst case ...military action actually happening. This scenario will result in the loss of oil supply for an undetermined period of time. The IEA will release oil from the global SPR but prices will likely move quickly to the levels experienced back when the all time highs were made in July of 2008. Depending on how this scenario evolves prices could actually exceed the 2008 highs by a substantial amount. Obviously this is the worst case scenario for not just oil but for the global economy. Hopefully it remains just a scenario.
On the global equity front the EMI Global Equity Index table (shown below) has moved back to the upside over the last twenty four hours. The EMI Index is now up by 0.4% for the week resulting in the year to date gain widening to 13.6%. Germany, Hong Kong and Brazil are soaring higher along with Japan. The global equity markets are clearly in an uptrend as discussed above in today's newsletter and all signs suggest that the uptrend is likely to continue with a few bumps n the road or better known as rounds of profit taking selling from time to time. Equities have been a positive price driver for oil prices as well as the broader commodity complex.
The API report showed a smaller than expected build in crude oil stocks along with surprise draws in both gasoline and distillate fuel inventories. The API reported a small build (of about 0.5 million barrels) in crude oil stocks versus an expectation for a modest draw in crude oil inventories as crude oil imports increased while refinery run rates decreased by 2.2%. The API reported a modest draw in gasoline stocks and a surprisingly larger than expected draw in distillate stocks versus an expectation for a more seasonal draw in inventories.
The report is bullish across the board. That said the changes overnight may not be from the API inventory report as prices are higher across the board and are being driven by the movement of the macro indicators and the evolving geopolitics of the Mideast region. The market remains tied to the evolving situation in Europe that has been unfolding along with the geopolitics of the mid-east this week as discussed above with inventory data a secondary driver. The API reported a build of about 0.5 million barrels of crude oil with a build of 1.6 million barrel build in Cushing and a build of about 1.3 million barrels in PADD 2 which is bullish for the Brent/WTI spread. On the week gasoline stocks declined by about 0.9 million barrels while distillate fuel stocks decreased by about 3.3 million barrels.
At the moment oil prices are still being mostly driven by the tensions evolving in the Middle East between Iran and the West (as discussed above) and to a much lesser extent based on the direction of the euro and the US dollar. As such I am not sure many market participants are going to pay much attention to this week's round of oil inventory data suggesting that this week's oil inventory reports may not have a major impact on price direction. At the moment all market participants are continuing to follow the new snippets out of the Middle East and the tick by tick direction of equities and the US dollar (driven by Europe)... as they are both the primary price drivers for oil. Even with the fundamentals and geopolitics starting to impact price it is the macro trade that dominates at the moment. As such this week's oil inventory report could remain a secondary price driver at best and only impact price direction if the actual EIA data is noticeably outside of the range of market expectations for the report.
My projections for this week’s inventory reports are summarized in the following table. I am expecting a mixed inventory report this week with a modest build in crude oil and gasoline stocks, a small decline in distillate stocks along with a small increase in refinery utilization rates. I am expecting a small build in gasoline inventories and a below normal draw in distillate fuel stocks as winter like weather was absent for most of the report period in many parts of the US...in particular the east coast. I am expecting crude oil stocks to increase by about 1.2 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 4.5 million barrels while the overhang versus the five year average for the same week will widen to around 6.7 million barrels.
With refinery runs expected to increase by 0.3% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by about 0.5 million barrels which would result in the gasoline year over year deficit coming in around 6.3 million barrels while the deficit versus the five year average for the same week will come in around 2.7 million barrels.
Distillate fuel is projected to decrease by just 0.2 million barrels on a combination of steady exports and a bit of warmer than normal weather last week. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 15.9 million barrels below last year while the surplus versus the five year average will come in around 3.6 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 for the same week the inventory changes were relatively minimal. As such if the actual data in line with the projections there will be some minor changes in the year over year comparisons for most everything in the complex except for crude oil inventories.
WTI is still trading above its most recent resistance level of $104/bbl (now a support level with $110/bbl the next level of resistance. Brent has also breached its resistance level of $120/bbl yesterday. But as with WTI... Brent is also settling into a new short term trading range of around $119/bbl to $126/bbl. Oil continues to be driven by the evolving geopolitics of the Mideast...in particular Iran with just about all of the other normal prices drivers taking a secondary role...including fundamentals. I am keeping my view at cautiously bullish and keeping the caution flag flying to remind all that the market is still susceptible to further profit taking selling in the short term.
I am still keeping my view at neutral and bias at bearish as once again there is not much supportive indications that Nat Gas is likely to embark on a major short covering rally anytime soon. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off even it gets cold over a major portion of the US and as such for the medium to longer term I am still very skeptical as to whether NG will be able to muster a sustained upside rally over and above a short covering rally.
The newly anointed spot Nat Gas futures contract...April is following in the footsteps of the expired March contract...lower and still bearish. The winter heating season although still officially has about three weeks left to go the projected weather looks more and more like an early start to spring in many parts of the country. Barring some surprise shift in the weather forecast winter related Nat Gas consumption is going to be below normal for the rest of the winter and into the early parts of the shoulder season. I do not know how many different ways I can say this but Nat Gas is short term and medium term bearish with a strong possibility that the futures market will remain in the $2.25 to $2.85/mmbtu technical trading range that has been in place for most of this year at least for the remainder of the winter heating season. If inventory withdrawals continue to underperform (mostly expected by the market) total inventories will end the season at an all time record high setting the stage for a possibility of the Nat Gas market trading with a $1 handle sometime during the shoulder season.
The Nat Gas market has been relatively quiet. There have been no new production cuts announced ever since the first round about a month ago. The announced cuts are minimal insofar as having any major impact on the growing overhang of Nat Gas in inventory. Industrial related consumption is still flat as the US economy is growing at a relatively slow pace. As such for the next several months (through the shoulder season) there is not likely to be any ramping up in consumption until the heart of the summer cooling season hits at the earliest. That also assumes that the summer months will have above normal temperatures. I have not seen any reliable forecasts yet for the summer months or the upcoming hurricane season. Thus for the short to medium term I have to remain with a bearish bias with only minimal risk to the upside.
Currently markets are mostly higher as shown in the following table.
Dominick A Chirichella
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