Oil taking trading cues from dollar and Chinese economy

The API report showed a surprise across the decline in oil inventories this week versus expectations for builds in both crude oil and gasoline and a much more modest draw in gasoline. The API reported a modest draw (of about 1 million barrels) in crude oil stocks versus an expectation for a modest build in crude oil inventories as crude oil imports decreased marginally while refinery run rates also increased by 0.6%. The API reported a large draw in gasoline stocks and a large draw in distillate stocks versus an expectation for a more seasonal draw in gasoline and a small build in distillate fuel inventories.

The report is bullish across the board especially if the EIA report is in sync with the API report. The market has not reacted strongly in overnight trading.  The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out tomorrow. The API reported a draw of about 1.0 million barrels of crude oil with a build of 1.0 million barrels in PADD 2 and a build of 0.6 million barrels in Cushing, Ok which is bullish for the Brent/WTI spread. On the week gasoline stocks decreased by about 3.6 million barrels while distillate fuel stocks decreased by about 3.6 million barrels. 

At the moment oil prices are still being mostly driven by the direction of the euro and the US dollar as well as by a view that China's economy is continuing to slow. The tensions evolving in the Middle East between Iran and the West have been easing as another meeting is scheduled for May.  As such we may see more market participants starting to pay attention to this week's round of oil inventory data suggesting that this week's oil inventory reports could also start to impact price direction. This week's oil inventory report could move to being a primary price driver especially 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, a small decline in gasoline inventories and a modest decline in distillate fuel stocks along with a small increase in refinery utilization rates. I am expecting a draw in gasoline inventories and a build in distillate fuel stocks as the summer planting season is still in play (increasing the demand for diesel fuel) while the heating oil demand is dissipating. I am expecting crude oil stocks to increase by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 13.6 million barrels while the overhang versus the five year average for the same week will widen to around 23.7 million barrels.

Even with refinery runs expected to increase by 0.2% I am expecting a modest draw in gasoline stocks. Gasoline stocks are expected to decrease by about 0.8 million barrels which would result in the gasoline year over year surplus coming in around 5.1 million barrels while the deficit versus the five year average for the same week will come in around 21.5 million barrels.  

Distillate fuel is projected to increase by 0.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 18.9 million barrels below last year while the deficit versus the five year average will come in around 2.8 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 inventories declined across the board. As such if the actual data is in line with the projections there will be a modest change in the year over year comparisons for most of the complex. 

 I am keeping my view at neutral for oil as WTI remains within my predicted trading range of $102 to $107/bbl. At the moment the oil complex is still going through a spread realignment driven by a reduction in the tensions in the Middle East and thus a receding of the Iranian risk premium along with a sentiment swing in the Brent/WTI spread due to the early start of the Seaway pipeline. I am more comfortable staying on the sidelines today for the flat price market.

I am now moving my view back to neutral but keeping my bias at bearish.  The surplus is still building in inventory versus both last year and the five year average is going to lead to a premature filling of storage during the current injection season.  However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.

Overall this has been a positive week for the Nat Gas market for both cash and futures prices. Unfortunately for all of the bulls in waiting two days do not make a trend. As I said yesterday I am neutral with a cautiously bearish bias. That is an upgrade after being bearish for well over a year. I changed my view because I am starting to believe that the market sentiment is slowly starting to change and producers are starting to look more seriously at the possibility of cutting production...much like the comments made by Conoco yesterday. I still view the Conoco comments as the beginning of what should be similar comments coming from other major producers.

Not only are the economics of producing dry gas at the worst level in years but as I have discussed many times in this newsletter the infrastructure will eventually force a cut in production as the industry gets closer to hitting the maximum storage capacity level. This is likely to incur in the Producing region first as only about 22% of capacity is left and we are only in the sixth week of the injection season. On average the injection season usually lasts about 34 weeks (basis the five year average data). Thus with about 82% of the injection season still in front of us there is no doubt in my mind that there will be infrastructure restrictions sooner than later. That said I believe that some producers...like Conoco will get in front of the issue and voluntarily start to reduce production as it is always more optimal to pick and chose how one manages its operations rather than having it dictated to you by the pipeline and storage facility operators.

I know some people are saying that we have heard the Conoco type story back in the beginning of the year and we did not see much of a cut in production from those announcements. My view is that in the beginning of the year the heart of what is normally the highest demand period for Nat Gas was still in front of the producers. At that point in time there was not yet a lot of motivation to cut production strongly especially if the winter would have turned out to be much colder than normal rather than the result we got this year. However, we are now in the lowest demand period of the year and so far the early forecasts for the upcoming summer season as well as the hurricane season is not very promising for a demand solution to the overhang of Nat Gas in inventory. Thus I believe that the producing sector is now looking at this issue a lot more seriously than they did in the beginning of the year.

I am not a raging bull rather I view this as a potential turn of events. I emphasize the word potential as it is yet to occur. The Conoco cuts are still relatively minimal. I am now in a watching phase and thus my neutral stance. The only thing I am doing at the moment is slowly starting to build a bullish winter intermonth spread as I have talked about for the last two weeks. I will continue to approach this market very cautiously until I see more follow through from other producers

Currently markets are mostly higher as shown in the table below.

Best regards,       

Dominick A. Chirichella