Quote of the Day
They can because they think they can.
Virgil
Selling has continued overnight in the oil complex on all of the normal worries plus the much larger than expected build in crude oil inventories reported in last night's API report (see below for more details). So far this morning the $92.50 Jul WTI technical support area held while the July Brent $109.50 tech support area also held. Whether or not this is a true hold on support or nothing other than a small dead cat bounce is certainly the main question of the day. The June Brent contract expires today and the June WTI contract expires on Tuesday. I am only focusing on the July contracts.
Let's ask the question as to what is going to make oil prices firm rather than discussing the current trading pattern from the downside. Unfortunately for the remaining bulls in the market there is not much out there to support a view of higher oil prices in the short- to even medium-term. The only unpredictable event that can change the current course of oil prices in the short term is a sudden collapse in the talks between Iran and the West. At the moment that looks highly unlikely as relatively high level technocrat meetings have been taking place this week (ahead of the main meeting on May 23) and the dribbling of comments from the meetings have been favorable with more progress being made.
Barring a geopolitical event, all other normal price drivers for oil and the broader commodity and equity complex are all simply bearish as of now. The fundamentals of oil are becoming more bearish as the inventories continue to build around the globe. In the IEA report last week they reported OECD inventories are now above the five year average while crude oil inventories in the US are at the highest level going back to the early 90s and well above the levels seen during the heart of the financial crisis a few years ago. Even with the EU embargo of Iranian crude oil purchases the global oil industry has been rebalancing itself... much as I indicated it would months ago... coupled with additional production coming from Saudi Arabia. At this point in time the Iranian's have been impacted by the embargo while the west has not (basis prices below the level they were at when the embargo was announced on January 23rd).
Moving to the projected fundamentals or the perception of what the market is going to be like down the road I have to still view it as biased to the bearish side. Projected fundamentals are going to be driven by the perception as to how the global economy evolves over the next six months or more. As of now I view the global economy as remaining in a very slow growth pattern for the rest of this year and likely into 2013. The developed world economies are struggling to remain out of another recession period. The US seems to be on slightly more solid ground than Europe. This week's GDP data for Europe came in at no growth but a zero GDP does not count in the official definition of a recession which requires two continuous quarters of negative GDP. The fourth quarter was negative and I guess the officials call a zero GDP a positive number. I on the other hand call it recession.
On top of the paltry economy in Europe the issue of whether or not Greece will exit the EU is forming a huge cloud of uncertainty over all of the financial and commodity markets. I still think in the long run Greece should exit the EU as I am not sure why it should have even been invited to join. The main problem of a Greek exit is it may not be very orderly creating potential unknown consequences that will more than likely be bearish for all markets. The next event for Greece will be another election in the first half of June which pretty much looks to me to be a de facto vote on whether or not to remain in the euro. Between now and then uncertainty will keep most all risk asset markets under some degree of pressure.
Neither the US nor Europe are the main growth engines for oil consumption and have not been for years. The main oil demand growth engines of the world are the emerging market countries in particular China and India. Both of these economies (and pretty much most of the emerging market world) are all experiencing a slowing of their economy as they all move to some form of monetary and fiscal stimulus to try to jump start their economies. The results of an easy money policy does not mean that those economies are going to return to an above average growth rate tomorrow...it will take months if not years. The current projected state of the emerging market world remains bearish for any major growth spurt in oil consumption.
Overall oil prices are likely to decline further and back to levels that are much more representative of a global economy that is growing in slow motion. Right now the spot WTI contract is trading at levels it was at in mid-December of 2011. If the current support levels do not hold I expect oil prices (basis WTI) to move back into the $80 to $90/bbl trading range that was in place back in the 3rd quarter of 2011 and a level when there was no immediate geopolitical risk as well as a timeframe representing a view of a much slower growth rate for the global economy and oil consumption.
I also view tomorrow's start of the Seaway Pipeline as the beginning of the normalization process for the Brent/WTI spread and thus the normalization of all oil commodities back to more historical relationships with WTI. I still expect the Brent/WTI spread to slowly move toward normalization over the next six to 12 months.
The global equity markets are continuing to lose whatever gains they had for the year as shown in the EMI Global Equity Index table below. The EMI Index is now lower by 4.1% on the week narrowing the year to data gain to just 0.7%. The Index level is back to where it was during the first week in January and has now given back just about all of its gains for 2012...which maxed out around 15.2% in early to mid-March. As a leading indicator for the global economy the equities markets are just another bearish price driver for oil and the broader commodity complex. There are now 4 of the 10 bourses in the Index in negative territory for the year.
Needless to say I am bearish for oil and just about every risk asset market in the world right now. Commodities as a group have now given back all of this year's gains and are back to the second half of last year's levels. Falling commodities as a group are yet another indication of the global economy slowing and thus another bearish indicator for risk asset markets. The markets are starting to feel more like a sentiment that is borderline panicky (mostly due to the unknowns surrounding Greece) and not simply a sell in May and go away feeling. At the moment the only hiding place for sidelined cash is in US dollars and US bonds...even gold is falling.
The API report showed another huge build in crude oil that was well above the expectations but a much larger than expected decline in gasoline stocks and another surprise draw in distillate fuel inventories. The API reported a large build (of about 6.6 million barrels) in crude oil stocks and above the expectations as crude oil imports decreased modestly and refinery run rates decreased by 0.5%. The API reported a large draw in gasoline stocks and a large draw in distillate stocks versus an expectation for a more seasonal build in gasoline and a small build in distillate fuel inventories.
The report is bullish for refined products and bearish for crude oil. The market has not reacted strongly in overnight trading but has been drifting lower for all commodities in the complex. The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning. The API reported a build of about 6.6 million barrels of crude oil with a build of 2.7 million barrels in PADD 2 and a build of 2.7 million barrels in Cushing, Ok which is bullish for the Brent/WTI spread. On the week gasoline stocks decreased by about 2.6 million barrels while distillate fuel stocks decreased by about 1.6 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 the global 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 expect more market participants 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 an across the board build in inventories this week with a modest build in crude oil, a small build in gasoline inventories and a modest build in distillate fuel stocks along with a small increase in refinery utilization rates. I am expecting a build in gasoline inventories and a build in distillate fuel stocks as the summer planting season is winding down (decreasing the demand for diesel fuel) while the heating oil demand is dissipating. 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 surplus of crude oil will come in around 10.4 million barrels while the overhang versus the five year average for the same week will widen to around 26.4 million barrels.
With refinery runs expected to increase by 0.3% I am expecting a small build in gasoline stocks. Gasoline stocks are expected to increase by about 0.2 million barrels which would result in the gasoline year over year surplus coming in around 1.4 million barrels while the deficit versus the five year average for the same week will come in around 27.4 million barrels.
Distillate fuel is projected to increase by 0.4 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 22 million barrels below last year while the deficit versus the five year average will come in around 13 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 were mixed. 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 to cautiously bearish after oil broke down on all fronts last week with a continuation to the downside to open trading for the week. Oil is now solidly below the trading range it has been in for the last month or so and well below several key support areas. WTI is now solidly trading in double digits with Brent currently holding up a tad better.
I am keeping my view at neutral and keeping my bias also at neutral with an eye toward the upside. The surplus is still building in inventory versus both last year and the five year average and could 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.
Currently markets are lower as shown in the following table.
Best regards,
Dominick A. Chirichella
