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Most of the risk asset markets including oil have been struggling all week as market participants continue to evaluate the evolving sovereign debt issues in Europe as well as the slowing of the global economy. The spot WTI contract has remained below the $80/bbl level for the fifth trading session in a row while Brent has managed to push back above the $90/bbl level as the Norwegian oil workers remain on strike for the last four days shutting in about 180,000 bpd of oil.
Overall oil supply is still plentiful even with the Norwegian strike and the official start of the EU Iranian crude oil purchase embargo scheduled to begin on July 1. In fact Iran has announced that their exports may decline by 20 to 30% due to field maintenance which according to Iran is timed to coincide with the start of the EU oil embargo. On the other side of the equation global oil demand is continuing to weaken as the global economy continues to weaken. Oil markets are settling into a new trading range with WTI likely to remain in the $75 to 85/bbl range while Brent is carving out a range of $85 to $95/bbl for the short term. The next several weeks will determine the trading range that will most likely hold for the medium term as the market evaluates the impact of the Iranian oil sanctions, how long the Norway strike lasts (probably not all that long) and the impact of the slowing global economy.
The EU Ministers meeting set for Thursday and Friday could also have an impact on the short term direction of oil and the broader risk asset markets. If something of substance comes out of the meeting it could result in a short term rally in most risk asset markets. However, history has told us that the vast majority of the EU Ministers meeting have not resulted in any major new solutions and the odds are that this meeting will end with lots of discussions and nothing new like euro bonds or a political union, etc. Germany's Angela Merkel seems mostly focused on continuing the austerity programs, getting the peripheral countries budgets in order and adding a modest level of stimulus as discussed last week with the big four pre-meeting. In addition the ECB meets on July 5th and they could also surprise the market with a rate cut as well as some form of stimulus program. The outcome of next week's ECB meeting could potentially have a larger impact on the direction of risk asset markets than this week's EU Ministers meeting.
Global equities are still lower for the week as shown in the EMI Global Equity Index table below. The Index is lower by 1.6% for the week resulting in the year to date loss widening to 1.8%. So far the Index has mostly been in negative territory for the year since the middle of May and currently about 17% off of its year to date high made back in the middle of March. Five bourses remain in negative territory with Canada still holding the bottom spot in the Index as oil prices are still down over 30% since peaking earlier his year. Germany and Hong Kong are holding the top two spots in the Index with Germany's market getting a boost from the lower euro which is favorable for Germany's export oriented economy. Global equities have been a negative price driver for oil and the broader commodity complex.
The API report showed a small build in crude oil versus an expectation for a larger build and a surprise draw in distillate stocks along with a build in gasoline inventories but below the expectations. The API reported a build (of about 0.5 million barrels) in crude oil stocks and outside the expectation range as crude oil imports decreased while refinery run rates increased by 0.8%. The API reported a modest build in gasoline stocks. They also reported a surprise draw in distillate stocks versus an expectation for a more seasonal build in distillate fuel inventories.
The report is bullish for distillate, neutral for crude oil and for gasoline. The market has not reacted strongly in overnight trading but has been stabilizing for all commodities in the complex ahead of the EU meeting starting tomorrow. 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 at 10:30 AM. The API reported a build of about 0.5 million barrels of crude oil with a draw of 1.4 million barrels in PADD 2 and a decline of 0.682 million barrels in Cushing, Ok which is bearish for the Brent/WTI spread. On the week gasoline stocks increased by about 0.4 million barrels while distillate fuel stocks decreased by about 1.0 million barrels.
At the moment oil prices are still being mostly driven by the events discussed above along with 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 currently underway. As such we may not see much of a reaction from market participants to this week's round of oil inventory data as the macro risk off momentum is currently the main concern of all market players. This week's oil inventory report will likely be a background price catalyst unless the actual outcome is significantly different from the market projections.
My projections for this week’s inventory reports are summarized in the following table. I am expecting the industry to continue its aggressive campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a draw in crude oil inventories and a build in both gasoline and distillate fuel stocks as the summer planting season is over (decreasing the demand for diesel fuel) while heating oil demand is also over. I am expecting crude oil stocks to decrease 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 come in around 26.8 million barrels while the overhang versus the five year average for the same week will widen to around 41.6 million barrels.
I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery run rates are starting to increase in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $13/bbl premium to Brent level for the last few days on the back of the Norwegian oil workers strike. I am still of the view that the spread will continue the process of normalization over the next 3 to 6 months.
With refinery runs expected to increase by 0.1% I am expecting modest build in gasoline stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 9.4 million barrels while the deficit versus the five year average for the same week will come in around 7.4 million barrels.
Distillate fuel is projected to increase by 1.0 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 20.1 million barrels below last year while the deficit versus the five year average will come in around 17.4 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's inventories are not in the same direction as the projections. 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.
The oil complex has broken down below the trading range it has been in for weeks and is now bearish with more downside still possible. WTI can now be categorized as being in a $75 to $85/bbl trading range with Brent setting up in a $85 to $95/bbl range. The outcome of all of the upcoming events I have been discussing in the newsletter over the last several weeks have been mostly bearish for oil prices while the vast majority of the macroeconomic data that has been released is also bearish for oil.
I am keeping my view at neutral to see if Nat Gas is able to hold onto the developing trading range. The surplus is still narrowing in inventory versus both last year and the five year average but 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 mostly lower heading into the opening of trading in Europe as shown in the following table.
Dominick A. Chirichella