Quote of the Day
The most difficult thing in life is to know yourself.
The market continues to react to any indication that the US Fed will join other major economies and embark on another round of quantitative easing. In overnight trading the US dollar has been easing ahead of today's release of the minutes from the US FOMC meeting from June. The market is anticipating that there may be some definitive comments that may lay out the conditions that the US Central Bank may have set at the last meeting that will indicate what they may do at the August Fed meeting. I am not sure there will be anything new in the minutes than what was already discussed at Bernanke's' press event after the last meeting. However, the market is slowly building in a new round of QE as the US economic data continues to suggest a further slowing of this economy.
The current situation reminds me of the Dunkin Donuts commercial from awhile back... the "World is Running on Dunkin." The global economy can best be described as the "World is Running on Easing and Money Printing." There is hardly any organic economic growth in any of the major global economies, rather the world's central banks are on a program of trying to inflate their way out of the malaise that is spreading around the world. As I have been suggesting market participants may be slowly moving away from being focused on the current economic and fundamental situation and moving more toward the perception trade. The perception trade or trading and investing based on what the economy might be like dominated trading decisions on and off over the last three years as central banks added new easing measures. I still think we are moving toward a sentiment that bad economic data could actually be good for most risk asset markets based on a view that bearish data will result in even more easing.
Global equity markets were mixed over the last 24 hours as shown in the EMI Global Equity Index table below. The Index is now down by 2% for the week pushing the year to date performance back into negative territory (minus 0.8%) for the year. Brazil took a bit hit in the last 24 hours as did Canada. Three of the ten bourses in the Index are in negative territory for the year with Germany still holding the top spot as the weakening euro is a positive for this export oriented economy. Global equities have been a negative for the oil complex as well as the broader commodity complex.
On the regulatory side the CFTC approved the swap definition by a vote of 4-to-1 required by the Dodd Frank Act. The swap definition will now trigger about 20 new Dodd Frank measures for reporting, clearing, trading and record keeping that could take effect as early as September. There is still a lot of work to be accomplished but the OTC market is now in play insofar as change is concerned.
The EIA released their latest Short Term Energy Outlook on Tuesday afternoon. As I suggested they did lower their projection for global oil consumption for 2012 and 2013 versus last month's report. They are now projecting about 700,000 bpd of oil demand growth for both 2012 and 2013 a reduction of about 100,000 bpd in 2012 and 400,000 bpd in 2013 from the last STEO based on the slowing of the global economy. Following are the main oil related highlights from the report.
The projected pace of global oil demand growth in this month's Outlook reflects less optimistic assumptions about the global economy. The forecast for global economic growth was lowered by 0.1 and 0.6 percentage points in 2012 and 2013, respectively, from last month's Outlook, and is now expected to average 2.9 percent in both years. The weaker growth outlook is prompted by increased economic concerns about the debt crisis in Europe and indications of slowing growth in China, both which could have spillover effects on other economies. The global liquid fuels consumption growth forecast for 2012 was lowered to 0.7 million bbl/d from 0.8 million bbl/d in last month's Outlook. Projected global consumption growth in 2013 was lowered by 0.4 million bb/d to 0.7 million bbl/d.
EU sanctions, including an embargo on Iranian crude and an insurance ban on tankers carrying Iranian oil, became fully effective on July 1, shortly after the latest set of U.S. sanctions entered into force. The United States issued exceptions to all major importers of Iranian oil from sanctions that could have been imposed on foreign financial institutions which facilitated oil-related transactions with the Central Bank of Iran, but only after they had demonstrated or pledged significant reductions in their purchases of Iranian crude oil. The complete market effects of these sanctions are unknown and difficult to disentangle from previous rounds of sanctions, but EIA believes that most of their current and expected effects on Iranian oil supplies have already been priced into the global oil market. Despite the market's mild reaction to the sanction start dates, upside price risks still persist, particularly if negotiations with Iran fail to progress.
World liquid fuels consumption grew by an estimated 0.8 million bbl/d in 2011. EIA expects consumption growth of 0.7 million bbl/d in both 2012 and 2013, with China, the Middle East, Central and South America, and other countries outside of the Organization for Economic Cooperation and Development (OECD) accounting for essentially all consumption growth (World Liquid Fuels Consumption Chart). Projected OECD liquid fuels consumption declines by 0.5 million bbl/d in 2012 and a further 0.3 million bbd/d in 2013.
EIA expects that OPEC members will continue to produce about 30 million bbl/d of crude oil over the next two years to accommodate the projected increase in world oil consumption and to counterbalance supply disruptions. Projected OPEC crude oil production increases by about 0.8 million bbl/d in 2012, and then falls by 0.9 million bbl/d in 2013, as non-OPEC supply growth increases and stocks rise slightly. OPEC non-crude oil liquids (condensates, natural gas liquids, and gas-to-liquids), which are not covered by OPEC's production quotas, averaged 5.5 million bbl/d in 2011 and are forecast to increase by 0.3 million bbl/d in 2012 and less than 0.1 million bbl/d in 2013.
EIA expects Iran's crude oil production to fall by about 1 million bbl/d by the end of 2012 relative to an estimated output level of 3.6 million bbl/d at the end of 2011, and by an additional 200 thousand bbl/d in 2013. Iran's output decline has continued to accelerate since the fourth quarter of 2011. EIA believes that this acceleration reflects erosion in Iran's crude oil production capacity due to the country's inability to carry out investment projects that are necessary to offset the natural decline in production from existing wells, as well as the impact of lower Iranian crude oil exports due to recently enforced EU and U.S. sanctions. A number of foreign companies that were investing in Iran's upstream have halted their activities as a result of previous U.S. sanctions, which have been compounded by tighter measures enforced since the start of this year that have made it increasingly difficult to do business with the country. EIA expects that the forecast decline in Iran's output will be offset by increased production from other OPEC member countries.
EIA estimates that OECD commercial oil inventories ended 2011 at 2.59 billion barrels, equivalent to 55.9 days of forward-cover (Days of Supply of OECD Commercial Stocks Chart). Projected OECD oil inventories increase to 2.63 billion barrels and 57.3 days of forward-cover by the end of 2012, which is among the highest end-of-year levels in the last decade, because of the decline in OECD consumption.
The API report showed a modest decline in crude oil but within the expectations and a surprisingly large build in gasoline stocks along with another surprise draw in distillate stocks. The API reported a draw (of about 0.7 million barrels) in crude oil stocks but within the expectation range as crude oil imports decreased while refinery run rates also decreased by 0.6%. The API reported a strong 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 bearish for gasoline. The market has not reacted strongly in overnight trading but has been stabilizing for all commodities in the complex ahead of the FOMC meeting minutes release later today. 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 draw of about 0.7 million barrels of crude oil with a draw of 0.5 million barrels in PADD 2 and a decline of 0.909 million barrels in Cushing, Ok which is bearish for the Brent/WTI spread. On the week gasoline stocks increased by about 2.5 million barrels while distillate fuel stocks decreased by about 0.7 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 seem to be easing again now with another meeting scheduled for July 24th. In addition the Norwegian strike is over eliminating another potential supply issue. 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 of the markets 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 report are summarized in the following table. I am expecting the US refining sector to continue its 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 heart of the summer driving season is now in full play. I am expecting crude oil stocks to decrease by about 0.9 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 26.5 million barrels while the overhang versus the five year average for the same week will narrow 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 continuing at high levels 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 $13.50/bbl premium to Brent level as the Norwegian oil workers strike is now over and is bearish for the spread. 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 0.3% I am expecting modest build in gasoline stocks. Gasoline stocks are expected to increase by 0.8 million barrels which would result in the gasoline year over year deficit coming in around 5.9 million barrels while the deficit versus the five year average for the same week will come in around 7.2 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 26.2 million barrels below last year while the deficit versus the five year average will come in around 24.2 million barrels. Exports of distillate fuel have been the main storyline this year with exports running around 1 million bpd.
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.
I still think the oil price is overvalued especially after last Friday's huge increase. However, the combination of the evolving geopolitical concern around Iran and the Middle East as well as the view that the global Central Banks are more likely to ease monetary policies further as well as initiating a new round of stimulus should contribute the market stabilizing (after some profit taking selling). For the moment the oil complex is trying to establish a new trading range.
I am moving my view back to neutral as the hot weather that has persisted across major portion of the US has subsided a bit and the rest of July is not likely to be as hot over the entire US as it was for the second half of June. In addition the economics of coal switching now favors coal which will result in a reduction in Nat Gas demand. Finally Nat Gas at current price levels is overvalued and is likely to decline further and settle into the $2.25 to $2.70 trading range.
Currently markets are mostly higher as shown in the following table.
Dominick A. Chirichella