Quote of the Day
If you do not hope, you will not find what is beyond your hopes.
St. Clement of Alexandra
Yesterday was a whipsaw kind of trading session as US Fed Chairman Ben Bernanke painted a negative picture for the US economy in his opening remarks but gave no indication as to what direction the US Fed is moving toward insofar as a new round of quantitative easing. The markets sold off during his opening remarks as the QE crowd headed to the sidelines. However, as the market digested his comments and testimony oil, commodities and equities gradually regained their footing as Mr. Bernanke said (as he has been saying ) that the US FOMC will take whatever action is necessary and they still have tools in their toolbox. So simply put Mr. Bernanke's comments were consistent with the comments he made at the presser after the June FOMC meeting as well as consistent with the minutes from the June FOMC meeting released about a week or so ago. The only change is the acknowledgement that the US economy is doing worse than the Fed previously projected which is not really new news to the market based on the plethora of macroeconomic data that has been released over the last several weeks and supportive of that view. Mr. Bernanke speaks before the House side of Congress today and I would expect more of the same.
Basically easing is a possibility but as I have been saying it is not a guarantee. I still rate it as a 50/50 chance at best. The economic data has to continue to deteriorate suggesting that the US economy is continuing to slow and move toward the recession level for the FOMC to act with a new round of QE. I do not think the Fed will act at the July 31 - August1 FOMC meeting with the earliest possibility of an announcement coming during Mr. Bernanke's speech at Jackson hole at the end of August (as he did a few years ago) followed up at the mid-September FOMC meeting. This will give the Fed many more data points to get more comfortable with the short to medium term direction for the US economy. The guessing game will continue with any and all bad economic data points likely met with buying on the premise that it signals the probability of QE3 is increasing.
Oil is getting toppy at current levels once again as most market participants continue to focus on the major headwind in the market...the slowing global economy. When the potential for quantitative easing is pushed down the road traders and investors have nowhere to look other than the simple fact that the economies of the US, Europe and China (and others) are all slowing and thus global oil demand growth is also slowing as we saw in all of the monthly forecast reports over the last week or so (IEA, EIA and OPEC).
Another indication of the slowdown in oil consumption is the decline to a 17 month low in the number of VLCC (2 million plus barrel capacity) ship charters booked according to an article in Bloomberg quoting ship broker Marex Spectron Group. They are projecting a decline to 115 fixtures in July a 10% decline from June and the lowest level since February, 2011. A reduction in charters heading to China represents the largest part of the decline. The fundamentals remain biased to the supply side with a shortage of demand still the main feature in the global oil market.
The negative news continues to come from China as the Premier said overnight that the labor situation will become more severe and that the weakest economic growth since 2009 will lead to increasing job losses. He went on to say that the government will implement a more proactive labor policy. He also said a few days ago that the economic rebound lacks momentum and difficulties may persist for awhile. All that sounds like more easing is coming and possibly even some form of a stimulus or spending program like the one China launched during the height of the financial crisis. Yes I still expect more easing from China in the short term but I do not expect it to have an immediate impact on the economy. Growth will remain sluggish for months to come. That said more stimulus could awaken the QE crowd again and send them back into the market from the long side as they move into a perception trading mentality.
Global equities recovered most of the losses from early in the week as shown in the EMI Global Equity Index table below. The Index is now down just 0.1% for the week with the year to date loss sitting at 0.6%. Three of the bourses remain in negative territory for the year. Over the last twenty four hours all of the markets in the west have added value with Asian trading mixed but mostly lower. Global equities remain a neutral to biased to the bearish side for oil and the broader commodity complex.
The API report showed a larger than expected decline in crude oil stocks and a surprisingly large build in distillate stocks along with a surprise draw in gasoline stocks. The API reported a draw (of about 2 million barrels) in crude oil stocks and greater than the expectation range even as crude oil imports increased while refinery run rates decreased strongly by 1.5%. The API reported a strong build in distillate stocks. They also reported a surprise draw in gasoline stocks versus an expectation for a more seasonal build in gasoline inventories.
The report is bearish for distillate, bullish for crude oil and gasoline. The market has not reacted much in overnight trading and has been drifting lower for all commodities in the complex ahead of the EIA oil inventory report at 10:30 AM 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 2.0 million barrels of crude oil with a build of 0.7 million barrels in PADD 2 but a decline of 0.451 million barrels in Cushing, Ok which is neutral to bearish for the Brent/WTI spread. On the week gasoline stocks decreased by about 0.1 million barrels while distillate fuel stocks increased by about 3.4 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 ratcheting up again even though another meeting is scheduled for July 24th. 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 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 21.2 million barrels while the overhang versus the five year average for the same week will narrow to around 36.3 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 $15.25/bbl premium to Brent level. 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 1.3 million barrels which would result in the gasoline year over year deficit coming in around 2.7 million barrels while the deficit versus the five year average for the same week will come in around 4 million barrels.
Distillate fuel is projected to increase by 1.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 22.6 million barrels below last year while the deficit versus the five year average will come in around 20.6 million barrels. Exports of distillate fuel have been the main storyline this year with exports running around 1 million bpd.
I still think the oil price is overvalued. 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 keeping my view at 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 lower as shown in the following table.
Dominick A. Chirichella