Quote of the Day
Along with success comes a reputation for wisdom.
Euripides
The markets just can't push the negative sentiment emanating from Europe into the background. The one-two punch of ongoing debt problems in Europe along with a slowing of the global economy is just too large of a headwind for the majority of the risk asset markets to catch much of a bid. The markets have been mostly lower since the euro started a new down leg last Friday. After mostly mediocre flash PMI data yesterday the UK reported a 0.7% contraction in its Q2 GDP which followed a 0.3% Q1 decline putting the UK now solidly in a double dip recession...the second in four years. In addition the German business climate gauge dropped more than expected in July. Aside from all of the debt issues the European economy is clearly in a contraction mode with more and more countries dipping back into recession.
In Asia today the IMF said China's slowing economy is now exposed to significant downside risk and relies too much on investment. The IMF went on to say the government needs to initiate a growth spurt in consumption and move individual savings out of the housing market. According to the IMF the leaders of China have taken their foot off of the brakes but have not put their foot on the accelerator. Achieving a so called soft landing will be a very challenging objective for China.
From an oil perspective the slowing Chinese economy will definitely result in a slowing of oil consumption. Further oil imports may have peaked for the short term as reported in an article in Bloomberg overnight. Net oil purchases declines by 12% in June versus May or the largest drop since October of 2010. China is reducing imports as its SPR is quickly filling. China will add about 40 million barrels of oil to its SPR over the next 6 months compared to 85 million barrels over the last 6 months. The fill rate is slowing which should reduce overall global oil requirements.
Late yesterday a WSJ released an article that indicated that the US Federal Reserve is growing very impatient with the slowing US economy and is moving closer to taking new steps to try to jump start the economy as well as the jobs market. According to the article conversations within the Fed have turned more intensely toward the question of how and when to initiate another round of easing. The FOMC meets next week (July 31-August 1) though they could wait until the September meeting to gain the benefit of having more economic data points before making any moves. There are certainly several options on the table that could be taken but for the market the main questions will be will they act and when. I have been of the view that a new round of QE was 50/50 at best. The WSJ article reads more like it is almost a certainty with the when part the only yet to be resolved variable.
For the short term... especially leading up to next week's Fed meeting... the QE crowd should provide a floor on most risk asset markets like oil, gold and other inflation sensitive markets. It could also stop the precipitous decline we have seen in the euro as more QE would certainly be a negative for the US dollar... at least for a short time frame. So once again the markets will move into QE watch mode for the next week... at a minimum.
Yesterday Iran and European officials meet in Istanbul to prepare for another possible round of talks on Iran's nuclear program. The meeting was at the deputy negotiator level but the chief negotiators from both sides are scheduled to be in contact very shortly to talk more about a full blown negotiating meeting. Not much information was released from this meeting. Simply put if another round of talks are in fact scheduled it would push the threat of a supply risk in the Middle East forward and would thus be somewhat bearish for oil. On the other hand if no new negotiations are scheduled it will raise the geopolitical risk as well as the risk of Israel taking some form of military action against Iran with the risk of oil flow out of the region starting to slow. It is time once again to put this issues back on the radar to see what evolves in the short term insofar as more negotiations.
Global equity markets have been under intense selling pressure all week as shown in the EMI Global Equity Index table below. The EMI Index is now lower by 2.8% for the week resulting in the year to date loss of the Index widening to 2.7%. The Index is now back to the level it was at in mid- May. Six of the ten bourses in the Index are now in negative territory for the year. Germany remains on top of the leader board as this export oriented country continues to enjoy the benefits of the falling euro from the perspective of making its exports even more competitive. The rest of the European bourses are all in negative territory for the year. The global equity markets are a negative price driver for oil and the broader commodity complex.
The API report showed a surprise build in crude oil stocks and larger than expected builds in both distillate fuel and gasoline stocks. The API reported a build (of about 1.3 million barrels) in crude oil stocks versus an expectation for a modest decline as crude oil imports increased and even as refinery run rates increased strongly by 1.9%. The API reported a strong build in distillate stocks. They also reported a large build in gasoline stocks versus an expectation for a smaller build in gasoline inventories.
The report is bearish is bearish across the board. The market has not reacted much in overnight trading with prices mixed 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 build of about 1.3 million barrels of crude oil with a build of 0.2 million barrels in Cushing, Ok which is neutral to bullish for the Brent/WTI spread. On the week gasoline stocks increased by about 2.3 million barrels while distillate fuel stocks increased by about 2.6 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 in the background even though another meeting is scheduled for today. 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 24.2 million barrels while the overhang versus the five year average for the same week will come in around 37 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/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 a small build in gasoline stocks. Gasoline stocks are expected to increase by 0.2 million barrels which would result in the gasoline year over year deficit coming in around 6.3 million barrels while the deficit versus the five year average for the same week will come in around 8.1 million barrels.
Distillate fuel is projected to increase by 1 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 23.9 million barrels below last year while the deficit versus the five year average will come in around 20.9 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 mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
I still think the oil price is overvalued. I am keeping my view at neutral for oil as the market seems to have switched from being primarily driven by geopolitical risk and the prospects for additional qualitative easing to concerns over the evolving debt situation in Europe as well as the slowing of the global economy. WTI seems to be working its way back into the $80 to $90/bbl trading range while Brent is moving back to the $95 to $105 trading range. There are a lot of dynamics that will impact oil prices in the short term and the ranking of the price drivers are fluid and very susceptible to changing. The only constant for oil prices in the short term is above normal levels of volatility.
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 becoming more susceptible to a round of selling.
Currently markets are mixed as shown in the following table.
Best regards,
Dominick A. Chirichella
