Oil market primed for inventory surprises

Smile more than you cry, give more than you take, and love more than you hate.

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Oil prices remain relatively range bound since the third week of October. The spot WTI contract has traded between $84/bbl to $88/bbl for the last 17 trading sessions. Similarly the spot Brent contract has been trading in a range of $105/bbl to about $112/bbl over the same timeframe. Volatility has been relatively low compared to most of 2012 even in an environment with major uncertainty coming from the major economies of the world.

From a fundamental perspective yesterday's IEA monthly oil report was just another monthly reminder that global oil demand is continuing to wane as supply is continuing to grow. The balances have been biased to the bearish side and are likely to remain biased to the bearish side barring any unforeseen geopolitical event arising in the Middle East. There have been some early signs of an increase in imports into China but it is not clear to me whether that is due to an increase in demand or partially a continuation to fill their SPR. With China's two largest export markets — Europe and the U.S. — both struggling it is hard to see any major growth spurt in Chinese oil consumption from a manufacturing perspective.

Europe (China's number one export market) does not seem to be any closer to putting their four year old sovereign debt issues into the background permanently. Just today Spanish and Portuguese workers are holding their first joint general strike while unions in Greece, Italy, France and Belgium are also holding work stoppages as part of a "European Day of Action and Solidarity" (as reported by Reuters). It certainly does not look like stability between the populace and the governments in the EU is coming anytime soon.

This has been festering for about four years with the governments trying to solve their debt issues with spending cuts in a region where government spending has hardly been challenged in the past. Austerity in Europe is helping the debt problems but it is not doing much for the faltering economy nor for the protesting populace who have been accustomed to a plethora of social programs in Europe. A dilemma that does not look like it will go away anytime soon and thus a likelihood that the EU economy will continue to falter and have a negative impact on oil demand growth.

In the U.S., the confidence level in the politicians (including the President ) to solve the so called fiscal cliff before the end of the year is not very high. The first meeting between the re-elected President and the Congress will occur on Friday. Both sides have sort of blinked indicating that they might compromise on a solution involving both tax increases and spending cuts. This uncertainty along with the uncertainty coming from social programs like the implementation of Obamacare are keeping many companies on the hiring sidelines and thus the lingering unemployment situation does not look like it will be solved anytime soon. Net result is that the US economy is also faltering as evidenced by the macroeconomic data as well as the performance of the equity markets over the last several months.

I am still of the view that the fiscal cliff will be avoided and President Obama and the Congress will drill down to a deal over the next several weeks. I do not think the President will want to start his next and last term in office (or what many refer to as a President's legacy term in office) with what would likely be another recession if the fiscal cliff hits (based on the projections of many economists). He is never going to run for office again and will likely be much more willing to negotiate a deal.

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