Diamonds are forever and we thought that quantitative easing was as well. So much for Federal Reserve transparency, it is very clear after the release of the Fed minutes that the Federal Reserve either misled the market after the last Fed meeting or there is something more sinister going on.
In the last Fed Statement, the Fed said quite clearly that that their intention is to keep the target range for the federal funds rate at 0 to 1/4 percent as long as the unemployment rate remains above 6-1/2 percent or inflation goes above 2 percent. Traders assumed that that included quantitative easing as the Fed talking about the woes of the fiscal cliff and the turmoil in the global economy would continue to support their dual mandate by continuing purchasing mortgage-backed securities at a pace of $40 billion per month and purchase longer-term Treasury securities at a pace of $45 billion per month.
The assumption was until the Fed dual mandate of employment and inflation was breeched. Now in the Minutes in the same meeting it seems that behind the scenes that assumption may have been mistaken. According to page nine of the Fed Minutes they said that “several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013.”
Yes, they said there were concerns about the balance sheet but some might assume it is because they think inflation is going to soar or that unemployment is going to drop. That is assuming that the Fed’s new targets for inflation and unemployment then would be meaningless. Or more sinisterly, perhaps they added that dissension to the minutes to thwart commodity bulls that would go to town driving prices higher. The hope may have been that putting a bit of doubt in the commodity traders’ minds might thwart the commodity bull-run that we have seen in the aftermath of QE1 and QE2.
Or maybe the Fed statement was to provide cover for the fiscal cliff or perhaps a bad jobs report. Today’s number all of a sudden became much larger for oil traders.
Speaking about a big report, how about that 12 million barrel drop in crude supply according to the American Petroleum Institute? Now normally this is the type of drop that would be grabbing the markets attention, but it is probably a simple case of an oil tanker getting lost on its way to the Gulf Coast only to find its destination after the taxman counted all of the barrels. Gas stocks up 3.3 million and distillate up a whopping 6.7 million barrels.
It appears that Credit Suisse agrees with my assessment that the West Texas Intermediate oil contract will reestablish itself in the New Year. As I wrote Jan. 3, 2013 “...despite the fact that crude oil supply in Cushing, Oklahoma is near record highs. The Increase of oil flow through the Seaway Pipeline and more transportation moving oil should help support WTI versus Brent that had blown out to ridiculous levels. In the New Year more infrastructures will be built to alleviate the glut in Cushing and the WTI will be on a path to restoring its reputation as the world’s benchmark and why not! The US is going to be the world’s largest oil producer in the world’s largest economy and soon to be a major exporter. The world is already looking much different as we head into the New Year.” As I wrote Dec. 19 2012 “Oil prices are starting to round off at the lower end of the trading range and should start to make a decisive move higher just as crude option volatility hits a low for the year. Crude option volatility fell below 25% as oil sunk deep into complacency.” Crude oil is well balanced and has priced in geopolitical risk scenarios when it comes to Iran, Syria and Egypt where there really has not been any earth shaking developments for some time. Yet when it comes to the oil market you had better beware of the sleeping lion because if it awakens we could see a major move. Of course in the nineties, oil slept for most of the decade with only a few exceptions.
Still as I have said, oil seems to be bottoming at the lower end of the range and then a move toward the mid-$90s would place it at the higher end of the range. So it may be a good time with the low volatility to put on bullish option strategies. Of course if we see the fiscal cliff talks break down, then it is possible that we could break out on the lower end of that range. Not likely, but possible. With low volatility option traders could straddle the market with an upward bias.
The WTI Brent Crude spread came in again as Reuters reported yesterday that “a major pipeline expansion that aims to ease the bottleneck at Cushing, Oklahoma that has depressed U.S. crude prices should pump at full rates from the end of next week, the backers of the project said on Wednesday. Enterprise Products Partners LP and Enbridge Inc said service on the Seaway pipeline that runs between Cushing and the U.S. Gulf Coast had been suspended to complete the work needed to expand the capacity of the 500-mile pipeline to 400,000 barrels per day. "In order to complete the remaining pump station connections, transportation service has been suspended on the 500-mile, 30-inch diameter pipeline and is expected to resume operations at full rates by the end of next week," the companies said in a joint statement. Seaway can currently move 150,000 bpd of crude out of Cushing, the delivery point for West Texas Intermediate crude oil futures, to refineries on the Texas Gulf Coast. Insufficient pipeline capacity at Cushing has made it difficult for traders to ship burgeoning inland U.S. oil production to more profitable markets on the U.S. Gulf Coast. As a result, West Texas Intermediate crude oil futures have traded at a substantial discount to other grades of a comparable quality such as North Sea Brent crude. “
The bottom line is that in 2013 WTI will reestablish itself as the world’s benchmark and that it was overdone to the downside!