Oil on the defense after EIA cuts demand projection

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After a few days of short covering the oil complex is starting today’s session on the defensive after a bearish API fundamental snapshot along with a weak demand projection by the EIA in their monthly Short Term Energy Outlook report. Oil prices are drifting lower ahead of this morning’s EIA oil inventory report. I still view the movement in the oil complex on Monday and Tuesday as mostly driven by short covering after last week’s strong declines. The fundamentals are becoming more bearish, but the technicals are improving slightly and once again are starting to show the early signs of forming a bottom. All of the commodities in the complex are in a trading range with WTI and Brent currently near the upper end of the range while refined products are in about the middle of the range. The external oil price drivers — equities and the U.S. dollar — were both supportive for oil on Tuesday.

The Brent/WTI spread has moved back into a short covering rally after narrowing strongly over the last several weeks. As I have been suggesting in the newsletter I am expecting a build in crude oil stocks at both Cushing and in PADD 2 in this week’s EIA report. Yesterday afternoon the API reported an almost 0.9 million barrels build in Cushing and a 2.3 million barrel build in PADD 2 as refinery maintenance season is still evolving while the Pegasus pipeline remains closed. The upside for the May Brent/WTI spread has been capped by the robust production level coming from the North Sea, but according to a Bloomberg survey the May production level in the North Sea could be lower by 5% compared to April.

Although I am still of the view that medium term the Brent/WTI spread will narrow and work its way to single digits sometime during the second half of 2013, in the short term we could see further widening of the spread. Currently it looks like the destocking pattern that has been in play in Cushing has reversed and is now setting up for a period of building especially if the Pegasus pipeline remains closed for an extended period of time. In addition if North Sea production does in fact start to decline a bit the spread is going to be supported to the upside. At the moment the spread is in an $11/bbl to $13/bbl trading range and if the aforementioned conditions materialize I would expect the spread to test the upper end of the trading range before resuming another leg to the downside.

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