“Knowledge speaks, but wisdom listens.”

Jimi Hendrix

As expected the oil complex traded mostly in sync with the externals on Tuesday. The U.S. dollar traded in positive territory throughout the session while most equity markets declined on the day leaving oil participants with little reason to buy. The main drivers for the financial markets were the macroeconomic data that hit the airwaves on Tuesday. Third quarter GDP came in within the consensus forecast at a level of 2.8% but lower than last month’s reading for the 3rd quarter of 3.5% suggesting that the economy is in recovery but confirming the current thinking that the recovery will be slow. In addition consumer the confidence index came in better than expected at 49.5 up from October’s 48.7. However, although it is improving it is improving only slowly and is still significantly below the level when most would interpret the result as representative of a fully growing economy. Thus another indicator that suggests a slow recovery.

Staying with the financials, today in the U.S. durable goods orders, consumer spending and new home sales all hit the media airwaves. With the U.S. holiday shopping season set to begin on Friday all eyes will be focused on consumer spending to see if Americans are finally beginning to open their pocketbooks. About 70% of U.S. GDP is dependent on consumer spending and until it picks up and becomes a lot more robust than it has been the economic recovery in the U.S. (as well as nations that are dependent on exports to the U.S.) will be slow at best. Today’s economic data will likely fall into the category as a market mover, especially for the financials.

So far this week the equity sector has been relatively quiet as evidenced by the latest snapshot of the EMI Global Equity Index (table shown below). Most global markets have been on the defensive over the last 24 hours with the Index now only up about 1.0% for the week. Asian markets have been mostly impacted by the decline the volatility of China’s bourse as the government alluded to the currency situation offset by a stronger recovery view coming from Australia. On the other end of the spectrum in the emerging market world, Brazilian shares have once again been rising on talk that the government may cut taxes for certain industries. The most important conclusion that one can take from the way the global equity market are trading is one of an uneven recovery (or at least the expectation of an uneven recovery). As the meeting between perception and reality continues the going forward picture is becoming more cloudy, insofar as the quality of the global economic recovery. 

As has been the case consistently, each time the U.S. dollar firms it has been relatively shallow and short-lived. Yesterday’s activity in the currency markets was true to form as the U.S. dollar has not only given back all of yesterday’s gains but has declined to a new 15 month low (versus the euro) and once again within earshot of re-testing the all time record low versus the euro made in July of 2008. As of this writing the dollar is trading back down to a level not experienced since August of 2008 and has breached the short-term support area of 1.5 versus the euro. The market is once again becoming more bearish to the dollar after yesterday’s U.S. Fed notes were released from their early November meeting in which they refrained from voicing any concern over the weak U.S. dollar situation. Using the old saying that “absence makes the heart grow fonder” the market is interpreting the Fed notes as absence any statement by the Fed translates into any U.S. intervention to support the dollar is likely not in the cards and thus the market is becoming even more fonder of being short the U.S. dollar.

At the moment the externals (as discussed above) are still generally supportive for oil and the broader commodity markets. However, we have seen the results of positive externals losing a bit in the translation back into the energy markets. In essence the market is paying more attention to the fact that the current fundamentals for both oil and natural gas are nothing other than bearish. A few months ago when the global economy was still in the contraction cycle many in the trading and investing world simply discount the bearish fundamentals in expectation that when the economy enters the expansion cycle (now) the overhang in inventories would begin to recede as demand would pick up as it normally does during any period when the economy is growing.  

We are in the expansion cycle in many places around the world and in some instances the overhang of oil is even greater than it was a few months ago. Inventories are still growing, OPEC is continuing to overproduce (via reducing their compliance rates) with their current production level at the highest level this year and most importantly demand is tepid at best, especially in the developed world markets like the U.S. and other OECD nations. Simply put the fundamentals are truly acting as a price ceiling on days when the externals are supportive and an outright negative on prices when the financials are not supportive which is a different trading pattern than what has existed since March. As elaborated (and shown in the chart) in yesterday’s newsletter the current trading range that WTI has been in since the middle of October has resulted in lower highs and lower lows or the description of a descending wedge or consolidation phase. The full thrust of any combination of strong equity movements or weak dollar movements is currently resulting in only modest upside movements in the oil complex.

Today we will get snapshots of both oil and natural gas fundamentals when the EIA releases both reports. The oil report will be released its normal time at 10:30 AM EST. while the Nat Gas report will be released at 1 PM EST. Late yesterday afternoon the API released their weekly report. The API results are summarized in the following table along with my latest projections for today’s EIA report as well as a comparison to both last year and the five-year average for the same week. From a macro perspective the API data was directionally in line with the projections and in sync with the view that last week’s large declines in inventories were a one-week anomaly due to the preemptive actions ahead of Hurricane Ida.

As shown in the table the API reported a significant build in crude oil stocks of 3.3 million barrels or more than twice the level of the expectations. The build was a result of an import level of about 666,000 barrels per day which likely offset the fact that the API reported an increase in refinery runs of a whopping 2.6%. If the EIA data turns out to be in sync with the API data the year over year overhang would once again be approaching the 20 million barrels mark while the surplus versus the five-year average will at around 22 million barrels. With the crude oil forward curve moving deeper into a contango it will not be too long when opportunistic storage trades once again working economically. 

The biggest surprise in the API report is the significant increase in refinery runs. Refinery margins have been under pressure for months and any increase in utilization rates with the huge surplus of refined products around the world is a dangerous economic strategy for refining industry. API reported a large build in gasoline and a large decline in distillate fuel. I expect the big drop in distillate stocks was mostly a result of heating oil consumption rather than a significant increase in diesel fuel use. We will get a more comprehensive feel for that topic when the EIA data is released later this morning. 

If the EIA data is in sync with the API report I would categorize the report as biased to the bearish side. It would also be supportive for our short WTI/long Brent spread and would also warrant recommending and entering the HO/RBOB spread via going long HO/short RBOB. It would also keep me on the sidelines for the time being in the crack spread arena.

This afternoon the EIA will also release the latest NG inventories. The forecast for this afternoon’s report (1 PM EST) is expected to show a build of 5 to 15 BCF with the consensus view around 6 BCF. Last year at this time inventories were already in a withdrawal pattern with the same week last year declining by 55 BCF while the five-year average show a net withdrawal of 21 BCF. Assuming a net injection of 6 BCF this week total stocks in working storage will be less than 50 BCF below the maximum storage capacity of the Nat Gas storage system in the U.S. This will be the highest level ever for Nat Gas inventories heading into the heart of the winter heating season. Needless to say it is bearish and irrespective of what mother nature presents for the next three months supply will definitely not be an issue. With the weather forecasters now expecting a bout of colder than normal weather to engulf a major portion of the US for at least the next several weeks heating fuel demand should begin to increase and as such next week could bring the first net withdrawal from inventory.

My individual market views are detailed in the table at the beginning of the newsletter. Today will be a day that likely starts off with price influence coming from the externals only to be overtaken by the fundamentals. If the externals are the least bit weak coupled with a bearish round of inventory reports we will more than likely enter the long US holiday break on a down note. In the very short term both the oil and natural gas markets are more susceptible to a breakout below the lower end of their respective trading ranges rather than an upside breakout. However, volatility will drop quickly as many players head to the sidelines for the rest of the week. Thus any major move from today through the rest of the week will likely occur on low volume trading and may not be long lasting.

Currently everything is higher except for the U.S. dollar which is in negative territory.

Best regards

Dominick A. Chirichella

dchirichella@mailaec.com  

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• • 11/26/2009 9:49:57 AM
  • lee chung soo
  • Hi
  • your report is quite good

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