Quote of the Day

We tend to look through language and not realize how much power language has.
Deborah Tannen


The big news hitting the financial markets over the last half hour has been the Chinese government's announcement that they are raising short term interest rates by 0.25% as their fight to mitigate inflation risk not only continues but seems to be ratcheting up a bit. This has resulted in a quick and bearish reaction to most all commodity markets around the world...including oil prices as China is the main growth engine for most all commodities. Any further slowing of the Chinese economy will only result in a slowing of demand growth for oil and most other major commodities includ9ing agricultural commodities. This action will dominate financial and commodity trading at least for a major portion of today at a minimum.
Oil prices were hit with a relatively strong round of long liquidation selling yesterday as the situation in Egypt continued to ease or at least become even less threatening to a stoppage in the flow of oil through the Suez Canal or Sumed pipeline as I have been projecting fir well over a week.

Overnight the selling has continued with both WTI and Brent in negative territory (selling accelerated over the last half hour due to China's action...see above). Brent is once again back below the $100/bbl mark while WTI is well below the psychological $90/bbl mark. Both WTI and Brent are now trading below the same level they were at toward the end of January when the Egyptian protests began to dominate the media airwaves. At the moment the Egypt factor or the risk premium associated with Egypt or potential contagion to the rest of the Middle East has mostly been eliminated. Although Mubarak is still in Egypt his influence seems to be greatly diminished as progress moves toward changing the constitution to provide more freedoms to the people along with progress toward free elections sometime in early fall of this year. There are still protests but the numbers are significantly smaller while the media is focusing less of its air time on Egypt. Unless something changes for the worst Egypt will continue to be less and less of a factor in driving the short to medium term direction of oil prices.

With Egypt quickly moving out of the oil picture the normal drivers that have been dominating the direction of prices have moved back into focus. The current fundamentals are certainly not a bullish factor at this point as discussed in more detail below and with China raising interest rates oil fundamentals may become even more bearish if Chinese oil consumption slows. On the financial front global equities and the US dollar have been mostly neutral factors for oil prices as well as the broader commodity complex in the very short term. The EMI Global Equity Index is about unchanged over the last twenty four hours as shown in the following table below. China and Brazil have continued to drag the overall index into negative territory for the year with a loss of 0.7% for 2011. For the second year in a row (so far) the developed world bourses remain in the lead in the winner column versus the emerging market bourses which are being impacted by governments in those countries continue to fight inflation risk.


The following chart highlights the two main financial or external oil price drivers with the spot WTI contract. For equities the chart is using the S&P 500 Index along with the US Dollar Index. As shown over the last several years the positive relationship of the equities market and oil prices and the inverse relationship of the US dollar and oil prices have been mostly in place. However, with the huge surplus of crude oil in the US (PADD 2 and Cushing in particular) WTI has decoupled itself a bit from these relationships over the short term. In fact even with the US Dollar Index declining today and global equities steady oil prices are continuing to decline and ignoring the normally supported declining US dollar. At the moment the easing of geopolitical tensions in the Middle East combined with bearish current fundamentals (and possible bearish projected fundamentals...see comments below) and China raising short term interest rates are currently dominating the direction of oil prices.


The weekly inventory cycle will get underway today as the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Thursday morning. My projections for this week's inventory reports are summarized in the following table. I am expecting a mixed report for US oil stocks but yet another overall build in total commercial stocks of crude oil and refined products combined. I am expecting another strong build of about 2.5 million barrels of crude oil inventories mostly as a result of the industry readjusting inventories after managing end of year stock levels as well as a modest increase in imports. If the actual numbers are in sync with my projections the year over year surplus of crude oil would come in at 14.3 million barrels while the overhang versus the five year average for the same week will be about 20.2 million barrels.


With runs expected to only decrease by about 0.1% and with imports expected to increase a bit I am expecting another strong increase in gasoline stocks. Gasoline stocks are expected to build by about 1.5 million barrels even as refiners which would result in gasoline stocks hovering around 20 years highs for this time of the year. This week the gasoline year over year surplus is projected to widen of around 7.3 million barrels while the surplus versus the five year average for the same week will widen to about 12.5 million barrels. Gasoline stocks will have built for seven weeks in a row if my projection for another build this week is in line with the actuals. If so gasoline stocks will have increased by about 20 million barrels over the aforementioned timeframe.

Distillate fuel is projected to decline modestly by 1.3 million barrels mostly as a result of the colder than normal temperatures we have been experiencing in the eastern half of the US. As has been the case for the last seven weeks or so it is only heating oil stocks that have been destocking as diesel fuel inventories have been rising strongly over the last two months as the US economy continues to grow very slowly. The latest NOAA weather forecasts are now calling for a return to not only normal winter temperatures but above normal temperatures for a good portion of the second half of February. With eh vast majority of the winter heating season now in the history books the consistent decline in heating oil stocks may also start to perform much like diesel stocks have been over the last several months and that is to start into a premature inventory building pattern during the projecting moderation of temperatures during the second half of February. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 6.6 million barrels above last year while the overhang versus the five year average will be around 23.4 million barrels.

Refiners are continuing to try to manage the overhang of crude oil by converting into refined products and moving products into inventory. Net result the US continues to remain well oversupplied of just about everything in the oil complex with supply expected to remain robust for the foreseeable future. The market will get a snapshot of projected fundamentals when the EIA released tier latest Short Term Energy Outlook early this afternoon. As mentioned yesterday I am expecting the EIA to keep their global oil demand projections pretty much at the same level as last month's report but we could see inventory projections coming in a bit less optimistic than last month. Overall I would expect today's report to be neutral at best and have a minimal impact on short term price direction at best.

As usual do not overreact to the API data which will be released late today as more often than not it is not in line with the more widely followed EIA data. If the EIA report is within the projection I would expect the market to view the results as modestly bearish as total commercial stocks of crude oil and refined products combined are likely to have increased for yet another week. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on with the evolving situation in Egypt as well as in the financial markets and how much the macro issues will offset any of the individual micro drivers like supply & demand.

My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view at neutral but downgrading my short term bias to bearish for oil as the market is continuing to eliminate the Egypt factor from the price and quickly incorporating the China inflation effect...which is a negative. With Egypt moving out of the picture oil prices seem to be moving back into the downward correction pattern they were already in prior to Egypt dominating the media airwaves around Jan 27/28. In addition with China just announcing an increase of 0.25% in short term interest rate the entire commodity complex has quickly moved into a selling mode...including oil prices as China continues to intentionally slow its economy.

I am maintaining my Nat Gas view at neutral but downgrading my short term bias to bearish as the weather projections for the second half of February are simply not supportive for Nat Gas prices. With supply still very robust and the advent of a round of warmer than normal winter weather conditions prices are likely to test the psychological and technical $4/mmbtu support levels. Weather is still the main driver of price direction but the oversupply situation continues to dampen any upside enthusiasm that may come from above normal heating fuel demand.
Currently most markets are weaker as shown in the EMI Price Board table below.


 Best Regards,
Dominick A. Chirichella