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Geopolitics around the Middle East continues to be the main driver for oil prices at the moment. With unrest in Iran, Algeria, Bahrain and Yemen over the last several days the concerns in the market over the potential interruption in oil flow has ratcheted up several notches. Unlike non oil exporting Egypt the contagion is now spreading to a part of the Middle East that could impact the flow of oil directly. Based on the EIA's latest Short Term Energy Outlook report Iran is producing 3.7 million bpd, Algeria is at 1.35 million bpd, Yemen is at 260,000 BPD and Bahrain shares 300,000 bpd of production with Saudi Arabia offshore. The total volume of oil from all of these countries combined is about 5.6 million barrels per day which exceeds the current EIA estimated surplus crude oil capacity of 4.65 million bpd in OPEC by about 500,000 bpd. Also as I mentioned yesterday the majority of the surplus crude oil capacity (3.76 million bpd) sits in Saudi Arabia which is also a potential hot bed as it is a ruling monarchy state. Whether or not the protests in any of these countries will continue to evolve or even spread to other areas like Saudi Arabia or Kuwait is a very big question. But you can understand why the market is concerned.
As you can see from this very brief analysis the numbers start to get big very quickly when one begins to talk about oil production in this region and the potential implications if there is a shut down in flow for any period of time. Fortunately the consuming world has significant supply of oil in both Strategic Petroleum Reserves (SPR) and commercial stocks around the world which will go a long way to mitigating the impact of any modest interruption in oil flow. However, it will certainly not completely dampen the impact on price as prices will surge higher but unless it is expected to be a prolonged outage and a significant outage the price surge should not last too long.
On a US budget note yesterday I saw that one of the proposals in the Obama budget was to sell off about $500 million dollars of SPR oil to run that group. I view this as a terrible strategy at a time when Geopolitics are surfacing around the oil world as well as bad precedent if politicians in the US begin to look at the SPR as an ATM machine. The SPR was designed back in 1974 to protect the US interest in times like this. The US and the rest of the consuming world should be adding more to their SPR's rather than thinking about selling off any of it.
The financial markets have not provided much if any external support for the oil markets or the broader commodity complex for that matter as equities have been only modestly firm while the US dollar has continued in an upward trend for the last several days. The EMI Global Equity Index (table shown below) has finally moved back into positive territory for the year to date with a 0.1% gain after increasing 0.9% over the last twenty four hours. The developed world markets continue to lead the Index higher with both Hong Kong and Brazil remain the laggards so far this year. Even China...who is actively fighting inflation... is finally seeing its bourse move into positive territory for the year. Overall the global equity markets remain mostly neutral for oil and the broader commodity complex.
The other area that is slowly beginning to gain a bit more momentum in the thinking and action by investors is the growing fear that the developed world is getting closer to inflation risk. With most all commodity prices surging over the last year or so and with most companies yet to begin to adjust their prices for higher commodity costs the consumer has been somewhat spared the pain of what is looking very much like a commodity driven inflation problem. It has already hit the emerging market world for months with governments already taking preventive measures. It is just beginning to hit the developed world consumer and corporations as FedEx issued guidance yesterday highlighting the higher cost of fuel on its operations. With all of the geopolitical issues bubbling up around the major oil producing region of the world the likelihood of higher oil prices going forward is increasing on a daily basis. The next big issue to watch closely is how does the developed world begin to absorb higher prices and when do governments in this region of the world begin their fight against inflation (raising interest rates for starters) and what impact will it have on the economic recovery. Needless to say 2011 is going to be yet another year of change and adjustment in the global financial and commodity markets.
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 2.3 million barrels of crude oil inventories mostly as a result of the industry continuing to readjust 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 12.9 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 0.2% and with imports expected to increase a bit I am expecting another strong increase in gasoline stocks. In fact I have seen estimates of around 300,000 tons (about 8 to 10 cargoes) of gasoline heading this way from Europe as the arb window has once again opened. Gasoline stocks are expected to build by about 1.6 million barrels 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 10.4 million barrels while the surplus versus the five year average for the same week will widen to about 16.4 million barrels. Gasoline stocks will have built for eight 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 21.6 million barrels over the aforementioned timeframe.
Distillate fuel is projected to decline modestly by 0.8 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 the 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 10.3 million barrels above last year while the overhang versus the five year average will be around 25.3 million barrels. Refiners are continuing to try to manage the overhang of crude oil by converting it 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.
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 and bias at neutral as contagion is now something that has to be watched carefully in the Middle East as discussed above.
I am maintaining my Nat Gas view at neutral and my short term bias at 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 have remained below the psychological and technical $4/mmbtu support level. 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 markets are mixed as shown in the EMI Price Board table below.
Dominick A. Chirichella