Oil and most all risk asset markets are in the hands of the two major central banks this week. The US Fed meets today and tomorrow while the much awaited ECB meeting is on Thursday. Is this a week where the main money printing presses will get dusted off and turned to high speed and thus be supportive of a rally in oil or do both of these meetings end with verbal commitments to do whatever is necessary to keep the US and the EU afloat? For the next several days oil prices are not going to be impacted much by the current fundamentals or technicals it is strictly an event week of trading.
The way the markets have been trading since the second half of last week I would say that the market is expecting some form easing coming from at least one of the two central banks and possibly both. This week certainly has the potential for a mini shock an awe outcome if the US announces a new round of quantitative easing while the ECB lowers short term rates and announces a bond buying program of its own. This outcome could be a major catalyst for a rally in all risk asset markets that could be sustainable for the foreseeable future. This would be a bold outcome and one that would be simply bullish.
On the other hand neither central bank could take action this go around and rather acknowledge that there is issues with each of their respective economies and vow to do whatever it takes when and if necessary. That has pretty much been the party line for the last month or so from both the US Fed and the ECB (party line for several years for the ECB). I am not sure the markets will buy into another month of words and promises and not embark into a major sell-off. I think the likelihood of the US FOMC pushing its QE decision down the road for a month or two is a higher probability that the ECB doing nothing. I think Draghi boxed himself into a corner last week with his bold statements on supporting the euro. I think the ECB will definitely lower short term interest rates (possibly as much as 50 basis ponts) and I think there is a modestly high probability that they will announce some form of bond action to backstop the weaker EU member countries. This outcome alone (without any action by the US FOMC) could be enough to initiate a modest rally in the euro and thus a correlation rally in oil, equities and most other major risk asset markets globally.
I am much less confident that the US Fed will do anything this go around as the US economic data of late has been projecting a sluggish growth pattern but it has not been a complete disaster. They may wait for a few more employment reports before announcing a QE3 type program. They will have an opportunity to announce something during Mr. Bernanke's speech at the Jackson Hole Symposium at the end of August and/or at the mid-September FOMC meeting. On the other hand I would say there is a better than 50/50 chance that the ECB meeting will result in a bold announcement of some sorts.
If Mr. Draghi needs more support the latest employment data for the euro zone was released today showing that unemployment in the EU is at the highest level on record at 11.2% Even German unemployment climbed for the fourth straight month. Simply put Europe is contracting and moving deeper into recession. Thus I am cautiously bullish for oil in the very short term strictly based on a positive announcement by the ECB this week. Just as a reminder event trading and event risk is highly
unpredictable and something that should always employ tight trailing stops and much smaller than normal position size.
Global equities have started the week higher as shown in the EMI Global equity Index table below. The global equity market sentiment seems to be leaning more toward a positive outcome by at least one of the central banks this week as the Index has already gained 1.2% on the week resulting in the year to date gain widening to 3.1%. There are now eight of the ten bourses in the Index in positive territory with Germany soaring higher and holding the top spot in the Index. Global equities have been a positive price driver for oil and the broader commodity markets so far this week. But as I said above this week is all about the outcome of the US FOMC and ECB meetings. Not much else matters in the very short term.
This week's oil inventory reports will be released at its regularly scheduled date and time. The API inventory report will be released late this afternoon with the more widely followed EIA data hitting the media airwaves at 10:30 AM EST on Wednesday. At the moment oil prices are still being mostly driven by the events discussed above along with the direction of the euro and the US dollar as well as by a view that the global economy is continuing to slow and one or two of the major central banks will come to the rescue. The tensions evolving in the Middle East between Iran and the West seem to be in the background for today. As such we may not see much of a reaction from market participants to this week's round of oil inventory data as the macro risk of the markets is currently the main concern of all market players. This week's oil inventory report will likely be a background price catalyst unless the actual outcome is significantly different from the market projections.
My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to continue its campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a small build in crude oil inventories and a build in both gasoline and distillate fuel stocks as the heart of the summer driving season is now in full play. I am expecting crude oil stocks to increase by about 0.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 26.6 million barrels while the overhang versus the five year average for the same week will come in around 40.1 million barrels.
I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery run rates are continuing at high levels in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $16/bbl premium to Brent level. I am still of the view that the spread will continue the process of normalization over the next 3 to 6 months.
With refinery runs expected to increase by 0.1% I am expecting a small build in gasoline stocks. Gasoline stocks are expected to increase by 0.2 million barrels which would result in the gasoline year over year deficit coming in around 3.3 million barrels while the deficit versus the five year average for the same week will come in around 3.2 million barrels.
Distillate fuel is projected to increase by 1 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 25.6 million barrels below last year while the deficit versus the five year average will come in around 21.6 million barrels. Exports of distillate fuel have been the main storyline this year with exports running around 1 million bpd.
The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year's inventories are mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
I still think the oil price is overvalued however with the potential for bold action by one or both of the central banks I am moving my view to cautiously bullish for oil as the market has moved to being mostly driven by the prospects for additional quantitative easing over concerns with the evolving debt situation in Europe as well as the slowing of the global economy. I want to emphasize the word cautious in my view. WTI is currently in a $85 to $95/bbl trading range while Brent is still in the $100 to $110 trading range. There are a lot of dynamics that will impact oil prices in the short term and the ranking of the price drivers are fluid and very susceptible to changing as we saw after Draghi's comments yesterday. The only constant for oil prices in the short term is above normal levels of volatility.
I am upgrading my Nat Gas view to cautiously bullish with a lot of emphasis on cautious as the hot weather has persisted across major portion of the US and is forecast to continue for at least another several weeks. Even though the economics of coal switching continues to be favorable to coal... which will result in a reduction in Nat Gas demand the above normal cooling demand and nuke outages should keep injections underperforming.
Nat Gas prices settled above the $3/mmbtu on expiration day on Friday and have not looked back since with prices higher by about 5.8% as of this writing. The main price driver for Nat Gas at the moment is primarily the forecast for above normal temperatures over a significant portion of the US through about the middle of August. The combination of above normal levels of cooling demand coupled with an above average level of nuclear plant outages should result in weekly injections continuing to underperform for the next several weeks and likely longer. Even with the economics of coal to gas switching still favorable to coal there should be enough demand to outstrip supply for the next several weeks.
Currently markets ended the week mostly lower as shown in the following table.
Dominick A. Chirichella
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