Tuesday Morning March 1, 2011

Quote of the Day
The most wasted of all days is one without laughter.
E. E. Cummings
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Geopolitics continues to be the main driver of oil prices as well as most major asset classes. Clashes continue in Libya as the opposition group fought off supporters of Gaddafi and have retaken an area very close to Tripoli. A portion of Libya's oil exports are shut in with the IEA indicating yesterday that production may be down by as much as 850,000 barrels per day. As each day goes by Gaddafi's ability to hold on to power is diminishing. The US has positioned naval vessels near Libya in the event that they are needed as well as a way of sending a message to Gaddafi. In addition the US and other western countries have frozen a substantial amount of Gaddafi money located in the US, UK and elsewhere as yet another way of tighthening the grips on Gaddafi.

In the rest of the region the opposition group in Iran is planning on holding a demonstration after several opposition leaders were arrested. Over the weekend we saw an uprising in Oman and the instability continues in Yemen, Bahrain as well as Algeria. Although the overall situation looked a bit stabilizing on Monday the situation remain uncertain with a significant amount of oil flow still at risk for a disruption much like we have already seen out of Libya. As long as the potential for a disruption persists the risk premium that has been built into the price of oil will linger and not recede anytime soon. The intraday price of oil will continue to be mostly driving by the 30 second news snippets about the region that hit the media airwaves all day long. As I have been suggesting throughout this crisis the price of oil may be overvalued and susceptible to a strong round of profit taking selling but until there are clear signs that stability is in the air in North Africa and the greater Middle East one can only trade this market from the long side or not at all. There will be a signal when to get short...it still has not appeared.

As another sign that geopolitics are in the driver's seat insofar as the price direction for oil is concerned last night the latest Chinese manufacturing index was released and it was disappointing and bearish but oil prices have remained firm. In the past this type of a number would have likely resulted in oil prices declining strongly as a declining PMI number suggests a slowing in oil demand growth from the number one oil demand growth engine in the world. The Chinese PMI expanded at the slowest pace in six months in February after the government raised interest rates and restrained lending to cool inflation and prevent the economy from overheating. The Purchasing Managersâ€TM Index fell to 52.2 from 52.9 in January, the China Federation of Logistics and Purchasing said on its website. So far the oil market has discounted the number and is focused on the geopolitics of the Middle East at the moment.

Although the risk premium is still present in the price of oil the overall oil markets have been surprisingly stable so far this week and as such we have seen some renewed buying coming back into the global equity markets over the last twenty four hours. The EMI Global Equity Index has gained ground since yesterday as show in the following table. The Index is higher by 1% for the week widening the year to date return also to 1%. The Index is still below the highs of the year but at least it is back into positive territory.
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Aside from the slowing of the Chinese PMI number other macroeconomic data from the US and EU have been mostly supportive of equity values. In the US personal income increased while the European Commission raised its economic growth forecast as German joblessness plunged in February as demand for exports surged. In addition Japan's unemployment rate held steady as payrolls increased. This is a big week for macroeconomic data with the major US data point hitting the media airwaves early Friday morning...the monthly nonfarm payroll numbers. When the markets enters period of quiet on the geopolitical front (like yesterday during US trading hours) traders & investors refocus their attention back to the macroeconomic data and on the depth and speed of the global economic recovery. So far this week the data has been positive and equity values have been supportive for oil prices.

The US dollar has also been supportive for oil prices as well as the broader commodity complex as it is now trading at a new one month low as traders are expecting the US Central Bank will likely trail the ECB and the UK in switching into an inflation fighting mode and begin to raise interest rates. Today Fed Chairman Bernanke will speak before Congress and his comments about jobs and the economy in general are likely to result in market moving 30 second news snippets throughout the US trading session.

Much like last week I am not sure it will matter to the direction of oil prices this week but 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 Wednesday morning. My projections for this weekâ€TMs inventory reports are summarized in the following table. I am expecting a mixed report with an overall build in total commercial stocks of crude oil but a marginal decline in refined products inventories as refinery runs likely declined marginally on the week. I am expecting crude oil stocks to decline by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil would come in at 6.7 million barrels while the overhang versus the five year average for the same week will be about 16.6 million barrels.

With runs expected to increase by about 0.2% and with imports expected to hold steady I am expecting a modest decline in gasoline stocks. Gasoline stocks are expected to draw by about 0.5 million barrels which would result in gasoline stocks still hovering around 20 years highs for this time of the year. This week the gasoline year over year surplus is projected to narrow to around 5.9 million barrels while the surplus versus the five year average for the same week will narrow to about 12.6 million barrels.
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Distillate fuel is projected to decrease modestly by 0.7 million barrels on a combination of some weather related demand as well as a decline in production. The latest NOAA weather forecasts are now showing a significant portion of the US expected to experience colder than normal temperatures for the first half of March. On the surface that is a positive for heating oil especially after the last several weeks of less than bullish inventory reports. However, the offset to the current short term weather forecast is the fact that there is just not much time left to the winter heating season and the start of the lower demand shoulder season.

With the vast majority of the winter heating season now in the history books 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. In fact heating oil stocks actually built in last week's EIA report. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 7.5 million barrels above last year while the overhang versus the five year average will be around 24.6 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 North Africa and the Middle East 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 to be in sync with my bullish bias for all of the reasons I have been discussing over the last few days. But again I raise the caution flag that prices are a bit overdone and susceptible to a correction. Any event can trigger a sudden change in the direction of prices as we saw over the last few trading sessions. Be cautious and use tight, trailing stops in your short term trading book.

I am maintaining my Nat Gas view and bias at neutral as I think the Nat Gas market is still range bound and Friday's gains were mostly short covering as evidenced by prices being back on the defensive already this morning.

Currently markets are mostly higher as shown in the EMI Price Board table below.

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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com