As has been the case for the last month or so it is refined products that have been leading when the market moves to the upside. Today it is distillate fuel prices leading the way higher after the API showed a huge 6.2 million barrel decline in distillate fuel inventories adding to an already atypically low level in inventory for this time for the year. If this morning's EIA report is in sync with the API report I would expect to see a strong surge in HO prices on the Nymex which could offset the expected build in crude oil and gasoline inventories. Distillate fuel inventories have been underperforming during the normal building season this year and are entering the heart of the winter heating season in the US at close to 30 million barrels below last year. If the winter heating season returns close to normal as predicted by NOAA (see below) the spot regional tightness seen with gasoline over the last month or so could easily shift to the distillate front as we get to the main part of the winter heating season.

The Nov Brent/WTI spread has continued to trade at elevated levels on the back of a prolonged maintenance season for North Sea crude oil. The spread has been rising strongly since the middle of September even as OPEC and Saudi Arabia in particular have been overproducing while domestic production in the US is slowly rising. Overall there is no shortage of crude oil anyplace in the world but the value of Brent has surged higher... more on the regional supply and demand balances in and around the North Sea than due to global issues. As much as many market participants consider that WTI is a broken benchmark due to the surplus of crude oil in both PADD 2 and Cushing, Ok I would suggest that the Brent benchmark may be equally broken as a portion of the price of Brent is being driven by the underperformance of the North Sea and not fully reflective of the global supply and demand balances.

Certainly sellers of crude oil are going to continue to benchmark their crude oil to Brent as it is the highest price of the two main benchmarks but is it time for the industry to consider a new benchmark other than WTI or Brent? It will be at least another year before the flow of oil out of the US Midwest would make the WTI price less driven by regional supply and demand balances. Even when it does return a more normal balance will Brent still be trading at a premium to WTI principally because the balances in the North Sea are still volatile and declining? Just a few questions to think about. I do not have all of the answers right now and I am not certain what would be a better benchmark than either WTI or Brent... possibly LLS for the US and maybe a liquid sour and sweet crude for outside the US. The only thing that seems clear to me at this point is that both Brent and WTI are broken benchmarks and neither seems to be reflective of the slowing of global oil demand and current oversupply of crude oil on a global basis.

Global equities continued to lose value over the last twenty four hours as shown in the EMI Global Equity Index table below. The Index is now lower by 0.9% for the week resulting in the year to date gain narrowing to 6.1%. Only Germany and Hong Kong are still showing double digit gains for the year as the US dropped below the 10% gain level yesterday after the second day of strong selling in US equities. Global equities are being driven by concerns over the slowing global economy and thus are acting as a bearish leading indicator for oil and the broader commodity complex.

The EIA released their Short Term Energy Outlook yesterday along with their Winter Fuels Outlook. Following are the main highlights related to the Oil sector.

• EIA projects average household expenditures for heating oil and natural gas will increase by 19 percent and 15 percent, respectively, this winter (October 1 through March 31) compared with last winter.

• The forecast for higher household expenditures primarily reflects a return to roughly normal winter temperatures east of the Rocky Mountains compared with last winter's unusual warmth. According to the National Oceanic and Atmospheric Administration's (NOAA) most recent projection of heating degree days, the Northeast, Midwest, and South will be about 2 percent warmer than the 30-year average (1971 - 2000), but still 20 percent to 27 percent colder than last winter, while the West is projected to be only about 1 percent colder than last winter.

• EIA expects the oil market to loosen in the fourth quarter of 2012, as global liquid fuels consumption falls from its seasonal peak and output from countries outside of the Organization of the Petroleum Exporting Countries (OPEC) recovers from unplanned outages and scheduled maintenance. Persistent unplanned production outages in non-OPEC countries helped keep the spot price for Brent crude oil near $110 per barrel in the third quarter of 2012. EIA forecasts that Brent crude, a benchmark for the global oil price, will average $111 per barrel for the fourth quarter of 2012. In 2013, EIA projects the Brent crude price to fall to an average of $103 per barrel, although a lingering supply risk because of instability in the Middle East and North Africa could keep prices higher. EIA also expects global inventory builds in the first half of 2013 to reach higher levels relative to the same period in 2012, mostly due to an increase in non-OPEC supply.

• World liquid fuels consumption grew by an estimated 1.1 million bbl/d in 2011. EIA expects consumption growth of about 0.8 million bbl/d in 2012 and 0.9 million bbl/d in 2013, with China, the Middle East, Central and South America, and other countries outside of the Organization for Economic Cooperation and Development (OECD) accounting for essentially all consumption growth. However, forecast consumption falls by 0.5 million bbl/d during the fourth quarters of 2012, following the end of the global seasonal demand peak in the third quarter.

• EIA expects non-OPEC liquid fuels production to rise by 570 thousand bbl/d in 2012, and by a further 1.2 million bbl/d in 2013. The largest area of non-OPEC growth is North America, where production increases by 1.0 million bbl/d and 670 thousand bbl/d in 2012 and 2013, respectively, due to continued production growth from U.S. onshore shale and other tight oil formations and from Canadian oil sands.

• EIA expects that OPEC members will continue to produce more than 30 million bbl/d of crude oil over the next two years to accommodate the projected increase in world oil consumption and to counterbalance supply disruptions. Projected OPEC crude oil production increases by about 1.2 million bbl/d in 2012 and remains mostly flat in 2013. OPEC non-crude oil liquids (condensates, natural gas liquids, and gas-to-liquids), which are not covered by OPEC's production quotas, averaged 5.3 million bbl/d in 2011 and are forecast to increase by 0.3 million bbl/d in 2012 and by 0.2 million bbl/d in 2013.

• EIA estimates that OECD commercial oil inventories ended 2011 at 2.60 billion barrels, equivalent to just under 56 days of forward-cover. Projected OECD oil inventories increase to 2.64 billion barrels and 57 days of forward-cover by the end of 2012. Forecast days of supply are at the highest end-of-year levels since 1991 because of the decline in OECD consumption over the last 7 years.

In the tropics there are now two weather patterns appearing on the radar. As of this morning there is one weather area... about 425 miles east of the Windward Islands. This pattern has a 50% chance of strengthening into a tropical cyclone over the next forty eight hours. In addition there is a pattern about 275 miles east of the central Bahamas that also has a 50% chance of strengthening into a tropical cyclone over the next forty eight hours. At the moment most of the models are projecting that neither of these storms are likely to wind up in the US Gulf of Mexico. However, it is still worth watching the progress over the next few days.

The API report was mixed and outside of the range of expectations. The crude oil build was lower than expected while gasoline showed a larger than expected build with distillate fuel showing a surprisingly huge decline versus an expectation for a modest build. The API reported a build (of about 1.6 million barrels) in crude oil stocks versus an industry expectation for a larger build as crude oil imports decreased modestly while refinery run rates also decreased modestly by 0.8%. The API reported a huge draw in distillate stocks. They also reported a large build in gasoline stocks.

The API report is mixed and mostly biased to the bullish side due to the very large draw in distillate fuel stocks. The market is mostly higher heading into the US trading session and ahead of the EIA oil inventory report at 11:00 AM today. The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning. The API reported a build of about 1.6 million barrels of crude oil with Cushing, Ok showing a build of 0.3 million barrels while PADD 2 stocks increased by 1.1 million barrel which is bullish for the Brent/WTI spread. On the week gasoline stocks increased by about 2.5 million barrels while distillate fuel stocks decreased by about 6.2 million barrels.

My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to hold relatively steady even as there have been a rash of refinery issues over the last several weeks. I am expecting a modest build in crude oil inventories, and a build in both gasoline and distillate fuel stocks. I am expecting crude oil stocks to increase by about 2 million barrels. If the actual numbers are in sync with my projections the year over year comparison for crude oil will now show a surplus of 29.1 million barrels while the overhang versus the five year average for the same week will come in around 35 million barrels.

I am 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 normally be bearish for the Brent/WTI spread in the short term but the spread is currently trading at the highest premium to Brent in over a year. The slow return from maintenance in the North Sea has been the main driver that has resulted in the Nov Brent/WTI spread now trading over the $22.50/bbl level as of this writing. The widening of the spread should begin to ease once the North Sea returns to a more normal production level over the next month or two.

With refinery runs expected to increase by 0.3% I am expecting a build in gasoline stocks. Gasoline stocks are expected to increase by 1 million barrels which would result in the gasoline year over year deficit coming in around 12.7 million barrels while the deficit versus the five year average for the same week will come in around 7.8 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 28.9 million barrels below last year while the deficit versus the five year average will come in around 26.1 million barrels.

The table below 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 not in directional sync with this week's projections. As such if the actual data is in line with the projections there will be a significant change in the year over year inventory comparisons.

The oil complex has breached all of its current support levels and as such I am keeping my view at neutral for today as crude oil continues to trade within a wide trading range (see above for more comments). The battle continues between the negativity from the slowing of the global economy compared to what global stimulus programs might do to the economy going forward while geopolitics has continued to remain an issue for market participants.

I am keeping my Nat Gas price view at neutral with a neutral bias. Even though current prices favor coal over Nat Gas (based on a macroeconomic comparison) the market is now more focused on the upcoming winter heating season and what it may due to Nat Gas demand.

Markets are mostly higher to start the US trading session as shown in the following table.

Best regards,
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.


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