Quote of the Day

The ability to simplify means to eliminate the unnecessary so that the necessary may speak.
Hans Hofmann

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Markets are drifting lower in overnight trading as the market digests yesterday's EIA inventory report as well as the evolving geopolitical events in and around the Middle East. WTI is continuing to depreciate versus Brent as participants watch the freedom protests also now start in Libya another substantial OPEC oil exporter adding another 1.6 million barrels per day to our at risk volume from Yemen, Bahrain, Iran and Algeria bringing the total to about 7.3 million barrels per day versus surplus crude oil capacity of 4.6 million barrels per day. Not that all of this oil will be disrupted or any of it for that matter the number is just the current level of exposure to the market place as the protests continue keeping a risk premium in the price of oil...especially everything in the complex other than WTI.
In addition yesterday Iran announced that they were sending two warships through the Suez Canal in route to Syria resulting in a quickly response from Israel who said it was a direct provocation. Overnight the Iranian plans may have changed but this situation remains something to watch. This is just another potential geopolitical incident in this region of the world that is making energy traders and end users more uncomfortable by the day as a significant portion of the world's oil flows from this area. For yet another day geopolitical risk remains at the top of the list insofar as having the largest influence on oil prices at the moment.
The external markets have continued to be neutral to marginally supportive for oil prices and the broader commodity complex. The US dollar has been on the defensive for the last several days but still trading well within the wide trading range it has been in for months. The US dollar index is currently trading in the lower half of the trading range with a growing possibility of testing the low made at the end of January. If so it would be supportive for oil prices.
On the equity front global equity markets have continued to recover over the last twenty four hours as shown in the EMI Global Equity Index table below. The Index has now gained 2% on the week widening the year to date gain to 1.2%. Brazil remains the only bourse still showing a negative return for 2011 as inflation fighting dominates that country. Investors have regained confidence in the main growth engine of the world...China after the latest data showed that inflation may be starting to level as the Chinese government has been aggressively working to throttle back growth for the last nine months or so. On the other hand Singapore raised its 2011 inflation forecast as its economy is continuing to expand at a record pace of 14.5%. Thus the developing world continues to be exposed to inflation risk while the advanced economy nations are just beginning to see inflation exposure growing. Yesterday the US Federal Reserve indicated that the economy in the US is better but still not good. They have raised their growth estimates but have kept their unemployment and inflation estimates the same. They did not indicate that they would prematurely end the current QE2 program. As the emerging market world continues to slow their economies the US is still in stimulus mode with QE2 and thus supported for oil.

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Yesterday's EIA inventory report was mixed as most everything came in less bearish than the expectations with total commercial stocks declining strongly for the first time in a month. There was only a modest build in crude oil stocks, and a smaller than expected build in gasoline stocks as refinery utilization rates decreased strongly by 3.5% (more than offsetting last week's strong increase of 2.7%) while distillate fuel declined much more than the expectations which were calling for just a modest draw. The EIA oil inventory report was overall neutral to marginally bullish in my view. The data is summarized in the following table along with a comparison to last year and the five year average for the same week.

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Total commercial stocks of crude oil and refined products declined by 8.4 million barrels on the week after growing consistently for the last five weeks. The year over year surplus of total commercial stocks of crude oil and refined products narrowed to 24.2 million barrels while the overhang versus the five year average for the same week also narrowed to 46.7 million barrels.
The modest build in crude oil inventories of 0.9 million barrels versus most expectations for a much larger build was not enough to offset the decline in refined and unfinished products resulting in total commercial stocks declining. The crude oil inventory overhang versus last year narrowed to 11.4 million barrels while the surplus versus the five year average also narrowed to 18.8 million barrels. Both PADD 2 and Cushing, Ok crude oil stocks increased on the week. Cushing crude oil stocks increased by about 0.3 million barrels while PADD 2 stocks built by about 1.3 million barrels offsetting last week's decline of about the same amount.
This region of the US is still sitting with record high inventory levels and as such WTI should still continue to trade at a large discount to Brent which is much more reflective of the events unfolding in the Middle East. The April Brent/WTI spread is currently trading around $16/bbl premium to the Brent contract as a risk premium is slowly growing in Brent while an overhang discount is continuing to grow in the price of WTI. WTI and Brent are two different crudes currently being driven by two different scenarios. WTI remains decoupled from the geopolitical event occurring in the Middle East while Brent is decoupled from the huge regional overhang of crude oil inventories in the mid-west portion of the US. As I have been mentioning the spread is overvalued and likely susceptible to a correction. However, that said one can only look for opportunities to get long Bent/short WTI as the trading pattern is not likely to change anytime soon.
Distillate stocks declined strongly versus an expectation for a modest decline in stocks. Heating oil/diesel stocks decreased by about 3.1 million barrels versus an expectation for a draw of around 0.8 million barrels. The decline was all in the diesel category with heating oil stocks building marginally on the week in spite of colder than normal temperatures throughout the main heating fuel consumption area of the US. The year over year surplus narrowed to 8 million barrel while the five year average overhang also narrowed to 23 million barrels.
Gasoline inventories increased only marginally and much less than the expectations. Total gasoline stocks built by about 200,000 barrels on the week versus an expectation for a build of about 1.6 million barrels. That said over the last seven weeks gasoline stocks have increased by almost 27.5 million barrels. The deficit versus last year is gone but the surplus did narrow on the week to about 9 million barrels above last year at this time while the surplus versus the five year average also narrowed to 15 million barrels. Gasoline stocks remain on the radar as the concern grows that the overhang may increase strongly as the industry continues to keep refinery runs modestly high to support the heating fuel requirements for the rest of the winter heating season.
The following table details the week to week changes for each of the major oil commodities at every level of the supply chain. As shown I have categorized everything as neutral to bullish as stocks either built less than expected or the decline was greater than expected for others with total commercial stocks falling strongly on the week. This week's report was marginally bullish. However, we can't lose sight of the fact that overall stocks in the US are still above normal and likely to remain at above normal levels for a considerable period of time even if the destocking pattern we are beginning to see continues to evolve over the next several months.

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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 something that has to be watched carefully in the Middle East. As discussed above my bias to WTI is more toward the bearish side while the rest of the complex is more supportive for all of the reasons I have been discussing for the last several weeks. Currently I do not see anything suggesting that the premium of Brent over WTI is going to collapse anytime soon. It is overdone and a correction is in order but that said this spread is not going to retrace back to normal historical levels anytime soon.
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 most markets are in negative territory as shown in the EMI Price Board table below.

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 Best Regards,
Dominick A. Chirichella