Nat-Gas: Energy Market Analysis
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As I have been discussing for the last several weeks the main oil price driver has been and continues to be geopolitics in the oil rich region of North Africa and the Middle East. The freedom protests accelerated throughout the region with Libya now seemingly entering a period of chaos and possible civil war as Gaddafi quickly loses his grip on the country. He has been ruling this country for the last forty one years with an iron fist and the people of Libya have finally risen in much the same way as we have recently seen in Egypt, Tunisia and elsewhere. From looking at all of the news circulating around the media airwaves it seems that the situation in Libya may have reached the point of no return with no clear cut replacement leadership if Gaddafi does in fact fall.
The Libyan situation has hit the markets very differently than the Egyptian situation in that Libya is the first OPEC nation to now be in the midst of a major change with a high risk for an oil supply interruption. Libya produces about 1.6 million barrels per day of oil with about 80,000 barrels per day coming to the US. The main international oil company operators seems to be in the process of pulling their key people out of Libya with about 100,000 barrels per day already reportedly shut-in. Information coming out of Libya is limited as western journalists are not permitted in Libya. The situation has resulted in a surge in oil prices around the world with a more historical reaction to the other interrelated markets. Global equities are lower around the world, the US Dollar Index is marginally stronger as cash flows to the safe haven dollar while gold and silver prices have also been surging higher for the last forty eight hours.
The way the global financial and commodity markets are reacting to Libya is very much in line to how markets have reacted historically during periods of time when there is a high risk for oil supply issues. The market thread is as follows....surging oil prices quickly reduces consumer confidence as prices at the pump quickly start rising resulting in less disposable income and thus a reduction in consumer spending which represents about 70% of the US GDP. In addition surging oil prices will quickly start to eat into the profit margins of many corporations and unless they are successful in raising the price of the goods and services they are selling their profits will decline and thus the value of their stocks will also decline. If they do raise prices their profits may still decline as the consumers may buy less of the goods and services they sell. On top of all of the above is the fact that surging oil prices are also inflationary and will result in the Central Banks raising interest rates quickly to mitigate inflation risk and thus intentionally slowing an economies that are only glowing slowly to start with (OECD nations).
All of the above said there is still no shortage of oil any place in the world as global commercial inventories are still at above normal levels especially in places like PADD 2 and Cushing, Ok in the US. In addition according to the February EIA Short Term Energy Outlook surplus crude oil capacity in OPEC is around 4.55 million barrels per day(in December, 2010)...well above all of Libya and then some. The only issue with surplus capacity is the fact that most of the crude oil availability is in Saudi Arabia also an autocratic monarchy and susceptible to a freedom uprising like we have seen in countries all around Saudi Arabia. But for now that oil is available to the world if in fact it is needed.
Further protecting the consuming world is the abundant amount of oil in Strategic Petroleum Reserves in the OECD world and also in places like China. The IEA SPR has about 1.6 billion barrels of oil with about 727 million barrels of SPR oil in the US. The amount of SPR oil in China is not readily available but it has become substantial as China has been filling their SPR for the last several year. If we look at just the IEA total that 1.6 billion barrels of oil translates to about 4.4 million barrels of oil per day for one year or 2.2 million barrels per day for two years and well above a Libya. So just SPR oil alone...excluding a drawdown of commercial stocks (which would also happen) could offset a shut down in Libya for well over two years. Or for a year or more to cover a Libya and an Algeria.
So as we can see above there is an ample cushion to cover a significant volume of lost oil from several medium size OPEC countries for an extended period of time with no interruption in supply for the vast majority of the consuming world. Furthermore with total commercial stocks still above normal or running well above the five year average there is substantial room for commercial stocks to drawdown on a global basis before even getting to below normal levels. In addition there is still well over 100 million barrels of oil sitting in floating storage on ships around the world.
From a supply point of view their is not a lot of risk for a disruption of supply for consumers at this time based on the countries that are currently at risk for ongoing freedom protests...Yemen, Bahrain, Algeria, Libya and Iran. That said if Saudi Arabia falls into the mix then the whole ballgame quickly changes and yes the world will be at risk for a disruption in supply for a period of time. As long as the insurrection remains contained to the countries mentioned above (ex Saudi Arabia) the world is not likely to experience an oil shortfall anytime soon as even if a Libya falls whoever takes control of the country will likely place a high priority on keeping oil exports flowing as it is their primary source of income for the country.
Unlike 2008 I think the world will begin to be impacted by high oil prices at a lower price level than in 2008. Elasticity of demand is likely to begin sooner than later as the developed world economies are only growing slowly, unemployment is at exceptionally high levels and the consumer is spending but with a lot more caution and less leverage. With the national average retail price of gasoline the US now $3.17/gallon coupled with surging food prices the amount of money coming out of the average consumer's budget for food and energy alone is already at a level that I would expect the consumer to start looking at possibly cutting their use of energy wherever possible. In addition with countries in the emerging market world like China, India, etc, already fighting inflation and intentionally slowing their economies oil consumption growth will slow down.
In a nutshell I see ample supply to cover most eventualities that are in the media airwaves for a reasonable period of time. In addition I expect oil demand will not grow as robustly as predicted as a result of already high prices and inflation fighting in the main oil demand growth engines of the world...the emerging markets. I also believe the price moves we have seen over the last forty eight hours is what I would normally expect from a market that was slowly getting short or at least neutral oil over the last week or so based on bearish current fundamentals. That said I also view the price reaction experienced so far to be overdone at the moment. However, one can only trade this market from the long side or not at all at the moment. But it you do trade it from the long side I strongly recommend using very tight, trailing stops as volatility will continue to increase and price action will be very susceptible to wide swings both up and down and both intraday and from day to day. I think it may be premature to try to time a short or corrective trade at the moment as the market needs to have the sellers and buyers get back into balance which has not yet occurred due to yesterday's holiday in the US.
Going forward over the short term I expect a lot of 30 second news snippets hitting the media airwaves some bullish and some bearish but most of them likely to impact price direction. For example:
• At the International Energy Forum Meeting currently going on in Saudi Arabia several OPEC members indicated (on the sidelines) that they stand ready to add more oil to the market if it is needed and/or there is a real shortage of oil. All OPEC members at this point in time view the market as well supplied with plenty of oil available.
• The IEA has already indicated that they stand ready to add more oil to the market via the SPR if and when it is needed.
• On the bullish side Iran is sending two warships through the Suez Canal to anchor off of Syria...thus raising the tensions with Israel as well as the entire region.
• Although it was considered a minor event and quickly put to an end but there were some freedom protests in China over the weekend.
I would suspect that the media airwaves will also begin to be filled with comments coming from the various leaders of the world like Obama, and others regarding their support for the people of Libya as well as their ability to release Strategic Oil Reserves if and when it is needed. But for now the market is likely to remain at elevated levels with a large price risk premium embedded in the value of oil for the short term as market participants await more clarity on the protests as well as getting a better understanding as to the ramifications of a shut down in Libya and possibly elsewhere.
My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view at neutral but moving my bias to the bullish side for all of the reasons I discussed above. But again I raise the caution flag that prices are a bit overdone and susceptible to a correction.
I am maintaining my Nat Gas view at neutral and changing my short term bias to neutral as I think the Nat Gas market is due for a correction.
Currently markets are firm as shown in the EMI Price Board table below. Today the Nymex March WTI contract expires likely resulting in even additional volatility.
Dominick A. Chirichella