Europe was the main driver yesterday (continues today) for most risk asset markets coupled with a surprise announcement by Enbridge to buy Conoco's share of the Seaway pipeline which sent the Brent/WTI spread into a massive unwinding leaving WTI above $100/bbl even as the rest of the oil complex declined in value around negative sentiment coming from Europe. Yesterday was also oil inventory (see below for a more detailed discussion on the EIA data) day working into the dynamics of a very interesting day of trading.

The main feature in the oil complex was the Seaway acquisition announcement followed by Enbridge indicating they planned to reverse the direction of the pipeline sending about 150,000 barrels per day from Cushing, OK to the US Gulf by mid-2012. This announcement triggered a massive unwinding of the Brent/WTI spread...which was already in the process of slowly unwinding since peaking around $28/bbl back in mid October. After the announcement the spread narrowed by about $4/bbl in under an hour resulting in the spot WTI contract breaching the $100/bbl mark and remaining above this psychological level for the remainder of trading (and into today so far). By the end of the session the spread recovered a bit of its earlier losses with selling resuming once again this morning as the spot spread is now trading around $8.20/bbl as of this writing. Many are now forecasting the spread will drop to around $6 to $6.50/bbl in the not too distant future with a return to normal (WTI over Brent) sometime down the road.

I must say I am much more convinced that the spread will return to a more normal relationship a lot faster than some in the market believe. PADD 2 inventories have been destocking since peaking back in early April. Stocks in this region of the US have declined by almost 16 million barrels during the aforementioned timeframe and are now only a few million barrels above last year at this time. Last year at this time the spread was trading around a $2/bbl premium of Brent over WTI. With inventories in PADD 2 still in a destocking pattern I expect the spread to retrace closer to even or possibly back to WTI trading at a small premium to Brent within the next two to three months.

Oil is flowing out of the region by other means other than the pipeline. That said PADD 2 stocks are currently about 4 million barrels below the level they were at when the spread was last trading with WTI at a premium to Brent while Cushing stocks are about 5 million barrels below. Thus the US Midwest crude oil inventories are not surplus and are not the driver of Brent trading at a premium. In fact at current inventory levels the spread should already be trading with WTI at a premium over Brent. The Enbridge announcement is just another added bearish driver of the spread.

So what else is driving the spread? Libyan oil is still underperforming and will so for a considerable period of time. That said the IEA expects Libyan oil production to return to about half of its pre-civil war level by the end of the year. This coupled with North Sea production operating at near normal levels along with the European economy barely growing (and talk of further refinery cutbacks) I see no reason why Brent should be carrying a premium over WTI for much longer. Thus most of the factors I view suggest to me that the spread should return closer to normal, historical levels possibly within the next few months if not sooner.

Aside from the Brent/WTI storyline the markets have been dominated by the situation in Europe after Fitch issued a report late in the day indicating that the large US banks had exposure to Europe but were basically ok for now as long as the Europeans solve the problems quickly. This report sent most risk assets markets into a massive sell-off in the last hour of trading in the US. It is almost impossible to pay attention to anything else in the market as what will happen with Europe outweigh any and all price drivers. In spite of relatively positive economic data and bullish fundamentals (like yesterday's EIA oil inventory report) the market sentiment has been bearish and remains bearish with oil and everything else trading as if the entire European Union is still on the cusp of collapsing (which it could).

Global equity markets have been hit over the last twenty four hours as shown in the following table of the EMI Global Equity Index. The Index is now down 0.7% on the week (after falling 0.2% in the last twenty four hours) and has added to the loss from last week. The US Dow is barely holding onto to its year to date gain while all of the other nine bourses remain solidly in negative territory for 2011. The equity markets are still painting a relatively negative picture for the forward economy and thus a negative picture for the oil complex. The selling has continued in Europe this morning (so far) after a mixed session in Asian trading hours. Not much has changed from yesterday and the modest loses so far in Europe and in US equity futures markets are still reflective from the negativity flowing from Europe. Although the Greek and Italian governments both seem to be making progress with their new governments in place and austerity budgets passed opening the door for EU/IMF funding.
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Yesterday's oil inventory report was mostly bullish (except for gasoline) but with Europe still dominating the media airwaves the oil market was unable to decouple itself for a major portion of the trading session until the Enbridge announcement which resulted in only crude oil decoupling itself from Europe. In the end prices closed in negative territory (except for WTI). Even with the uncertainty surrounding the financial markets (especially in Europe) crude oil fundaments did play a role in price movement on Wednesday and into this morning so far. Total commercial stocks declined strongly for the second week in a row led by a large decline in distillate fuel inventories just weeks before the start of the upcoming winter heating season while crude inventories also declined but gasoline stocks built.
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The inventory report showed a significant decline in total stocks, a larger than expected draw in distillate inventories along with a surprisingly modest build in gasoline stocks as implied demand was strongly lower while refinery utilization rates increased on the week to 84.8% of capacity an increase of 2.2% in refinery run rates. The data is summarized in the following table along with a comparison to last year and the five year average for the same week.

Total commercial stocks of crude oil and refined products decreased on the week by 8.7 million barrels. The year over year status of total commercial stocks of crude oil and refined products remain in a deficit position for the 34th week in a row. The year over year deficit narrowed to 74.8 million barrels while the overhang versus the five year average for the same week switched to a deficit of around 13.7 million barrels.

Crude oil inventories decreased more than the expectations. With a decrease in stocks this week the crude oil inventory status versus last year is still showing a wide deficit of around 27.9 million barrels while the surplus versus the five year average for the same week narrowed to around 4 million barrels. PADD 2 stocks decreased about 1.0 million barrels on the week while Cushing stocks declined by about 0.9 million barrels. Crude oil inventories in this region of the US have been in a decline and are still at levels not seen since the middle of 2010 when the Brent/WTI spread was trading at significantly lower levels. The spread continued to depreciate in value as the inventory situation in the US moves to more normal levels while Libyan oil continues to flow into the market.

Distillate stocks decreased versus an expectation for a smaller decline. Heating oil/diesel stocks decreased by 2.2 million barrels as exports remain robust on the week. The year over year deficit widened to 26.2 million barrels while the five year average overhang deficit narrowed to about 9.6 million barrels. Exports of distillate fuel from the US and in particular from the US Gulf Cost have been steadily growing over the year with the pace of exports accelerating over the last year or so. In fact total distillate fuel exports are still hovering around the 950,000 barrels per day level or almost the equivalent of 25% of US consumption of distillate fuels. With the economics and demand still likely to hold outside the US and unless the upcoming winter heating season comes in much colder than any of the expectations the current level of exports will likely continue.

Gasoline inventories increased modestly on the week versus an expectation for a small draw. Total gasoline stocks increased by about 1.0 million barrels on the week versus an expectation for a draw of about 0.7 million barrels. The deficit versus last year narrowed to 5.1 million barrels while the deficit versus the five year average for the same week narrowed to about 3.7 million barrels.

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 presented a bullish categorization for the entire complex except for gasoline. Production is up, demand is lower and imports were down but exports were up...all contributing to my mostly bullish assessment.
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WTI is still trading above the key technical support level of the mid- $94's/bbl and along with the changing fundamentals I am still keeping my view and bias at cautiously bullish even as the cloud of uncertainty remains in Europe. The situation in the EU is still in turmoil but progress seems to be slowly emerging. That said WTI & Brent could become linked back to the direction of the US dollar at any moment.
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I am still bearish and am becoming more convinced that there is more downside in the price of Nat Gas. Right now I would categorize the current market action as a market with a downside bias. I am keeping my view and bias at bearish as I watch how price activity plays out over the next several trading session. I must say in looking at the fundamentals it is still hard to be anything other than bearish.

Nat Gas prices continued to drift lower ahead of today's upcoming EIA injection report. The spot futures contract set another new year to date low price on its way to a possible test of the next support level of $3.22/mmbtu. The main drivers all remain bearish as of now. The technicals are pointing lower, the forecast for mild temperatures for the next several weeks are point to lower prices and the robust supply situation is also pointing lower. Irrespective of the size of tomorrow's inventory injection it will set a new all time record high inventory level and that certainly is a bearish outcome also. The only bullish factor in the mix at the moment is the fact that everything and most everyone is bearish.

A bearish injection report has been building into the price since trading started the week and the market could be heading into yet another sell the rumor (projections for the inventory report) and buy the fact (tomorrows injection report irrespective as to what it is). As the market moves to new lows the pool of potential sellers is getting smaller and as such it is going to have to be a very bearish inventory report...say above the upper end of the expectations to result in a strong move to the downside. Anything that is within the lower half of the expectations is likely to be met with a round of short covering along with the emergence of the seasonal bottom pickers that have been looking around for weeks searching for the shoulder season bottom. Eventually they will find it but if the injections continue beyond this week it may be at an even lower level than where the market is currently trading. Even if we do get a short covering rally we will need to see a period of sustainable up moves to start gaining confidence that the bottom is in and Nat Gas is now moving into a winter trading mode. Certainly all of this will require some winter like weather which is absent from the US right now and is projected to remain absent thorough the month of November.

Currently as a new day of trading gets underway in the US markets are lower as shown in the following table.

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