Oil is continuing to move lower with the spot WTI contract now trading around the lower end of the range that has been in play for about a week or so. The markets are quickly coming to the reality that QE3 in the US, more QE in the UK and Japan as well as the ECB bond buying program are not likely to result in a major growth spurt in any of the aforementioned economies. In fact the Philadelphia Federal Reserve Bank President said in a speech yesterday that the new stimulus program probably will not boost economic growth in the US. In the EU the newly proposed ECB bond buying program will likely result in eventually pushing the three year old sovereign debt issues into the background once and for all but it will not result in an economic growth spurt either. The EU economy is in the midst of a contracting economy with recession spreading around to the individual member countries.
If the markets can put the EU sovereign debt problems on the back burner they still have to worry about how deep the recession will grow in the EU. In addition if there is a growing view that QE3 will not result in economic growth (as above) the already fragile and slow growth US economy can easily recede even further and possibly move closer to a double dip recession. All of the above scenarios are once again permeating around the markets and as such most risk asset markets have been under selling pressure this week including the oil complex.
If the slow growth or contracting economic scenario becomes a reality oil demand growth is also going to slow as oil consumption is highly correlated to economic growth. With supply not an issue anyplace in the world today any further slowing of economic growth and thus oil consumption will result in global inventories starting to move back toward the upper end of the normal inventory range. If so it could put pressure on oil prices from a fundamental perspective.
Although more participants do not expect QE to result in an economic growth spurt (myself included) the open-ended printing of money has a high probability of resulting in an increase in inflation around the world. If so an inflationary push could easily result in oil prices as well as most traditional commodities negating the impact of bearish fundamentals and thus still pushing prices higher. In addition the geopolitics of the middle east area have not gone away nor is all of the turmoil especially with Iran's nuclear program going to go away anytime soon. It will be with us for the foreseeable future and as I have been discussing in the newsletter the risk of a possible military intervention is likely to ramp up after the US election. At a minimum the market is likely to see it that way if the rhetoric between Iran and the West remains at the current elevated level. Today Iran's President gives his annual caustic speech at the UN which is likely to raise the rhetoric another notch. Yesterday President Obama spoke at the UN and said that there is a time limit on negotiations.
The oil complex remains in a tug of war between the economic and growth headwinds that have been plaguing oil and the risk asset markets for an extended period of time. On the other hand the headwinds from the evolving geopolitical situation in the middle east as well as the exposure of increasing inflation risk from all of the money printing going on around the world are what is driving the upside perception view in the oil complex. Both side of this battle have impacted oil prices in their respective directions over the last month or so with the headwind price drivers taking a slightly dominant role this week. I do expect oil to remain in this tug of war for the foreseeable future with price movements in both directions and thus the development of the trading range that has been starting to form over the last week or so.
Global equity markets declined strongly over the last twenty four hours as shown in the EMI Global Equity Index table below. After starting the week in positive territory the Index is now lower by 1.4% for the week resulting in the year to date gain narrowing to 7.6%. There are now only three bourses showing double digit gains for the year as China is still the only bourse in negative territory for the year. Over the last twenty four hours the economic growth headwinds dominated global equity trading.
The API report was outside of the range of expectations. The crude oil build was lower than expected as was the gasoline build while distillate fuel showed an inventory draw versus an expectation for a small build. The API reported a build (of about 0.3 million barrels) in crude oil stocks versus an industry expectation for a larger build as crude oil imports decreased strongly while refinery run rates also decreased modestly by 0.9%. The API reported a surprise draw in distillate stocks. They also reported a smaller than expected build in gasoline stocks.
The report is mixed and mostly biased to the neutral side for everything other than distillate which is marginally bullish. The market is mostly lower heading into the US trading session and ahead of the EIA oil inventory report at 10:30 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 0.3 million barrels of crude oil with Cushing, Ok about unchanged while PADD 2 stocks increased by 0.5 million barrel which is bullish for the Brent/WTI spread. On the week gasoline stocks increased by about 0.1 million barrels while distillate fuel stocks decreased by about 0.5 million barrels.
This week's oil inventory report could be a price catalyst especially if the actual outcome shows a large deviation from the projections. However, any inventory reaction is likely to be short lived as the main event for this week is still likely to be the markets focusing on the macroeconomics as well as the evolving geopolitical situation in the middle east.
My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to still be working its way back to a full return to normal operations from the preemptive shutdowns ahead of Isaac. I am expecting a modest build in crude oil inventories, a build in gasoline and a seasonal build in distillate fuel stocks. I am expecting crude oil stocks to increase by about 1.5 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 30.1 million barrels while the overhang versus the five year average for the same week will come in around 40.4 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 be bearish for the Brent/WTI spread in the short term which is now trading around the $18/bbl premium to Brent level. I am still of the view that the spread will continue the process of normalization over the next 6 months.
With refinery runs expected to increase by 2% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by 0.5 million barrels which would result in the gasoline year over year deficit coming in around 17.3 million barrels while the deficit versus the five year average for the same week will come in around 7.9 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 28.4 million barrels below last year while the deficit versus the five year average will come in around 23.9 million barrels. Exports of distillate fuel are likely to be back to their pre-hurricane levels.
The following table 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 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 comparisons for crude oil and to a lesser extent for gasoline.
Oil is slowly starting to become a bit more reasonably valued after about a 10% downside correction (basis WTI). WTI is still currently in a $90 to $100/bbl trading range while Brent is in a $110 to $120 trading range. That said prices are almost solely being driven in the short term by a combination of the outcome of the ECB meeting and the new round of QE along with the growing geopolitical risk in the mid-east on one front. With the bearish current fundamentals driving price from the other end of the spectrum. The bias is to downside in the near term based on the profit taking selling that started on Monday with prices for WTI now near the lower end of the newly forming trading range.
I am keeping my view at neutral with a bias to the downside as the industry is back to normal operations after Isaac. At current prices the economics now favor coal over Nat Gas and there are no major weather pulls on demand.
Markets are mostly lower ahead of the US trading session as shown in the following table.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.
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