Europe remains in the headlines and thus one of the main price drivers for both oil and equity markets. Today Merkel and Sarkozy are meeting ahead of the next EU meeting to discuss plans designed to revive the euro over the next three months. The euro did stage a big of a recovery rally early in the European trading session but over the last hour or so it is back on the defensive and thus a negative for both oil and global equities.

While the world continue to watch the evolving situation in Europe it also has one eye on the 30 second news snippets coming out about the Iranian nuclear situation. The latest is a statement by a diplomatic source (reported via Reuters) that Iran has started enrichment at an underground site (Fordow). While the Iranian Supreme leader Khamenei says that Iran will not yield to pressure of sanctions by the west. So the rhetoric continues and as I have been mentioning it is likely to continue for months into the future. I still am of the view that there will not be a militarily conflict anytime soon and Iran will not attempt to block the Straits of Hormuz. I do think the likelihood of Europe embargoing Iranian crude oil purchases (to some degree) is increasing but it is not an immediate event as many details still have to be worked out. I also expect any embargo to be solved by a combination of extra oil supply from Saudi Arabia & other GCC members, oil from the IEA SPR and the rebalancing of the global oil system...oil going to Asia sent to Europe while Iranian oil that was going to Europe will be sent to Asia. That all said Iran will remain an issue for the foreseeable future and will impact the price of oil to some degree over the next several months...if nothing other than acting as a floor on the price of oil.

Today through the 13th the major indices will be balancing the percentage of WTI (decreasing it ) and Brent (increasing it) in their Index. This action was announced months ago but the event happens this week. I am not sure if it is going to have a major impact on the price of WTI or Brent as it is likely that the market has pretty much priced in this action. But it is something worth watching this week especially insofar as how the Brent/WTI spread trades. The spread has widened around $3/bbl last week mostly as a result of the evolving situation in Iran and the potential of the EU embargoing purchases of Iranian crude oil. That said the spread is still holding over the $11.50/bbl level (premium to Brent as of this writing) even though the Iranian situation has been in the market for well over a week already.

As we begin the second trading week of the year the main price drivers that have been in the market for all of 2011 continue to dominate...Europe, geopolitics of the Middle East, the US economy and whether or not China will be able to orchestrate a soft landing. These are the main macro issues that will set the trading stage each day while the micro data...recurring economics, corporate earning (which begins this week) and fundamental data (like inventories) along with the plethora of thirty second news snippets will create the volatility and impact the intraday moves in all of the major risk asset markets. Most of the major correlations are still in play...i.e. falling euro/rising US dollar is a negative for oil, commodity and most equity market values. But as I have been mentioning it could be changing...time to watch closely.

Basis the daily charts the uptrend that oil was in from late September to mid - November of last year has now been replaced by a trading range that has been in place since the middle of November, 2011. The trading range for the spot Nymex WTI contract is between about $103.25 on the upper end and $92.50 at the lower end of the trading range. I see the spot ICE Brent contract in a range of about $106 to $116/bbl. The trading range is being driven toward the lower end of the range by the negative sentiment driven by the expectations for a slowing of oil consumption growth due to a faltering EU economy, a slowly recovery US economy and a slowing of the main oil demand growth engine... China. On the other hand the market is being driven toward the upper end of the range based on the potential for a supply disruption(s) from the evolving geopolitical situations in MENA and in particular surround Iran.

At the moment the supply side concerns seems to be impacting the overall market sentiment more than the shrinking demand view as prices of both WTI & Brent remain closer to the upper end of their respective trading ranges. As the market becomes more comfortable that there is not likely to be a supply disruption in the short to even medium term most market participants will place a lot more focus on the major economic drivers of risk asset values like Europe, etc.

So far this week is starting out on a quiet note with marginal losses in oil prices after last week's gains in most all risk asset markets. There is a lot of ground to recover from last year's losses in the equity markets but last week ended modestly higher as shown in the EMI Weekly Price Board table below. As the situation in Europe unfolded and by the time the end of the week arrived most all risk asset markets were still able to end the week in positive territory. Last week was less about Europe and more about the positives coming from the US while the war of words between the west and Iran ratcheted up a notch. The action and volatility last week was in all of the oil and commodity markets as well as the global equity markets. Last week was all about market players acting around the cloud of uncertainty that seemed to marginally shrink for all risk asset markets. Equity bourses were higher as uncertainty started to decrease throughout the week. Precious metals increased modestly even as the US dollar firmed strongly on the week as cash moved into the safe haven of the US dollar and out of the euro.
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Over the last week the oil complex was higher across the board with HO the biggest gainer in the complex. The Feb WTI contract increased about 2.76% or $2.73/bbl. The Feb Brent contract ended the week with a larger gain of 5.29% or $5.68/bbl. The Feb Brent/WTI spread moved higher by about $3/bbl last week for all of the reasons discussed above.

On the distillate fuel front the Nymex HO contract increased even as distillate fuel inventories increased more than expected and US distillate fuel exports were flat on the week. The spot Nymex HO contract increased by 5.35% or $0.1560/gal. Gasoline prices increased on the week even as gasoline stocks also increased strongly and much more that the expectations. The spot Nymex gasoline price increased by 4.84% or $0.1275/gal this past week.

On the week Nat Gas futures increased by 2.44% or $0.073/mmbtu. After falling hard on Thursday on bearish EIA inventory data the Nat Gas market is back into short covering mode ahead of the weekend. Although the current weather has reverted back to milder conditions the latest NOAA six to ten day and eight to fourteen day forecasts have become a tad more bullish and has garnered the attention of some of the weak shorts who seem to be heading to the sidelines today. As I have been saying for weeks Nat Gas is all about the weather and any normal to above normal winter looking weather is going to act as a underlying bid in the market as the first step in the price recovery process. The second step in the recovery process...and in my opinion the more important step... is will the potential winter like conditions result in above normal inventory withdrawals.

This step is far from a slam dunk as we are now entering the so called heart of the winter heating season when the coldest temperatures normally occur. For the upcoming inventory report period the weather last year and on average over the five year period for the same week was very cold resulting in strong withdrawals of over 200 BCF from inventory. The very early numbers I am hearing quoted around the market for next week's report is for a range of withdrawals of 95 to about 100 BCF or less than half of last year withdrawal of 226 BCF and 216 BCF for the five year average. Last week was cold over a major portion of the eastern half of the US and if all we are going to get out of inventory is a meager 100 BCF withdrawal the surplus that has been building in inventory versus the historical period is not likely to dissipate anytime soon.

Irrespective of the occasional bouts of short covering the market remains in a technical downtrend that has been in place since last spring. The next level of support within the downward channel for the spot Nymex Nat Gas contract is around $2.88/mmbtu with not much out there until we start working back to 2009. The first important support level from 2009 is at $2.72/mmbtu hit in late Sep of 09 followed by the low of $2.39/mmbtu hit in early Sep of 2009. I do not think we are going to hit the 2009 lows during the next month or so especially if cold weather does in fact show up. However, if the inventory surplus versus the historical period continues to grow we could be setting up for a test of these critical support levels during the shoulder season.

On the financial front equity markets around the world ended decidedly higher. Fear of contagion coming from the southern EU member countries... is still a huge concern in the financial markets but did ease a tad as the week progressed. Global equity values increased as shown in the EMI Global Equity Index table below.

The EMI Index gained 2.0% on the week. Over the last week the Index held most of its gains even though the euro declined strongly and the US dollar has surged higher(moves in this direction would normally result in strong moves to the downside in equities..not this time). As mentioned above the correlations are still mostly in play but they could possibly be changing warranting us to watch this more closely. Last week the global equity markets were a positive driver for oil and most commodity prices.
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The US Dollar Index appreciated in value on the week as confidence in the euro faded once again. By the end of the week cash was moving into the dollar and out of risk asset markets. The currency markets are still in the midst of a major realignment as I have been warning for months. Cash flowed back into gold (and the rest of the precious metals complex) which increased by 3.2% on the week.

The WTI market remains above support but has been drifting lower since peaking last week. I am keeping my view at cautiously bullish but keep the caution flag flying that the market will be very volatile over the next few days and prices can easily recede back below the $100/bbl mark versus WTI. The market is already more than $1/bbl off of its highs.
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I am maintaining my view and bias at cautiously bearish. The surplus that is building in inventory versus both last year and the five year average is going to get harder and harder to work off until it gets cold over a major portion of the US and as such for the medium term I am still very skeptical as to whether NG will be able to muster a sustained upside rally absent some very cold weather for an extended period of time. If the winter weather does not arrive over the next few weeks I would not be the least bit surprised to see the spot Nat Gas futures contract consistently trading with a $2 handle.

Currently as a new day of trading gets underway in the US markets are mixed.

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