A mixed week in the oil complex with the main move lower centered in the gasoline market as US RBOB dropped a little over 6%. All of the anticipation of a major shortfall of gasoline in the US this summer...especially along the East Coast (due to shut downs of several refineries in that region of the country) is starting to subside and as such the risk premium in the price of gasoline is finally in decline with the high of the season possibly now in. Although gasoline stocks in the US are still below the five year average they are above last year by about 4.3 million barrels. In addition implied demand is still running well below last year with this week's EIA data showing implied gasoline demand below last year by 406,000 bpd or 4.4%. Using the four week average to balance out some of the noise in the weekly data we find a similar conclusion with implied gasoline demand down by 257,000 bpd year over year or 2.9%.
With refinery runs starting to increase as the spring maintenance season comes to an end and with more gasoline earmarked from Europe all signs suggest that there will be ample supply of gasoline as the summer driving season gets underway. Gasoline consumption is likely to continue to recede for a combination of reasons. First as shown in the following chart of the US nonfarm payroll data and the four week implied gasoline demand gasoline consumption has been in decline since peaking at about the same time that employment peaked back in the first part of 2007. Employment has been going through an extremely slow and sluggish recovery with many Americans choosing not to even look for a new job. As such with a significant amount of the population still out of work the unemployed are certainly not going to be very aggressive gasoline buyers anytime soon. The result we see... gasoline consumption still continuing to decline.
Further adding to the slow erosion in gasoline consumption is more efficient vehicles replacing less efficient autos. This is a slow process as US auto sales are still considerably below the level they were at prior to the recession. This trend will continue and likely accelerate as the US economy starts to improve and auto sales also increase accordingly.
Finally until the price of gasoline starts to recedes we are in the price range where we do see some elasticity of demand. I am of the view that the price of gasoline has just about peaked for the summer driving season (barring any unplanned geopolitical event...especially in the middle east). If the next four or five months turn out to be a normal oil world I would say that the worst is over insofar as the high price of gasoline...especially at the retail level. Retail prices should continue to decline to levels that do not include a gasoline supply shortfall premium nor a geopolitical premium. The only variable I see for gasoline is certainly the geopolitical premium which is receding at the moment as talks continue between Iran and the west. However, this situation could change on a dime and just like that we could see the risk premium surge once again in the price of crude oil and thus in the price of gasoline.
For all of the reasons I have been discussing for several weeks in the newsletter I still expect to see the Brent/WTI spread continuing to narrow...especially in the front end of the forward curve as the Seaway pipeline reversal becomes a reality. As such I expect all oil commodities that have been indexed against Brent to continue to depreciate versus WTI. For example I especially expect the RBOB WTI crack spread to move even lower. The June RBOB crack spread has narrowed by about $9/bbl since peaking back in early April. It is now hovering around a technical support level and if breached (with a close) the spread could decline another $10/bbl to the next support level of around $16/bbl. I have been short the June RBOB crack and will remain short until proven wrong. Even if the oil complex itself does not decline strongly I still expect RBOB gasoline to depreciate versus the rest of the oil complex.
Over the last week the oil complex was mostly lower with the spot WTI contract the only commodity in the oil complex to end the week with a small gain. The expiring May WTI contract increased about 0.21% or $0.22/bbl or about the same size increase as the previous week. The June Brent contract ended the week with a decrease of 2.02% or $2.45/bbl. The June Brent/WTI spread narrowed by about $3/bbl and has been contracting since peaking close to the $20/bbl level. The combination of the market looking toward the early start of the Seaway pipeline in mid-May (expected to move about 150,000 bpd of oil out of PADD 2 to the US Gulf) and the easing of the tensions in the Middle East has been enough to send some of the spread bulls to the sidelines. Barring any change in the current geopolitics of the Middle East I would expect the spread to gradually continue to narrow over the next 3 to 6 months as the surplus in the US mid-west continues to recede.
On the distillate fuel front the Nymex HO contract was about unchanged on the week even as distillate fuel inventories decreased much more than expected last week and as US distillate fuel exports were steady on the week. The spot Nymex HO contract increased by 1.17% or $0.0370/gal. Gasoline prices decreased on the week even as gasoline stocks declined. The spot Nymex gasoline price decreased by 6.08% or $0.02034/gal this past week (see above for a more detailed discussion on the gasoline price decline this past week).
On the week Nat Gas futures declined once again and remains below the psychological $2/mmbtu level and is continuing to trade with a $1 handle as the inventory injection came in exactly as expected this past week. The spot Nat Gas futures contract lost another 2.73% or $0.054/mmbtu on the week as it is now solidly trading with a $1 handle.
I must say I see and hear a lot more participants more focused on trying to pick a bottom and looking at ways to set up trades to take advantage of a turn in Nat Gas than I see traders focused purely on either being short or setting new shorts. The sentiment is starting to slowly change with less conviction for the outright shorts and more conviction coming from the potential bulls or bottom pickers who have been waiting for a turn since Nat Gas broke the $3/mmbtu level. So far this year the spot Nat Gas futures contract has had 10 down weeks and only 5 up weeks. But the most interesting part is the down weeks are currently showing smaller losses than earlier in the year and certainly compared to last year. Possibly this along with the aforementioned sentiment change could be a signal that a floor in prices is getting closer. Unfortunately the analysis above is certainly less than perfect nor very scientific and the actual turning point for Nat Gas will come when the market actually hears and/or sees real production cuts starting to take place.
Let's look at the market from the inventory overhang perspective. So far 143 BCF of Nat Gas has been injected into inventory through the first five weeks of the injection season. Last year 182 BCF was injected during the first five weeks. This year is running at 78.6% of last year. Assuming (and this is a huge assumption) the rest of the injections season continues to run at only 78.6% of last year's level than a total of 1,703 BCF will be injected this year versus last year's injection of 2, 168 BCF. At first glance sounds like problem solved!
Even if the injection season underperformed as assumed ending inventory would come in at 4,072 BCF this year versus last year's 3,871 BCF. It would certainly just fit into storage which has a maximum workable capacity (as per the EIA) of 4,103 BCF. That all said last year experienced a very hot summer with about 46 days of over 100 degree F in many parts of Texas. It was a very hot summer. So far the forecasters are calling for a more normal summer this year. Or in other words the possibility of the this year's injection season underperforming at the rate mentioned above with no production cuts is tremendously low. I come back to my original conclusions ...significant production cuts will be needed. I remain bearish and still expect to see prices drift lower until there is a sign that production will be cut.
On the financial front equity markets around the world ended mostly higher as the downside correction paused for a bit last week. The financial markets were mostly impacted by a series of macroeconomic data in several locations around the world that were a bit better than expected along with two favorable bind auction for Spain (the EU's newest debt risk country to watch) causing a modest short covering rally last week. Global equity values increased as shown in the EMI Global Equity Index table below.
The EMI Index increased by 1% on the week. Over the last week the Index increased in value along with a firming euro increased slightly while the US dollar weakened on the week. Last week the global equity markets were a bullish price driver for oil and most commodity markets (although oil prices were mostly lower on the week). Last week was a risk on trading week for most risk asset markets.
I am keeping my view at neutral for oil as WTI remains within my predicted trading range of $102 to $107/bbl. At the moment the oil complex is going through a spread realignment driven by a reduction in the tensions in the Middle East and thus a receding of the Iranian risk premium along with a sentiment swing in the Brent/WTI spread due to the early start of the Seaway pipeline. I am more comfortable staying on the sidelines today for the flat price market.
I am still keeping my view at and bias at bearish. My overall view remains biased to the bearish side. The surplus is still building in inventory versus both last year and the five year average is going to lead to a premature filling of storage during the current injection season. As such for the short to medium term I doubt Nat Gas is going to reverse the downtrend it has been in for an extended period of time. We may certainly see times when short covering rallies take hold but I do not expect a sustained trend change.
Currently markets are mostly lower as shown in the table below.
Dominick A. Chirichella
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