The potential for an EU embargo of Iranian oil purchases has slowly moved to the background as oil prices have peaked from this latest event and have been gradually declining. The main storyline at the moment is the falling euro which is now trading at the lowest level since September of 2010 pushing the US dollar higher and oil and other commodity prices lower. The latest negative on the euro is the mediocre French bond auction today coming in at slightly higher interest rate levels than the December bond auction. No matter how hard the Europeans try to move to the background it just does not last for more than a few days. The French bond sale and subsequent down leg in the euro is yet another reminder to the market that the evolving EU sovereign debt problems are far from over. On a slightly positive out of Europe is the interbank lending rate has declined for the 12th session in a row or since the injection of liquidity from the ECB. So all may not be entirely bad in Europe right now. The market is just skeptical over any 30 second news snippet that hits the media airwaves and almost always overreacts to anything that looks even remotely bearish.
Back to the Middle East the rhetoric between Iran and the west continues as the EU indicated that they have an agreement in principle to institute an embargo of Iranian oil purchases with the details still to be worked out including a starting date. This has helped to boost WTI back into triple digit trading levels and has resulted in a huge expansion of the Brent/WTI spread of over $3/bbl since the beginning of the year. I remain of the view that even if the Europeans go through with embargoing Iranian oil the oil that was flowing to Europe will simply wind up in Asia to China and Japan while other PG crude oil that was going to Asia like Saudi and Kuwaiti oil will wind up in Europe.
This will turn out to be a logistics exercise or rebalancing of global supply and demand and not a net loss of oil to the market place. In fact with growing supplies out of Libya and the Saudi's and other GCC member countries already indicating they would up production to replace any Iranian oil over the medium term an embargo of Iranian oil should not result in any major upward move in prices over a sustainable period of time as more oil is likely to be in the market than before the embargo. In spite of Iran's threats they will not keep oil off of the market as their economy will not support such a move nor will they enter into a military engagement with the west over the Straits of Hormuz. Iran is negotiating with bluster much like Saddam Hussein did in the 90's. But as I said in my opening year newsletter we have to watch geopolitics as an oil price driver especially Iran during the first half of the year.
Equity markets around the world have traded in a tight slightly lower pattern over the last twenty four hours as shown in the EMI Global Equity Index table below. The Index has declined about 0.1% since yesterday but remains 2.9% higher for the year so far. Both Paris and China dropped into negative territory for the year already with China holding the bottom spot and Brazil still on top of the list of bourses in the Index. Equities are already back into the mode of being driven by the macro trade or simply the direction of the euro and the US dollar which have both been a negative for equity prices since yesterday's trading session. the main concern around Europe is the potential for it to fall back into a double dip recession which would have a negative impact not only on their economy but on international companies operating in and around Europe as well as on China as Europe is their number one export market. Amazing how the sentiment has changed over the last twenty four hours... all mostly around a bond auction in France that came in with a slightly higher interest rate with the market pretty much ignoring a decent bond auction out of Italy. The market quickly gravitates toward the negative in Europe and discounts anything positive. For now equities are a negative for oil prices and the broader commodity complex.
The API data was mixed. The API reported a large draw in crude oil stocks versus an expectation for a modest decline in crude oil inventories of about 4.4 million barrels even as crude oil imports increased while refinery run rates also increased by 0.4%. The API reported a large build in gasoline stocks versus projections for a modest build and a significantly larger than expected build in distillate fuel inventories.
The market was expecting a modest draw in crude oil stocks and a modest build in gasoline with a small build in distillate fuel inventories this week. The report is somewhat bearish for the entire complex. That said it is difficult to differentiate whether the losses overnight were from the inventory report (I doubt it) or from the falling euro and negatives out of Europe (most likely). The market remains hostage to the evolving situation in Europe that has been unfolding once again this week as discussed above with inventory data a secondary driver. The API reported a draw of about 4.4 million barrels of crude oil with a 0.2 million barrel build in Cushing but draw of about 1.3 million barrels in PADD 2 which is negative for the Brent/WTI spread which has been widening this week over the evolving Iranian situation. On the week gasoline stocks increased by about 3.4 million barrels while distillate fuel stocks surged by about 5.2 million barrels. The more widely watched EIA data will be released this morning at 11 AM. Whether or not the market will react to anything that comes out of the EIA this morning will be dependent on what revolves around Europe today. Finally keep in mind that the large variations from the expectations are likely related to the industry still optimizing the yearend inventory situation for LIFO accounting purposes.
At the moment oil prices are being mostly driven by the tensions building in the Middle East between Iran and the West (as discussed above) coupled with the direction of the euro and the US dollar. As such I am not sure many market participants are going to pay much attention to this week's round of oil inventory data suggesting that this week's oil inventory reports may not have a major impact on price direction. At the moment all market participants are continuing to follow the new snippets out of the Middle East and the tick by tick direction of equities and the US dollar (driven by Europe)... as they are both the primary price drivers for oil. Even with the fundamentals and geopolitics starting to impact price it is the macro trade that dominates at the moment. As such this week's oil inventory report could remain a secondary price driver at best and only impact price direction if the actual EIA data is noticeably outside of the range of market expectations for the report.
My projections for this week's inventory reports are summarized in the following table. I do want to caution that there could be surprises in the data as the industry adjusts their inventory levels to meet whatever their LIFO accounting objectives turned out to be for 2011. We have seen some of this already over the last several weeks. I am expecting mixed inventory data with a small increase in refinery utilization rates which should result in a neutral weekly fundamental snapshot. I am expecting a modest draw in crude oil stocks with an increase in refinery utilization rates. I am expecting a modest build in gasoline inventories and only a small build in distillate fuel stocks as winter like weather did not arrive during the report period in most parts of the US...especially the large HO market along the north east. I am expecting crude oil stocks to decrease by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 13.2 million barrels while the overhang versus the five year average for the same week will come in around 4.2 million barrels.
With refinery runs expected to increase by 0.3% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by about 1.0 million barrels which would result in a gasoline year over year surplus of around 1.3 million barrels while the surplus versus the five year average for the same week will come in around 7.5 million barrels.
Distillate fuel is projected to increase by only 0.4 million barrels on a combination an increase in production and lower than normal heating oil consumption. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year the deficit will likely now be about 22.6 million barrels below last year while the deficit versus the five year average will come in around 4.5 million barrels.
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 experienced pretty much the same directional moves as the projections for this week's inventory report but with a significant draw in crude oil stocks. Thus based on my projections the comparison to last year will result in a minimal year over year change in refined product inventories only.
The WTI market remains above support but has been drifting lower since peaking yesterday. I am keeping my view at cautiously bullish but raise the caution flag 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.
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 any kind of strong upside rally absent some very cold weather for an extended period of time. I do not see the trend changing as the mild temperatures will return in a few days.
The weather has turned decidedly colder for a few days as an Arctic blast hits portions of the East Coast. This has resulted in acting as a floor in Nat Gas prices at the moment with a modest amount of short covering taking place. The latest NOAA weather forecast is changing a bit with a return to more normal temperatures over the eastern half of the US by mid-month with the central part of the US still expecting above normal temperatures. This has been enough to send some of the shorts to the sidelines in a market that has been modestly oversold.
Currently as a new day of trading gets underway in the US markets are lower.
Dominick A. Chirichella
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