Oil prices are recovering some of yesterday's losses in overnight trading. Yesterday's sell-off in the oil complex was due to a combination of factors. First the announcement of the February 25th meeting between Iran and the West was viewed as a bearish event as it suggests that the risk of a supply interruption between now and the meeting date (at least) has diminished. Also we finally got a modest round of profit taking selling in the global equity markets that quickly impacted oil prices as the correlation between oil, the economy and equities have been very much in sync this year so far. The round of selling in the equity markets was partially attributable to concern over the debt situation in Spain... once again bringing the EU sovereign debt issues back into the forefront. In addition most of the equity markets... in particular in the developed world... have been overbought for at least the last week or so.

Overnight the macroeconomic data out of Asia and Europe have been mostly supportive for the global economic recovery thus bolstering the market sentiment a tad. Most of the data released so far today revolved around the services sector which mostly came in better than expected in China, Hong Kong, and the EU. In fact the services sector PMI Index for China released by HSBC/Markit increased to 54 in January from 51,7 in December or the fastest growth pace in four months.

The central Bank of Australia (RBA) held is short term interest rate at 3% but indicated that the current low inflation scenario would allow for further easing if necessary down the road. Australia like many other developed world nations continue to operate their economies with a very accommodative monetary policy which to some extent has served to provide a floor (at a minimum) on most risk asset markets and in particular in the equity sector.

The global economy continues to show many signs that the economic recovery is picking up steam. In addition a major portion of corporate earnings and revenues came in better than expected for the fourth quarter or another sign that the private sector is picking up momentum. Much of this positive news has been quickly priced into equities and many of the traditional commodity markets like oil. There are still many headwinds that can potentially derail the recovery including the upcoming sequester spending cuts and debt ceiling in March in the US as well as the many geopolitical issues evolving in and around the Middle East and North Africa. For the time being the momentum is still pointing higher for equities and based on its tight correlations... the oil complex. However, there will be further rounds of profit taking selling as the markets still remain relatively overbought even after yesterday's sell-off.

The March Brent/WTI spread has breached the $19.50/bbl resistance level this morning and if it settles above this level it could likely be heading for a test of the March spread highs made back in the second half of November at around $20.75/bbl. With the Seaway pipeline still constrained and with the start of the spring refinery maintenance season in the US inventories in the both PADD 2 and Cushing may build even further thus creating a scenario that will be bullish for the Brent/WTI spread and thus a driver that could push the March spread back to its November highs.

Global equities took a modest hit during yesterday's sell-off as shown in the EMI Global Equity Index table below. The Index has lost about 1.4% of its value so far this week or what I would categorize as only a modest downside correction and not anything that would change the overall upward trend in global equities that has been in play this year. China is now holding the top spot the Index after being at the bottom of the list for all of 2011 while Brazil is still the only bourse in the Index that is in negative territory for the year. The year to date gain for the Index has narrowed to 1.2%. As I have been mentioning the direction of oil prices have been strongly in sync with the direction of the equity sector. I expect the correlations to remain high going forward as market participants continue to view the global equity market as a leading indicator for the global economy and thus an indicator as to the consumption of oil and other traditional commodities.

The weekly oil inventory cycle will follow its normal schedule this week. The weekly oil inventory cycle will begin with the release of the API inventory report on Tuesday afternoon and with the more widely followed EIA oil inventory report being released Wednesday morning at 10:30 AM EST. With geopolitics still less of an issue or price driver than it was the last month or so the main oil price drivers are likely to be any and all macroeconomic data on the global economy with oil fundamentals equally important. This week's oil inventory report could be a modest price catalyst especially if the actual outcome is outside of the range of industry projections.

My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to decrease marginally. I am expecting a modest build in crude oil inventories, a small build in distillate fuel... as the weather was not very winter like over the east coast... and a modest build in gasoline stocks during the report period even as refinery runs continue to decline ahead of US maintenance season. I am expecting crude oil stocks to increase by about 2.5 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 32.3 million barrels while the overhang versus the five year average for the same week will come in around 43.8 million barrels.

I am expecting a build in crude oil stocks in Cushing, Ok and in PADD 2 as the Seaway pipeline has been has been running at constrained levels for most of the report period. This will be bullish for the Brent/WTI spread in the short term as the spread is currently trading well above the level it was trading at just prior to the Seaway pipeline announcement.

With refinery runs expected to decrease by 0.2% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by 1.6 million barrels which would result in the gasoline year over year surplus coming in around 2.1 million barrels while the surplus versus the five year average for the same week will come in around 4.2 million barrels. If the actual gasoline build is in sync with my projection gasoline stocks will have built by about 37 million barrels since November.

Distillate fuel is projected to increase by 0.3 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 15.7 million barrels below last year while the deficit versus the five year average will come in around 16.5 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's inventories are mostly in directional sync with this week's projections. As such if the actual data is in line with the projections there will only be modest changes in the year over year inventory comparisons for just about everything in the complex.

I am maintaining my view at neutral and keeping my bias at cautiously bullish even though the current fundamentals are still biased to the bearish side. However, the technicals and forward fundamentals are suggesting that the market could be setting up for a continued move to the upside now that the spot WTI contract has breached its upper resistance level once again. That said I am continuing to fly the caution flag as any additional equity market corrections will impact oil prices in much the same way... round of profit taking selling (as we saw yesterday).

I am keeping my Nat Gas view and bias to cautiously bearish as the weather forecasts and nearby temperatures remain bearish. As I have been discussing for weeks the direction of Nat Gas prices are primarily dependent on the actual and forecasted weather pattern now that we are in the heart of the winter heating season and currently those forecasts are bearish at the moment.

Markets are mostly higher heading in the US trading session as shown in the following table.

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


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