Geopolitics and support from the macro price drivers sent oil prices higher yesterday...including WTI which has been the main laggard in the oil complex. WTI found additional support as modest profit taking selling hit the surging Brent/WTI spread after a recommendation by GS to sell the spread. Even with a round of spread selling the Brent/WTI spread is still hovering around the $17/bbl level (premium to Brent) and still overvalued with more downside to come. Finally, last night's API inventory report (see below for more details) showed a small draw in PADD 2 and a small build in Cushing, OK crude oil stocks which is mostly neutral at the moment. The more important or more widely followed report will be the EIA report that will be released later this morning. As I have been discussing for several weeks the order of oil price drivers has changed with the macro or external price drivers playing a more secondary role while geopolitics and fundamentals are playing a more primary role in setting the direction of oil prices.

On the macro front the Greek saga is still continuing although some progress was made yesterday as the Greek government appears to have completed a deal with the Troika (ECB, IMF & EU) but not yet with the party leaders in Greece (expected today) nor the private debt holders and the Greek banks. The situation is still messy but in the midst of the uncertainly a modicum of progress is emerging.

A completely done deal in Greece will certainly bolster the external markets. It should be a positive for the euro, a negative for the US dollar and thus a positive for oil, equities and the broader commodity market. That said I am not sure how much of a done deal has already been priced into the market over the last three weeks and thus we could see a bit of sell the news happening if a deal is completed...certainly volatility will rise. I expect a deal to be completed as the EU has come a long way in trying to stem the evolving sovereign debt issue of its member countries and I do not think they will allow an un-orderly default by Greece. I remain in the camp that is expecting a deal. If and when one is struck Europe will once again move into the background (until the next crisis) which will allow most risk asset values to move based more closely on their normal fundamentals and technicals and less on the macro or external price drivers.

The global equity markets are still holding onto to the majority of the year to date gains as shown in the EMI Global Equity Index table below. The Index gained another 0.86% over the last twenty four hours widening the year to date gain to 12%. the majority of last year's losses have now been recovered (15.2% loss for the Index in 2011) which demonstrates the strength of the rally that started at the beginning of the year. It also suggests that market participants are becoming more and more confident that the global economy will be able to orchestrate a soft landing including Europe. I also still view the global equity markets as very overbought and susceptible to a round of profit taking selling sooner than later. With Europe/Greece looking like they are closer to a deal I am not sure what the catalyst will be to slow the global equity rally. For the moment global equities are still a positive for oil prices as well as the boarder commodity complex. Yesterday the EIA released their latest Short Term Energy Outlook (STEO) report. They said that US oil demand for 2012 to be about the same as 2011 even though they are projecting a 2.1% decline for the first quarter. The main oil highlights from the report follow.

  •  Absent a significant oil supply disruption, EIA expects world markets to continue to gradually tighten in 2012 and 2013, as increases in global consumption outpace production growth in countries outside of the Organization of the Petroleum Exporting Countries (OPEC). World liquid fuels consumption grows by an annual average of 1.3 million barrels per day (bbl/d) in 2012 and 1.5 million bbl/d in 2013. Supply from non-OPEC countries increases by 0.8 million bbl/d in 2012 and 0.9 million bbl/d in 2013. EIA expects that the market will rely on both inventories and increases in production of crude oil and non-crude liquids from OPEC members to meet world demand growth.
  •  There are many significant uncertainties that could push oil prices higher or lower than projected. Should a significant oil supply disruption occur, and OPEC members do not increase production, or projected non-OPEC projects come online more slowly than expected, oil prices could be significantly higher than projected in this Outlook. If the pace of global economic growth fails to accelerate in Organization for Economic Cooperation and Development (OECD) countries, or if economic growth slows in non-OECD countries, reduced demand could result in lower prices
  •  World liquid fuels consumption grew by an estimated 0.8 million bbl/d to 87.9 million bbl/d in 2011. EIA expects that this growth will accelerate over the next two years, with consumption reaching 89.3 million bbl/d in 2012 and 90.7 million bbl/d in 2013. OECD consumption fell by 490 thousand bbl/d in 2011 and is expected to decline again in 2012 as very modest consumption growth in the United States and Japan will be more than offset by a decline in consumption in Europe. Non-OECD countries are expected to account for most of the world's consumption growth over the next two years, with the largest contributions coming from China and the Middle East (World Liquid Fuels Consumption Chart). EIA expects that non-OECD consumption growth will increase from 1.3 million bbl/d in 2011 to 1.5 million bbl/d and 2012, and then slow to 1.3 million bbl/d in 2013.
  •  EIA expects non-OPEC crude oil and liquid fuels production to rise by 770 thousand bbl/d in 2012 and by a further 850 thousand bbl/d in 2013. The largest area of non-OPEC growth will be North America, where production increases by 350 thousand bbl/d and 260 thousand bbl/d in 2012 and 2013, respectively, resulting from continuing growth in production from U.S. onshore shale formations and Canadian oil sands. Other major growth areas include Brazil, where production increases annually by an average of 170 thousand bbl/d over the next two years with increased output from its offshore, pre-salt oil fields, and Kazakhstan, which will commence commercial production in the Kashagan field in 2013, increasing its production annually by an average of 140 thousand bbl/d. Production also increases in Colombia, Norway, and China. Production declines in Russia, Mexico, and the United Kingdom.
  •  EIA expects that OPEC members' crude oil production will continue to rise over the next two years to accommodate increasing world oil consumption. Projected OPEC crude oil production increases by about 250 thousand bbl/d and 520 thousand bbl/d in 2012 and 2013, respectively. OPEC non-crude petroleum liquids (condensates, natural gas liquids, and gas-to-liquids), which are not subject to production targets, increase by 640 thousand bbl/d in 2012 and by 80 thousand bbl/d in 2013. EIA expects that OPEC surplus production capacity will increase from about 2.2 million bbl/d In December 2011 to 3.9 million bbl/d at the end of 2013, as the assumed recovery of Libyan production to pre-disruption levels allows other OPEC producers to scale back production.
  •  EIA estimates that commercial oil inventories held in the OECD ended 2011 at 2.64 billion barrels, equivalent to about 56.8 days of forward-cover (days-of-supply). Although the December 2011 inventory is slightly lower than the 2.66 billion barrel level at the end of December 2010, the days of forward-cover is the highest end-of-year level since 1994 because of a decline in OECD consumption last year. Projected OECD oil inventories decline slightly over the forecast, with OECD inventories falling to 2.59 billion barrels, or 55.5 days of forward cover, at the end of 2013.

The API report showed a surprisingly large draw in a crude oil along with a much larger than expected build in gasoline stocks. The API reported a large draw (of about 4.5 million barrels) in crude oil stocks versus an expectation for a modest build in crude oil inventories as crude oil imports decreased and refinery run rates also increased by 2.0%. The API reported a large build in gasoline stocks and a build in distillate stocks versus an expectation for a modest draw in inventories.

The report is mixed..bullish for crude oil, and bearish for refined products. That said it is difficult to differentiate whether the gains overnight were from the inventory report (I doubt it) or from the firming euro and positives out of Europe (most likely). The market remains hostage to the evolving situation in Europe that has been unfolding once again along with the geopolitics of the mid-east and Nigeria this week as discussed above with inventory data a secondary driver. The API reported a draw of about 4.5 million barrels of crude oil with a 0.4 million barrel build in Cushing and a decline of about 0.2 million barrels in PADD 2 which is neutral for the Brent/WTI spread. On the week gasoline stocks surged by about 4.4 million barrels while distillate fuel stocks increased by about 0.4 million barrels. The EIA data will hit the media airwaves at 10:30 AM EST today. 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. My projections for this week's inventory reports are summarized in the following table. I am expecting a mixed inventory report this week with a modest build in crude oil and gasoline stocks, a seasonal decline in distillate stocks along with a small increase in refinery utilization rates. I am expecting a modest build in gasoline inventories and a seasonal draw in distillate fuel stocks even as winter like weather still did not arrive during the report period in many parts of the US. I am expecting crude oil stocks to increase by about 2.2 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 3.9 million barrels while the overhang versus the five year average for the same week will widen around 10.8 million barrels.

With refinery runs expected to increase by 0.2% I am expecting a build in gasoline stocks. Gasoline stocks are expected to increase by about 0.5 million barrels which would result in the gasoline year over year deficit coming in around 10.2 million barrels while the surplus versus the five year average for the same week will come in around 1.9 million barrels.

Distillate fuel is projected to decrease by 0.9 million barrels on a combination of an increase in export. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year the deficit will likely now be about 19.9 million barrels below last year while the deficit versus the five year average will come in around 0.6 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 for the same week was directionally in sync with the projections for this week. As such if the actual data in line with the projections there will not be a major change in the year over year comparisons. WTI has now breached its intermediate resistance level and is now looking at the $104/bbl level for the next level of resistance. Brent has also continued to rise breaking its resistance level with a path that could possibly take it to the $118/bbl level. I am moving my view back to cautiously bullish. I am still keeping my view at neutral and bias at bearish as once again there is not much supportive indications that Nat Gas is likely to embark on a major short covering rally anytime soon. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off even it gets cold over a major portion of the US and as such for the medium to longer term I am still very skeptical as to whether NG will be able to muster a sustained upside rally over and above a short covering rally.

Currently markets are mostly higher as shown in the following table.

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