Europe remains in the headlines but for the first time in a long time the market has been interpreting the comments from a Merkel/Sarkozy meeting as somewhat positive. They both indicated that progress was being made toward the initiative to modify the treaty with an expected signing date of March 1. Not overwhelmingly bullish but certainly the news out of Europe was not bearish...as has been the case for a very long time.

Overnight the economic news out of Asia showed China's trade data experienced a slowing of exports as well as a slowing of imports. Today's trade data was a bit below the consensus. However, the signs that both external and domestic demand may be slowing is supporting the view that the Chinese government is likely to get very aggressive in switching to an accommodative monetary policy. The Asian and in particular China bourses responded with gains in this sector on the potential change in monetary policy with oil prices also gaining ground on this view along with the evolving situation in Iran.

So basically what has evolved over the last twenty four hours is less bad news out of Europe, a growing view that the US economy is progressing...albeit slowly, a view that China is on the cusp of stimulating their economy while switching to an accommodative monetary policy which have all contributed to a modicum of cash being moved back into an assortment of risk asset markets like equities and commodities.

In addition the oil markets are getting a further boost as the war of words or rhetoric continues between Iran and the EU. The latest news coming from the west was the decision by the EU to move up their meeting to finally decide if Europe will embargo purchases of Iranian crude oil. The act of moving the meeting forward suggests to me that Europe has already worked out how they plan to replace the embargoed Iranian oil as well as being convinced that there will not be a major surge in oil prices as a result of their actions. As I have been discussing in this newsletter for well over a week I do not see any shortfall of crude oil coming from an EU embargo of Iran.

I still view it as a logistics exercise as oil that was heading to Europe will head to Asia and oil that was heading to Asia will head to Europe. This rebalancing of the global oil distribution system coupled with additional supply from Saudi Arabia and other GCC members will more than offset any supply problems...especially with 1.6 billion barrels of oil sitting and ready to go from the IEA Strategic Petroleum Reserve.

The action by Europe will definitely be more of an impact on Iran than it will be on the rest of the world. Finally I still do not see a very high likelihood that Iran will attempt to block the Straits of Hormuz. They may have some capability to do it but if they tried they would not be a match to the US and other western Naval and Air Forces in the region. In addition Iran is no position to start a military conflict with the west as their economy is in horrible shape right now and any military action would make things even worse in Iran. Iran continues to negotiate with bluster much as Saddam Hussein did.

On a positive not global equity markets have added to their gains over the last twenty four hours as shown in the EMI Global Equity Index table below. For the first time in awhile all ten bourses in the EMI Index gained ground over the last twenty four hours. The Index added about 0.8% and is now up 1% on the week and 3% year to date. A positive sign but the global equity markets have a lot of ground to make up after last year's huge losses (EMI Index was down 15.2% for 2011). As of today only Japan is still in negative territory for 2012 with Germany taking over the top spot with Brazil a close second so far. Both of these markets were at the bottom of the performance list in 2011 and what we are seeing so far is a lot of short covering and some bottom picking buying coming into the dogs of 2011. Currently the global equity markets are supportive for oil prices as well as the broader commodity complex.
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At the moment oil prices are still 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. The normal weekly reports get underway this afternoon when the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Wednesday morning at 10:30 AM EST.

My projections for this week's inventory reports are summarized in the following table. I am expecting across the board builds in inventory this week with a modest build in crude oil stocks along with an increase in refinery utilization rates. I am expecting a strong build in gasoline inventories and an unseasonably large 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 increase by about 1.0 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 2.4 million barrels while the overhang versus the five year average for the same week will widen around 14 million barrels.
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With refinery runs expected to increase by 0.4% I am expecting a strong build in gasoline stocks. Gasoline stocks are expected to increase by about 1.9 million barrels which would result in the gasoline year over year deficit coming in around 1.1 million barrels while the surplus versus the five year average for the same week will come in around 5.9 million barrels.

Distillate fuel is projected to increase by 1.5 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 19.7 million barrels below last year while the deficit versus the five year average will come in around 1.2 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 somewhat different than the projections for this week. As such if the actual data in line with the projections crude oil will gain ground versus last year while refined products inventories will decline versus the same time last year.
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Today the first round of the three major monthly oil supply & demand forecast reports get underway when the EIA releases their monthly Short Term Energy Outlook report today. As has been the case for months the main item the market will be looking at will be the forecast for global consumption and whether or not the EIA made any downside consumption adjustments since the last report was issued. I think they may lower their demand forecast a tad more based on the slowing we have been seeing in the Chinese economy which has been the main growth engine for oil consumption for years. The IEA will release their report on Jan 18th while the OPEC forecast will come out on the 16th of Jan.

The WTI market remains above support but has been trading in a lower range since peaking last week. I am keeping my view at cautiously bullish but I will keep the caution flag flying expecting the market to 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.

My view of this market has not yet changed as the spot Nymex Nat Gas futures contract remains in its long term downtrend that has been in place since last spring. Until I see prices solidly trading above the down channel upper resistance are of around $3.365/mmbtu I have to assume that the downtrend remains the dominant trend and a trend reversal has not taken place. Trading in the NG market has been light with the aforementioned battle pretty much the main feature in this commodity. From a longer term trend perspective GS lowered it 2012 annualized price forecast for Nat Gas from $3.70/mmbtu to $3.10/mmbtu. If their forecast is correct we will have to see a period of time with Nat Gas trading with a $2/mmbtu handle for the average to work out since the market remains in a longer term contango. Unless we get a very strong cold wave that lasts for an extended period of time I am expecting end of season Nat Gas inventories to end at modestly higher levels than where they ended last year and as such I am expecting the upcoming shoulder season to be ripe for another strong down leg in Nat Gas prices and thus the timeframe we could see a lot of $2 handle trading taking place.

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

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