The battle between those concerned about a slowing of the US/EU/China economies and thus a negative for oil consumption versus those fearful of a supply interruption over the evolving Iranian nuclear situation continued to rage yesterday and into this morning. Yesterday those biased to the supply interruption won the daily battle as oil traded near a one week high. On the other hand concerns over the faltering European economy have the edge so far this morning as oil is now trading in negative territory for the session. Sounds crazy but the markets are still trading from a very short term perspective with the so called risk on, risk off mentality prevailing for all risk asset classes including oil.

You know my view on the Iranian situation...I do not think it will wind up with a military conflict nor will oil supply be interrupted by an embargo of Iranian oil purchases from the EU. It will result in a logistics exercise as the global oil supply system gets rebalanced. However, today an Iranian nuclear scientist was killed by a bomb placed on his car in an attack Iran has already blamed on Israel. So the tensions are increasing but so far it has not resulted in any surge in oil prices. China so far seems to be against the US & EU's strategy of curbing oil sales from Iran as they oppose unilateral sanction. It sounds like the meeting between Geithner and China's leader did not sway China and it also sounds to me that China is likely to be the main recipient of any diverted Iranian oil from Europe. Although the Iranian debacle is not impacting oil prices at the moment this issue will be around for months into the future and will result in a floor in oil prices at a minimum.

On the supply side a short term risk exists from Nigeria where strikes have been evolving over the Nigerian governments decision to remove fuel price subsidies. So far there have been no interruptions in supply. However, the Oil Workers Union says it will decide today whether or not to strike and shut down oil output. This is an issue to watch over the next few days as it could result in a short term supply interruption. So far the market is not reacting to this threat.

Yesterday was another positive day for most global equity markets as shown in the EMI Global Equity table below. The Index gained 0.8% over the last twenty four hours widening the year to date gain to 3.9%. Brazil is now holding the top spot with Germany a close second. The US Dow ...which held the top spot all of last year is now in the middle of the pack. So far this year global equities have been a positive support for oil prices and the broader commodity complex.
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Yesterday afternoon the EIA released their latest monthly Short Term Energy Outlook (STEO) report. Following are the main highlights of the report related to the oil sector. As expected they did lower their estimates for global oil consumption but they also lowered their projections for non-OPEC crude oil supply for 2012.

  •  World oil consumption grew by an estimated 1.0 million bbl/d in 2011 to 88.1 million bbl/d. EIA expects that this growth will accelerate over the next two years, with consumption reaching 89.4 million bbl/d in 2012 and 90.9 million bbl/d in 2013. OECD consumption fell by 420 thousand bbl/d in 2011 and is expected to decline again in 2012 as very modest demand growth in North America will be more than offset by demand decline in Europe. A projected European economic recovery contributes to a small increase in forecast OECD consumption in 2013. Non-OECD countries are expected to account for most of the world's growth over the next two years, with the largest contributions coming from China, the Middle East, and Brazil (World Liquid Fuels Consumption Chart). EIA expects non-OECD consumption growth will slow slightly, from 1.5 million bbl/d in 2011 to 1.4 million bbl/d in 2012 and to 1.3 million bbl/d in 2013.
  •  EIA expects non-OPEC crude oil and liquid fuels production to rise by 910 thousand bbl/d in 2012 and a further 760 thousand bbl/d in 2013. The largest area of non-OPEC growth will be North America, where production increases by 290 thousand bbl/d and 250 thousand bbl/d in 2012 and 2013, respectively, stemming 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 production in the Kashagan field in 2013 and increase production annually by an average of 125 thousand bbl/d. Production also increases in Colombia, Norway, and China. Notable production declines occur in Russia, Mexico, and Sudan 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 90 thousand bbl/d and 590 thousand bbl/d in 2012 and 2013, respectively. OPEC non-crude petroleum liquids, which are not subject to production targets, increase by 410 thousand bbl/d in 2012 and by 250 thousand bbl/d in 2013. EIA expects that OPEC surplus production capacity will increase from about 2.3 million bbl/d at the end of 2011 to 3.7 million bbl/d at the end of 2013, in part due to the assumed recovery of Libyan production to pre-disruption levels over the forecast period.
  •  EIA estimates that commercial oil inventories held in the OECD ended 2011 at 2.64 billion barrels, equivalent to about 56.4 days of forward-cover (days-of-supply), which is the highest end-of-year level in terms of forward-cover since 1994. Projected OECD oil inventories decline slightly over the forecast, with days of forward-cover falling from current levels to 54.9 days at the end of 2013.

The API showed across the board builds. The API reported a small build in crude oil stocks versus an expectation for a larger build in crude oil inventories of about 0.4 million barrels as crude oil imports increased and refinery run rates also increased by 1.1%. The API reported a large build in gasoline stocks and within the expectations and a smaller than expected build in distillate fuel inventories.

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 build of about 0.4 million barrels of crude oil with a 0.8 million barrel draw in Cushing and a draw of about 0.2 million barrels in PADD 2 which is negative for the Brent/WTI spread. On the week gasoline stocks increased by about 1.9 million barrels while distillate fuel stocks increased by about 0.8 million barrels. The more widely watched EIA data will be released this morning at 10:30 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.
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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.

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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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.

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

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