The oil complex is drifting lower after a modestly lower session on Monday. With the geopolitical risk in the Middle East easing over the last few weeks the main price drivers for the oil complex have been the state of the global economy which by most measures is still slowing along with a major realignment of the Brent/WTI spread and all of the oil commodities that are indexed to Brent in particular. Oil prices have been in decline since peaking in early March. Since then the spot WTI contract is down by about $6/bbl while the spot Brent futures contract is lower by about $10/bbl. With less attention being placed on the possibility of a military intervention in the Middle East as sanctions and diplomacy play out market participants have been forced to focus most of their attention on the daily outlook of the global economy via the plethora of macroeconomic data that is released each day. The vast majority of the data has pointed to a slowly growing global economy for the foreseeable future including China which is the main oil demand growth engine in the world.

The current fundamentals are still relatively balanced with oversupply in some areas of the world. Global demand is growing slowly but since late last year the majority of the price move in oil has not been driven by current or even projected demand rather it has been driven by the perception that a supply shortfall or interruption was imminent as the tensions between Iran, Israel and the West continued to heat up. As the market becomes more confident that supply will not be interrupted the attention will be shifted to the demand side of the equation which at the moment is not very robust. As long as the potential for a supply disruption continues to recede the current demand pattern is not strong enough to result in a surge in oil prices anytime soon. In fact the demand pattern is such that barring a flaring up of the geopolitical risk it should result in oil prices continuing to slowly drift lower as the rest of the Iranian risk premium is removed from the price of oil.

That all said some analysts (most recently the global head of research at Societe Generale) are still viewing the possibility of a release of oil from the IEA Strategic sometime in June to coincide with the official implementation of the EU Iranian crude oil purchase embargo. The embargo was announced on January 23rd and has been in the process of a slow implementation to allow all EU member countries to ease into a replacement for the Iranian oil they were using in their individual systems. As mentioned the other day this process has proceeded so well the EU has postponed a review of the economic impact of the transition away from Iranian oil on the EU economy.

All signs suggest to me that this has been a very successful logistics transition with oil added into the system from Saudi Arabia. There is no shortage of oil in the world today and there will not likely be a shortage of oil anytime soon associated with the Iranian embargo. Unfortunately it is an election year in the several consuming countries and high gasoline prices is a negative for the incumbent leader. With Sarkozy's potential for reelection fading fast that leaves President Obama as someone that may likely push hard for a release of the oil from the SPR. I still think this is a waste of oil into a market that does not need the oil and as such is can only be categorized as an Oil for Votes program if it occurs and not a strategic release to solve a supply problem...as there is no shortage or supply problem.

In addition to the oil complex drifting lower so far this week the global equity markets have also started the week with mostly selling as shown in the EMI Global Equity Index table below. Over the last twenty four hours the EMI Index is lower by 1.6% for the week narrowing the year to data gain to the lowest level of the year at 7.8%. The global bourses that make up the EMI Index have now given back about 50% of the gains for the year. The Index is now back to the level it was at in the third week of January. Slow economic growth and the potential that the global economy will continue in this pattern for the foreseeable future is impacting the overall market sentiment and offsetting any positives that could be derived from a decent corporate earnings season so far. Equity markets are a decent leading indicator of the global economy and the value of most of the bourses in the Index are suggesting that economic issues are still on the horizon. In fact the Paris CAC 40 Index has now gone negative for the year with Canada very close behind. For the moment the global equity markets are a bearish price driver for the oil complex.
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This week's oil inventory reports will be released on their normal schedule. The API data will be released on Tuesday afternoon while the EIA data will hit the media airwaves at 10:30 AM EST on Wednesday. At the moment oil prices are still being mostly driven by the direction of the euro and the US dollar as well as by a view that China's economy is continuing to slow. The tensions evolving in the Middle East between Iran and the West have been easing as another meeting is scheduled for May. As such we may see more market participants starting to pay attention to this week's round of oil inventory data suggesting that this week's oil inventory reports could also start to impact price direction. This week's oil inventory report could move to being a primary price driver especially 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 am expecting a mixed inventory report this week with a modest build in crude oil, a small decline in gasoline inventories and a modest decline in distillate fuel stocks along with a small increase in refinery utilization rates. I am expecting a draw in gasoline inventories and a build in distillate fuel stocks as the summer planting season is still in play (increasing the demand for diesel fuel) while the heating oil demand is dissipating. I am expecting crude oil stocks to increase by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 13.6 million barrels while the overhang versus the five year average for the same week will widen to around 23.7 million barrels.
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Even with refinery runs expected to increase by 0.2% I am expecting a modest draw in gasoline stocks. Gasoline stocks are expected to decrease by about 0.8 million barrels which would result in the gasoline year over year surplus coming in around 5.1 million barrels while the deficit versus the five year average for the same week will come in around 21.5 million barrels.
Distillate fuel is projected to increase by 0.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 18.9 million barrels below last year while the deficit versus the five year average will come in around 2.8 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 inventories declined across the board. As such if the actual data is in line with the projections there will be a modest change in the year over year comparisons for most of the complex.
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I am keeping my view at neutral for oil as WTI remains within my predicted trading range of $102 to $107/bbl. At the moment the oil complex is still going through a spread realignment driven by a reduction in the tensions in the Middle East and thus a receding of the Iranian risk premium along with a sentiment swing in the Brent/WTI spread due to the early start of the Seaway pipeline. I am more comfortable staying on the sidelines today for the flat price market.
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I am now moving my view back to neutral but keeping my bias at bearish. The surplus is still building in inventory versus both last year and the five year average is going to lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.

The pattern of early week short covering is continuing for yet another week. This pattern has been in place for the last several weeks with selling generally coming in during the second half of the week. This week I expect to see a more seasonal injection level in inventory (see below for more details). One of the catalysts for today's short covering rally were statements by Conoco Phillips in their earnings report indicating that half of its first quarter drop in US Nat Gas production was due to curtailments. In addition they are continuing to evaluate further production cutbacks. They said that their Nat Gas production in the second quarter will definitely drop versus the first quarter.

As I have been indicating for months the only solution to the oversupply problem that has plagued Nat Gas prices for several years is a significant production cut. Conoco's comments today were definitely a sign that other producers are likely going through the exact same calculations as Conoco and are likely to come to the same conclusions as Conoco and start (if they have not already started ) to curtail production during the second quarter. I know one company does not make a trend but in my many years of experience in the oil and Nat Gas sector generally tells me is that most companies in this sector tend to act similarly. As such I would say that Conoco's comments are a early warning signal that raises the yellow caution flag in my view.

I still do not think that we have bottomed but Conoco's comments suggest to me that we may be closer to forming a bottom than I thought just last week. I certainly will be looking very closely for more announcements similar to Conoco's and if they come (which I believe they eventually will) the bottom will quickly follow. I am now moving my view back to neutral but keeping my bias at bearish. This goes with my comments from last week that I have been seeing more indications of traders & investors looking for buying opportunities and sellers starting to lose some of their strong selling conviction. I believe the tide is changing and a few more announcements like Conoco's will certainly bolster the resolve of the bottom pickers who have been trolling this market for months.

Currently markets are mostly lower as shown in the table below.
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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.