The oil complex is continuing its selloff with WTI & Brent now trading at the lower end of the trading range and showing all of the signs that they are breaking down technically and supported by the slowing economy and easing of tensions in the Middle East. The Iranian premium is continuing to recede even though the rhetoric has picked up overnight (coming from Iran). However, the fact that the May 23rd meeting is still to come the likelihood of a supply interruption is very low. In addition the main price driver this week has been a continuation of the weaker than expected macroeconomic data hitting the media airwaves from both the US and Europe in particular.
Much like the US manufacturing data Europe's services and manufacturing output contracted more than expected in April suggesting that the EU region may very well be heading for a double dip recession. The data out of Europe this morning not only declined month on month but the services and manufacturing indices remain below 50 which historically is a sign of contraction. In the US the indices declined but still remain above the 50 level suggesting that there is still a modicum of expansion in this energy sensitive sector.
As I have been discussing for the last month or so the oil demand side of the equation is not going to act as a bullish price support anytime soon. With the global economy continuing to show all of the signs of slowing even further oil demand growth is going to underperform the projections for this year and likely into next year. At the moment there is nothing to indicate that the developed or even the developing world economies are going to turn around in the very short term and experience a sudden growth spurt. Rather the likelihood of a EU recession and ongoing underperformance in the US is a more likely scenario as China and the rest of the emerging market world also continues to slow or flat line at best.
This morning the US nonfarm payroll data will hit the airwaves with many now expecting another underperformance in this important economic indicator for the second month in a row. The consensus is still hovering around the 165.000 to 170,000 with the headline unemployment rate holding steady at 8.2%. As mentioned the vast majority of macroeconomic data this week has been bearish. The market may react interestingly after the data is released.
If the data comes in much better than expected I would expect the market to react positively sending the US dollar lower, equities higher and setting the stage for a short covering rally in oil and most other commodities. If the data is anywhere from 130,000 to the 160,000 than I would expect the global risk asset markets to view the data as a confirmation of the economy slowing and I would expect risk asset values (including oil) to drift lower. Finally if the data is a big miss...something less than 120,000 new jobs created I would expect the QE3 crowd to take control of the market and set the stage for a day of trading where bad economic news may be good news for the market as the sentiment will once again start to view the likelihood of another round of easing increasing.
In any case the oil complex is weak on all fronts...technicals, geopolitics, fundamentals and projected fundaments based on the perception of a slowing economy. From a technical perspective the spot WTI contract will need to hold above the $101 level to remain in the trading range that has been in place since mid March while Brent will have to hold the $115/bbl level. A breach of these levels is a strong sign that oil prices are likely headed back to the levels they were at prior to the announcement of the EU Iranian crude oil purchase embargo on January 23rd. On January 20th WTI was at $98.46 and Brent was at $109.42. These levels are a good possibility especially if progress continues on a diplomatic resolution to the Iranian nuclear situation.
The other factor working in the crude oil market is the slow evolution of the narrowing of the Brent/WTI spread which will continue for the next six to nine months as it works its way back to more normal, historical levels. The reversed Seaway pipeline will start pumping oil out of the mid-west in a few weeks signaling the beginning of the end of the huge surplus of crude oil that has pushed the spread to historically high levels. At the moment the spread has been in a bit of a consolidation mode as it sets up for its next leg down.
Prior to the EU embargo announcement the spot Brent/WTI spread had already retraced to some degree and was trading in a range of about $9 to $11.50/bbl. That was months before the Seaway start-up. Currently Seaway is weeks away and the Geopolitical risk in the Middle East is significantly lower today than it was at the end of last year. Finally the global economic outlook is much more bearish today than it was several months ago. As such I see the spot Brent/WTI spread working its way back the end of last year's trading range levels over the next month or so...barring a collapse in the Iranian/West diplomatic meetings. The spot spread is hovering around a technical support level of around $12.65/bbl. If breached on a close the next stopping point will be late last year's trading range (above).
With most all oil commodities switching their pricing basis to Brent over the last several years the rest of the complex is also in the midst of a spread realignment as Brent/WTI narrows. We have already seen this for the US based Nymex cracks with both the RBOB and HO cracks in decline as Brent has continued to depreciate versus WTI. In this regard I expect both of these crack spreads to continue to recede in line with my view of a narrowing Brent/WTI spread. In addition the revitalization of several Atlantic Basis refineries (Delta deal and the sale of the two PetroPlus refineries) suggest that there will be ample refined product flow especially during the upcoming summer driving season in the US. Finally refiners in the US are ramping up there utilization rates. For example Tesoro announced yesterday they were planning on running their refineries at the 90% level. All signs suggest to me that the crack spreads will narrow over the next month or two.
On the equity front the EMI Global Equity Index (table shown below) has started to give back most of its gains from earlier in the week. The Index is now just higher by 0.2% on the week with the US nonfarm payroll data yet to be released. The year to date gain narrowed back to 9% with Canada once again on the cusp of moving into negative territory for the year as this energy sensitive economy gets hit with falling oil prices. A disappointing number today from the US could easily send the Index back into negative territory for the week and put the downside correction recovery in jeopardy. Equities are a neutral to negative for the oil complex.
I am keeping my view at neutral for oil as WTI remains within my predicted trading range of $101 to $106/bbl. However, I now have one eye toward the cautiously bearish side as a breakdown out of this trading range will clearly point to double digit prices for WTI and possibly even for Brent (further down the road). In addition 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 until the nonfarm payroll data is digested.
I am keeping my view at neutral and keeping my bias also at neutral with an eye toward the upside. The surplus is still building in inventory versus both last year and the five year average and could 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 sell-off Wednesday on news of a major hedge fund closing its shop was a very overdone sell-off but a needed downside correction in the price of Nat. Gas. The strategy of buying dips back to the $2.25 to $2.30/mmbtu support zone turned out to be a good strategy as the market is significantly higher today. The gains have held after the bullish inventory report that reported an injection level a tad lower than expected.
At least for today the recovery rally is now two weeks old and holding. Demand increases due to coal to gas switching have been helping injections to underperform so far this season. However, the market will need to see some significant production cuts in the near future for the rally to continue. As discussed below the overhang in inventory has turned the corner and has been narrowing for the last month or so but the rate of narrowing will have to accelerate significantly to avoid the industry running into infrastructure limitations as storage capacity slowly works its way toward maximum capacity.
Currently markets are lower as shown in the table below.
Dominick A. Chirichella
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