The oil market is following the downward pattern established last week as market participants continue to be concerned over the slowing of the global economy and thus a potential decline in oil demand growth going forward. Most of the macroeconomic data over the last month or so have indicated that many of the high growth economies of the world are finally starting to slow. Chinese data along with actions by the government are clearly pointing to a slowing of the main economic and oil demand growth engine of the world. The combination of oil demand potentially slowing coupled with the ongoing success of US supply is resulting in the global oil balances likely to remain biased to the oversupply side of the equation for the medium term.
However, in the short term there are significant oil production shortfalls in several key areas of the world… Iraq, Sudan, Libya, Nigeria with the North Sea undergoing maintenance. At the moment the supply issues are acting as a floor in the market keeping prices relatively bid even with clear signs that demand is likely to slow further from current levels. In essence there is a mixed picture with the short term looking biased to the undersupplied side of the equation as we have seen by the significant reductions in US inventories over the last month or so. That said the medium term is looking more biased to the oversupplied side as demand is expected to falter as several of the aforementioned production issue are likely to be cleared going forward.
Oil prices declined last week for the first week in about a month with modest declines so far this week. However, the decline of about $5/bbl or so in the spot WTI contract over the last week is still less than half of the almost $13/bbl gain since bottoming during the third week of June. From a technical perspective the market formation is one of a pattern that has peaked with the short term tend pointing lower. However, I do not think there is enough downside momentum to push prices significantly lower over the short term. The oil complex seems to be trying to form a trading range for prices to settle into until the uncertainty as to supply and demand are more clearly established.
The spot Brent/WTI spread has continued to make a strong recovery as it approaches the next technical resistance level of around the $3.50/bbl level. With WTI leading the oil complex lower (after acting as the main upside leader during the late June rally) the Brent contract has moved into a following mode during the latest down move with Brent losses lagging WTI. The result has been a widening of the spread after hitting parity early last week. Much as the strong narrowing move that occurred during the previous two weeks is now resulting in a strong recovery since early last week. The market is reacting to a loss of production in the North Sea due to maintenance as well as the shortfalls occurring from the aforementioned oil producing regions around the world even as Cushing remain in a destocking pattern.
The short term direction of the spread is still in a widening pattern or what I still view as a short covering rally within a broader longer term narrowing trend that has been in play since early February of this year. With Cushing stocks likely to show another strong decline and maintain the destocking pattern currently in play and with European oil demand weak at best there will be a limited move to the upside before the spread starts to top out once again. As I have previously mentioned the widening of the spread is an opportunity to layer in new shorts once this current move has topped out.
Global equities were mostly higher over the last twenty four hours with Japan increasing strongly. The EMI Index is slightly higher for the week so far with the year to date loss sitting at 3.2 percent. The QE supported country bourses remain the high flyers in the Index as the developing world bourses continue to lag behind. Global equities have been a neutral price catalyst for the oil complex and broader commodity complex so far this week as is the direction of the US dollar at the moment.
This week's round of oil inventory reports will follow its normal schedule with the API data being released on Tuesday afternoon followed by the EIA report hitting the media airwaves at 10:30 am on Wednesday. My projections for this week's inventory report are summarized in the following table. I am expecting another modest draw in crude oil inventories with a build in both gasoline and distillate fuel stocks.
I am expecting crude oil stocks to decrease by about 2 million barrels. If the actual numbers are in sync with my projections the year over year comparison for crude oil will now show a deficit of 11.4 million barrels while the overhang versus the five year average for the same week will come in around 15.9 million barrels.
I am expecting crude oil stocks in Cushing, Ok to decrease this week and continue its destocking trend. This will be bearish for the Brent/WTI spread as the fundamentals are in play and are driving the spread (see above for a more detailed discussion).
With refinery runs expected to increase by 0.2 percent I am still expecting a draw in gasoline stocks. Gasoline stocks are expected to decrease by 0.5 million barrels which would result in the gasoline year over year surplus of around 14.3 million barrels while the surplus versus the five year average for the same week will come in around 8.2 million barrels.
Distillate fuel is projected to increase by 1 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 3.2 million barrels above last year while the deficit versus the five year average will come in around 19.8 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's inventories are mostly in directional sync with some differences compared to last year's changes. As such if the actual data is in line with the projections there will be modest changes in the year over year inventory comparisons for most everything in the complex.
I am maintaining my view at neutral with a bias at cautiously bearish for the short term as the downside correction may continue this week. I am continuing to fly the caution flag that the current round of profit taking selling could continue for a few more days.
I am maintaining my Nat Gas view and bias at cautiously bearish on a less supportive short term temperature forecast. The fundamental picture is beginning to shift as the temperatures across the US do not appear to be moving back to warmer than normal weather anytime soon.
Markets are mostly lower heading into the US trading session as shown in the following table.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.
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