Yesterday's activity in the oil complex was all about the growing concern over the evolving situation between Israel and Hamas. The market has not overreacted to the situation as there is no shortage of oil anyplace in the world and the area of the Middle East under question is not the oil producing region of the Middle East. Thus at the moment there is no imminent threat for an interruption in the supply of oil. The market has built about a $3 to $5/bbl risk premium into the price of oil since the fighting began last week. That said there seems to be a effort underway from the international community... including the US to work a cease fire out. Secretary of State Clinton is on her way to the region to meet with the various players in the conflict as well as some of those trying to broker a deal between both sides.

Today Israel postponed a decision to launch a ground offensive into the Gaza Strip to give international negotiators a chance to put together a cease fire. The Israeli Prime Minister said he prefers a diplomatic solution. I believe with all of the effort currently taking place from the UN, US, European and Middle Eastern diplomats the likelihood of some sort of a cease fire and subsequent negotiated solution is increasing. So far in overnight oil trading the price of both Brent and WTI have stop rising and have in fact eased marginally as some market participants are starting to view a diplomatic solution may be possible in the short term. If it is accomplished the price of oil will likely fall quickly and pretty strongly shedding a major portion of the risk premium built into the price over the last week or so.

Absent the geopolitical risk of the current Middle East flare-up most all of the other normal oil price drivers are biased to the bearish side. The current fundamentals are well supplied while the global economy is continuing to falter with no signs that a reversal is imminent. As I detailed in yesterday's newsletter the short term direction of oil prices is primarily being driven by geopolitics and will be under that influence (in either direction) for the short term.

In Europe the EU Finance Ministers are meeting once again to discuss Greece's financial situation in Brussels. The Ministers will also be discussing Spain. The market is looking for any signs that the EU will be able to solve this four year old problem once and for all. The issue on Greece is trying to find a way to discuss a $19 billion dollar gap in Greece's public accounts. Last week EU leaders granted Greece two more years to cut its budget deficit. Greece and the rest of the EU nations engulfed with sovereign debt problems has been lingering issue for years and is likely to be a cloud over the EU economy for the foreseeable future. The EU is now officially in a recession and will likely remain in that state for several quarters to come. Thus oil demand will likely continue to also falter from this region.

In Asia just a reminder that the so call main global economic growth engine...China is also still struggling... direct foreign investment in China declined 0.2% in October compared to a year earlier for the 11th decline in the last 12 months. The Chinese economy is only slowly growing as its two main export regions of the world... Europe and the US are also struggling economically.

Global equities rebounded about 1% over the last twenty four hours as shown in the EMI Global Equity Index table below. The Index has now recovered all of last week's losses primarily on a strong short covering rally in the US, Canada and Brazil. The year to data gain for the Index widened to 4.3% with only two bourses still in negative territory for the year... China and Brazil. The German bourse is now back to showing a gain of over 20% for 2012 while Hong Kong is in second place with a 15.2% gain for the year. So far this week the global equity markets have been a positive price driver for oil as well as the broader commodity complex.

The weekly oil inventory cycle will follow its normal schedule this week. The weekly oil inventory cycle will begin with the release of the API inventory report on Tuesday afternoon and with the more widely followed EIA oil inventory report being released Wednesday morning at 10:30 AM EST. With geopolitics the main oil price driver and the global economy and oil fundamentals a close second this week's oil inventory report may not be much of a price catalyst especially if the actual outcome is within the range of the industry projections.

My projections for this week's inventory report are summarized in the following table. I am expecting the US refining sector to increase marginally as the refining sector continues to return to normal from the recent storm on the east coast. I am expecting a modest build in crude oil inventories, a build in gasoline and another draw in distillate fuel stocks as the weather was colder than normal over the east coast during the report period. I am expecting crude oil stocks to increase by about 1.2 million barrels. If the actual numbers are in sync with my projections the year over year comparison for crude oil will now show a surplus of 46.3 million barrels while the overhang versus the five year average for the same week will come in around 44.8 million barrels.

I am expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is still pumping and refinery run rates are continuing at high levels in that region of the US. This would normally be bearish for the Brent/WTI spread in the short term but the spread is currently trading at a relatively high premium to Brent but off of the highs hit about a week or so ago. The slow return from maintenance in the North Sea as well as the evolving situation in the Middle East have been the main drivers that have resulted in the Jan Brent/WTI spread still trading close to the $23/bbl level as of this writing. The widening of the spread should begin to ease once the North Sea returns to a more normal production level and the situation in the Middle East quiets down.

With refinery runs expected to increase by 0.2% I am expecting a build in gasoline stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 6.7 million barrels while the deficit versus the five year average for the same week will come in around 2.1 million barrels.

Distillate fuel is projected to decrease by 0.8 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 18.2 million barrels below last year while the deficit versus the five year average will come in around 28.4 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 this week's projections (except for crude oil). As such if the actual data is in line with the projections there will be a modest change in the year over year inventory comparisons for crude oil.

I am keeping my view at neutral with a bias to the bullish side for today primarily due to the evolving geopolitical situation in the Middle East. At the moment there is no shortage of oil anyplace in the world but the market is slowly building a risk premium into the price of oil in anticipation of a spreading of the fighting taking place between Israel and Hamas as well as the civil war in Syria.

The geopolitical risk is currently the only bullish price driver for oil as the current fundamentals as well as the slowing of the global economy are both bearish price drivers for oil. In the short term the price of oil will move based on the evolution of the situation in the Middle East. This is an event driven move in the price of oil at the moment. BE CAUTIOUS as many diplomats are trying to broker a cease fire. If successful we will see a sudden drop in oil prices.

I am keeping my Nat Gas price view at neutral as the fundamentals and technicals are once again keeping suggesting that the market may have topped out for the short term. I anticipate that the market will remain in a trading range until it becomes clearer as to how the heating season will evolve.

Markets are mixed into the US trading session as shown in the following table.

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


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