After a few days of short covering the oil complex is starting today's session on the defensive after a bearish API fundamental snapshot along with a weak demand projection by the EIA in their monthly Short Term Energy Outlook report. Oil prices are drifting lower ahead of this morning's EIA oil inventory report. I still view the movement in the oil complex on Monday and Tuesday as mostly driven by short covering after last week's strong declines. The fundamentals are becoming more bearish but the technicals are improving slightly and once again are starting to show the early signs of forming a bottom. All of the commodities in the complex are in a trading range with WTI and Brent currently near the upper end of the range while refined products are in about the middle of the range. The external oil price drivers… equities and the US dollar were both supportive for oil on Tuesday.

The Brent/WTI spread has moved back into a short covering rally after narrowing strongly over the last several weeks. As I have been suggesting in the newsletter I am expecting a build in crude oil stocks at both Cushing and in PADD 2 in this week's EIA report. Yesterday afternoon the API reported an almost 0.9 million barrels build in Cushing and a 2.3 million barrels build in PADD 2 as refinery maintenance season is still evolving while the Pegasus pipeline remains closed. The upside for the May Brent/WTI spread has been capped by the robust production level coming from the North Sea but according to a Bloomberg survey the May production level in the North Sea could be lower by 5% compared to April.

Although I am still of the view that medium term the Brent/WTI spread will narrow and work its way to single digits sometime during the second half of 2013… in the short term we could see further widening of the spread. Currently it looks like the destocking pattern that has been in play in Cushing has reversed and is now setting up for a period of building especially if the Pegasus pipeline remains closed for an extended period of time. In addition if North Sea production does in fact start to decline a bit the spread is going to be supported to the upside. At the moment the spread is in an $11/bbl to $13/bbl trading range and if the aforementioned conditions materialize I would expect the spread to test the upper end of the trading range before resuming another leg to the downside.

Global equities have continued to rally this week as shown in the EMI Global Equity Index table below. The EMI Index is now higher by 1.5 percent for the week with the year to date loss narrowing to 0.2 percent or the best level since mid-March. Canada rallied strongly yesterday and has now moved out of negative territory for 2013. Brazil, Hong Kong and China remain the three bourses still showing losses for the year to date. Japan continues to surge and is now higher by 27.8 percent for 2013 as the weak Yen continues to be the big story for this export driven economy. Equities have been a positive price driver for the oil complex.

The EIA released their Short Term Energy Outlook. They lowered their forecast for oil demand growth as did the IEA last month. Following are the main oil highlights.

EIA estimates that global liquid fuels consumption outpaced production in the first quarter of 2013, resulting in an average draw in global liquid fuel stocks of 1.3 million barrels per day (bbl/d). Projected world liquid fuels consumption grows by an annual average of 1.0 million bbl/d in 2013 and 1.3 million bbl/d in 2014, lower by 140,000 bbl/d in 2013 and 200,000 bbl/d in 2014 compared with last month's STEO. Countries outside the Organization for Economic Cooperation and Development (OECD) drive expected consumption growth. Projected world supply increases by 0.6 million bbl/d in 2013 and 2.1 million bbl/d in 2014, reflecting a 100,000 bbl/d reduction in 2013 and a 40,000 bbl/d increase in 2014 from last month's STEO. Most of the supply growth comes from North America and other countries that are not members of the Organization of the Petroleum Exporting Countries (OPEC).

World liquid fuels consumption grew by 0.7 million bbl/d in 2012 to reach 89.0 million bbl/d. EIA expects growth will be higher in 2013 and 2014 due to a moderate recovery in global economic growth. World consumption reaches 90.0 million bbl/d in 2013 and 91.3 million bbl/d in 2014.

Non-OECD Asia is the leading regional contributor to projected global consumption growth. EIA expects refinery crude oil inputs in China to increase in 2013 as new refining capacity continues to come on line and investment in the property market and infrastructure sectors expands. Recent indicators of weaker industrial data at the beginning of 2013 signal slower growth than in prior years. EIA estimates that liquid fuels consumption in China increased by 380,000 bbl/d in 2012. Projected consumption increases by 450,000 bbl/d in 2013 and by 510,000 bbl/d in 2014. This compares with average annual growth of 540,000 bbl/d from 2004 through 2010.

EIA projects non-OPEC liquids production will increase by 1.1 million bbl/d in 2013 and by another 1.6 million bbl/d in 2014. North America accounts for almost all of the projected growth in non-OPEC supply over the next two years because of continued production growth from U.S. tight oil formations and Canadian oil sands.

OPEC member countries, particularly Saudi Arabia, cut crude oil production heavily in the fourth quarter of 2012. EIA estimates that Saudi Arabia cut crude oil production from an average of 9.9 million bbl/d during the third quarter of 2012 to 9.0 million bbl/d in the first quarter of 2013. • EIA estimates that OPEC surplus capacity, which is concentrated in Saudi Arabia, continued at about 2.8 million bbl/d in the first quarter of 2013, an increase of 0.7 million bbl/d compared with the year-ago level but still 0.2 million bbl/d lower than the previous three-year average.

EIA estimates that OECD commercial oil inventories at the end of 2012 totaled 2.65 billion barrels, equivalent to 57.9 days of supply. Projected OECD oil inventories fall slightly and end 2013 at 2.60 billion barrels (56.2 days of supply). Inventories increase to 2.66 billion barrels (57.8 days of supply) by the end of 2014.

Tuesday's API report was bearish for crude oil and gasoline but supportive for heating oil. There was as surprisingly larger than expected build in crude oil stocks (for the third week in a row) along with a surprise build in gasoline inventories. Total crude oil stocks increased by 5.1 million barrels versus an expectation for a smaller build. Gasoline showed a build in inventory while distillate fuel stocks declined. The API reported a 5.1 million barrel draw in crude oil stocks versus an industry expectation for a modest build of around 1.5 million barrels as crude oil imports increased modestly while refinery run rates also increased by 2.1 percent. The API reported a modest draw in distillate fuel inventories and a build in gasoline stocks.

The API report was mixed with a bearish bias. The entire oil complex is in negative territory so far this morning heading into the EIA oil inventory report to be released at 10:30 AM EST today. The market is usually cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning. The API reported PADD 2 stocks built by around 2.3 million barrels while Cushing stock increased by 0.9 million barrels. On the week gasoline stocks increased by about 2 million barrels while distillate fuel stocks decreased by about 1.3 million barrels.

My projections for this week's inventory report are summarized in the following table. I am expecting a modest build in crude oil inventories, a modest decline in distillate fuel... as the weather was colder than normal over the east coast during the report period... and a draw in gasoline stocks as refinery runs remain at below normal levels during the maintenance season.

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 comparison for crude oil will now show a surplus of 24.9 million barrels while the overhang versus the five year average for the same week will come in around 38.9 million barrels.

I am expecting a modest build in crude oil stocks in Cushing, Ok and in PADD 2 as the Seaway pipeline has been has been running at constrained levels for most of the report period. In addition the shutdown of the Pegasus pipeline will likely impact this week's report as the line was shut on Friday March 29th or the beginning of the period for this week's EIA inventory snapshot. This will be bullish for the Brent/WTI spread and should serve as a catalyst to keep the short covering rally going.

With refinery runs expected to increase by 0.2 percent I am expecting a draw in gasoline stocks. Gasoline stocks are expected to decrease by 1.5 million barrels which would result in the gasoline year over year returning to a surplus of around 1.6 million barrels while the surplus versus the five year average for the same week will come in around 0.1 million barrels.

Distillate fuel is projected to decrease by 1.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 20.4 million barrels below last year while the deficit versus the five year average will come in around 24.1 million barrels.

I am maintaining my view of the entire complex at neutral across the board but with a cautiously bearish bias as inventories are starting to build and jeopardizing the technical bottoms that have been put in place in the complex over the last several weeks. WTI has now breached its range support level as has Brent and refined products. The complex is now showing signs that the next move could be a continuation to the downside.

I am adjusting my view back to neutral for Nat Gas with the caution flag flying for a possibility of a move to the downside if range support is breached. From a technical perspective the market is still in the breakout trading range of $4/$4.02 to $4.16/mmbtu albeit at the lower end of the range. Also the failed attempt to get to the upper end resistance level and failure to solidly breach this level a few times this week raises a big question mark as to the validity of the current up move. The market may have put in a short term top.

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

Dominick A. Chirichella

Follow my intraday comments on Twitter @dacenergy.

View All Market Commentary

*Disclaimer: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.

Copyright CME Group All rights reserved.