Last week was a week that was driven by the potential for stimulus from all corners of the world. First out of the starting gate was the announcement by ECB President Draghi about the details of the new bond buying program. This was followed by the increased likelihood (the view of the market) that the US Fed would embark on a new round of quantitative easing at the September 12/13 FOMC meeting after the weak jobs report on Friday. China's President HU said at the APEC conference that infrastructure development is the key to promoting and achieving sustained and stable growth amid increasing downward risks to the global economy... or in simple words more stimulus.
With the global economy continuing to slow and absent any stimulus there would be downward pressure on just about all risk asst markets including oil. However, the prospects of more stimulus is creating a level of buying enthusiasm in most risk asset markets (led by gold) as more money printing is a signal to the market that the major economies of the world will once again attempt to inflate their way out of the malaise that has settled over the global economy. The markets are one again trading in a perception pattern rather than a current fundamental pattern. The perception that a new round of quantitative easing and stimulus programs will result in the global economy halting the slide and turning the corner back into a growth pattern.
Whether or not that will be the outcome (there are many different opinions floating around the market) for the moment the market is trading as if the new potential rounds of easing will in fact result in growth and an improvement in the bleak jobs picture in the US.
The oil market is juggling the prospects of a decline in demand as a result of the weakening of the global economy... in particular China the main oil demand growth engine of the world... versus how more stimulus would impact demand... if at all. After the dust settles the price of oil will ultimately come down to how global oil demand materializes over the next three to six months. Certainly supply could be impacted over that timeframe as the geopolitical risk in the middle east is still at the highest level it has been at in years... especially related to Iran. I do not think there will be any military action prior to the US election but beyond that it gets a bit riskier. For the time being oil is trying to settle into a trading range with prices currently closer to the higher end of the range and at a level that may not be sustainable in the short term. As I have said repeatedly in the newsletter it is all about the possibility of more easing and stimulus from the major countries of the world.
As I have been suggesting in the report the recovery from the preemptive shut-ins ahead of hurricane Isaac are almost complete. As of yesterday afternoon there is now just 185,592 bpd or 13.4% of GOM crude oil production shut in and just 397 mmcf/d or 8.8% of GOM Nat Gas production shut down. The industry will be at normal operating levels in the next day or so. There are no reports of any major or lasting damage to the energy infrastructure and all of the shutdowns of production, refining, processing and logistics were simply preemptive. At the moment there is nothing in the tropics that is a threat to the energy operations in the Gulf of Mexico or US land for that matter.
I am not sure how much it will matter but there will be a plethora of oil fundamentals reports and data this week. The weekly oil inventory reports will be released on their regular scheduled days with the preemptive shut-ins from Hurricane Isaac still impacting the overall balances but to a lesser extent than in last week's reports. In addition the monthly oil reports will also be released this week. On Tuesday both the EIA and OPEC will release their oil market projections while the IEA report will hit the media airwaves early on Wednesday morning. Market participants will be focused on the supply side of the equation in the weekly oil inventory reports. On the other hand market players will be mostly focused on the projections of demand for the rest of 2012 and 2013 in the three monthly reports. The main question most players will be looking for in the monthly reports is how much will each of the agencies lower their forecast for demand as most of the macroeconomic data over the last month have continued to suggest a further slowing of the global economy.
The oil complex ended the week mostly lower but well off of the lows from earlier in the week as the prospects of more stimulus sent the oil markets into a recovery rally during the second half of the week. RBOB gasoline was the only energy commodity to end the week in positive territory. WTI decreased a tad less than Brent as US crude oil inventories were impacted by the Isaac shut-ins. Crude oil stocks in PADD 2 were marginally lower while Cushing was about unchanged on the week. The October WTI contract decreased by about 0.05% or $0.05/bbl while the October Brent contract ended the week with a decrease of 0.28% or $0.32/bbl. The Oct Brent/WTI spread narrowed by about $0.27/bbl for the week as the normalization process is only slowly proceeding. I still expect the spread to gradually continue to narrow over the next 6 months as the surplus in the US mid-west is starting to recede from a combination of exports of crude oil out of the region through the Seaway pipeline coupled with refinery utilization rates at the highest level in months.
On the distillate fuel front the Nymex Oct HO contract decreased by 0.98% or $0.0313/gal on the week as distillate fuel inventories increased modestly on the week in spite of the refinery interruptions from Isaac. Gasoline prices increased modestly on the week. The Oct Nymex gasoline price increased by 1.57% or $0.0468/gal this past week.
Nat Gas futures continued to lose value with this week's loss gaining a bit of momentum even with the bullish inventory report that was reflected of the shut downs in production ahead of Isaac. The October Nat Gas futures contract decreased by 4.18% or $0.117/mmbtu on the week and is still trading below the key psychological level of $3.00/mmbtu as the market seems to be attempting to settle into a trading range of around $2.65 to about $3/mmbtu.
About 92% of GOM Nat Gas production has already been restarted and it seems that the industry will be fully back to normal in the next day or so. Thus the direction of prices are once again back to being impacted by the normal fundamentals that have been driving Nat Gas prices for the last several months....temperature forecasts and coal to Nat Gas switching. These two factors have been the primary reason why weekly Nat Gas injections have underperformed versus both last year and the five year average for the majority of the injection season so far.
Over the same timeframe last year saw about 400 BCF more gas go into inventory than this year so far even though supply this year is higher than last year. Compared to the five year average for the same timeframe this year about 500 BCF less gas has gone into inventory. The main reason has been the hotter than normal temperatures across major portions of the US during the majority of the summer. In addition for the vast majority of the period of March through today the economics have been favorable for Nat Gas over coal. These two factors have been responsible for demand during the injection season running at levels above both last year and the five year average.
With the market now moving toward fall and the lower demand shoulder season the temperature effect on demand is going to disappear very quickly. As such the only demand driver for Nat Gas will be that from coal to Nat Gas switching. At current prices the economics still remain favorable to coal but if prices move toward the upper end of the trading range the economics would change very quickly. As such Nat Gas prices will be capped on the upside by the potential loss of coal related demand if prices get too high. On the other end of the range the floor is currently being set by the extra demand that is coming from coal to Nat Gas switching. Thus I continue to expect the market to remain range bound for the foreseeable future.
On the financial front equity markets around the world were mostly higher for the week on the back of the growing view that more stimulus and a new solution by the ECB will bolster the global economy. The increase in equities were mostly impacted by the expectation of the new bold action by the ECB and more easing by the US Fed as still being a possibility as discussed above. Global equity values increased as shown in the EMI Global Equity Index table below and are now solidly in positive territory for the year.
The EMI Index increased by 1.4% on the week and is still in positive territory for the year by 5.3%. Over the last week the Index increased in value in most all of bourses with just one bourse still in negative territory for the year... China. Over the last several months the global equity markets have been struggling to stay in positive territory but the perception of more potential global easing has moved market participants back into a risk on trading sentiment.
The euro was higher on the week while the US dollar was lower. Last week the global equity markets were a positive price driver for oil and most commodity markets during the second half of the week.
I still think the oil price is overvalued and toppy at current levels as it approaches a key technical resistance area. WTI is still currently in a $90 to $100/bbl trading range while Brent is in a $110 to $120 trading range. That said prices are being impacted by a combination of last week's inventory report as well as by the outcome of the ECB meeting and the growing view that more stimulus from both China and the US is on the way.
I am keeping my view at neutral as the industry is already almost back to normal operations after Isaac. At current prices the economics still favor Nat Gas but if prices do work their way to the upper end of the trading range utilities could begin to move back to coal.
Markets are mixed as shown in the following table.
Dominick A. Chirichella
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