As has been the case for the last three years or so when it comes to the details of the sovereign debt problem solution it takes a long time to achieve consensus when it moves to the detail level. Along the way the disagreement back and forth among the main leaders has an impact on the direction of risk asset markets. Of late Germany's Merkel and France's Hollande are in disagreement on the timetable for starting joint oversight of Europe's banking sector. Eventually they will come together but as the posturing continues for each part of the so called forward solution the markets interpret it as the deal will fall apart and as such the markets view it as being bearish for equities and commodities.
On top of the concerns over the details of the agreements today business confidence unexpectedly declined in Germany. Not only is Germany the main economic growth engine of the EU it is also the best performing equity market of all of the major country bourses in the world. This week is starting out with the cloud of uncertainty hovering over the major risk asset markets with just about everything in negative territory so far this morning.
At the moment the concerns over reaching a unified detailed argument is outweighing the ongoing geopolitical risk emanating from the middle east as WTI is lower by about 1.2% to start the US trading session. The rhetoric between Iran and the West is ongoing as Iran continues to say it will defend itself if attacked by Israel. In essence the same rhetoric has been hitting the media airwaves for months and I believe the market is starting to accept that the rhetoric may continue but it may not mean that military action is imminent. As I have said repeatedly in this newsletter I think the likelihood of any military intervention by Iran, Israel or the West prior to the US is election is very low. Beyond the election I would expect the risk of military action to increase but then again I would think that Iran might be more motivated to come back to the negotiating table if they felt that military action was more likely... especially if potential military action involved more than Israel. For now the geopolitical risk of a supply disruption from the middle east is on the low side but the risk is still high enough that I see it as acting as a lower end put in the market. Oil prices are not likely to collapse in the near term.
Oil is now lower by about 10% since peaking about a week or so ago. The magnitude of the downturn in WTI is not a surprise and well within what any technical analyst would call a normal downside correction in a longer term uptrend. I have been indicating that oil prices have been overvalued and the movement lower for the crude oil market is a normal reaction to the growing surplus of crude oil in inventory along with the ongoing concerns of the slowing of the global economy which will result in a slowing of global oil consumption. I view the oil complex as currently trying to form a bottoming pattern or consolidation pattern for the near term. Once the complex has established a floor I would then expect the market to move higher as there are still many headwinds ...like all of the stimulus programs around the globe that are supportive of higher oil prices.
The oil complex ended lower across the board as market participants digested the newly announced stimulus programs by the US Fed, Japan, etc. WTI led the complex lower after a surprisingly huge build in crude oil this week. WTI decreased by 6.48% or $6.44/bbl as Brent held up slightly better falling 4.49% of $5.24/bbl. Crude oil stocks in PADD 2 were modestly higher while Cushing was about modestly lower on the week. The Nov Brent/WTI spread narrowed modestly in the week by $1.20/bbl as the normalization process is 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 3.67% or $0.1188/gal on the week even as distillate fuel inventories decreased modestly on the week. Gasoline prices decreased modestly on the week. The Oct Nymex gasoline price decreased by 2.42% or $0.0731/gal this past week.
Nat Gas futures moved back into negative territory for the week after adding values during the previous week. The October Nat Gas futures contract decreased by 1.97% or $0.058/mmbtu on the week and is still trading below the key psychological level of $3.00/mmbtu as the market seems to be settling into trading range of around $2.65 to about $3/mmbtu.
Last Thursday's injection report was a catalyst to reverse the selling of the last few sessions and push futures prices higher for the day. The weekly injection was modestly above the last two weeks... which were impacted by Hurricane Isaac but still below both last year and the five year average. The main price drivers... temperature forecast and coal to Nat Gas switching are still neutral to biased to the bearish side. As we saw this week injections are going to continue to increase and move toward more historically normal levels for the rest of the injection season. The surplus in inventory is also likely to begin to expand once again.
I still view the market as range bound and likely to remain in a trading range of $2.60-$2.65/mmbtu on the lower end to $3-$3.10/mmbtu on the upper end at least through the shoulder season. The additional Nat Gas demand that has materialized from the very hot summer as well as from coal to Nat Gas switching is quickly starting to disappear. As such going forward we can expect to see weekly injections starting to increase and approaching more normal historical levels thus resulting in the surplus in inventory starting to widen once again.
Last week's EIA report was bullish from the perspective that the injection was below both last year and the five year average. However, the 67 Bcf injection was within the expectations and a tad above the market consensus. The net injection of 67 BCF was above my model forecast (65 BCF) this week and within the range of market projections. The inventory surplus narrowed versus both last year and the more normal five year average. The current inventory level has narrowed to 278 BCF above the five year average.
On the financial front equity markets around the world were mostly lower for the week as market participants digested the new solution presented by the ECB and QE3 by the US both of which are viewed as actions that will bolster the global economy. The decrease in equities were mostly a result of a light round of profit taking selling that has extended into today's session so far. Global equity values decreased as shown in the EMI Global Equity Index table below but are still solidly in positive territory for the year.
The EMI Index decreased by 0.8% on the week with the Index now showing a year to date gain of 9.0%. Over the last week the Index decreased in value in most all of bourses with just one bourse remaining 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 what the new rounds of global easing might do to the global economy has moved market participants back into a risk on trading sentiment.
The euro was lower on the week while the US dollar higher. Last week the global equity markets were a neutral price driver for oil and most commodity markets for most of the week's trading sessions.
Oil is slowly starting to become a bit more reasonably valued after about a 10% downside correction (basis WTI). 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 almost solely being driven in the short term by a combination of the outcome of the ECB meeting and the new round of QE along with the growing geopolitical risk in the mid-east on one front. With the bearish current fundamentals driving price from the other end of the spectrum. The bias is to downside in the near term based on the profit taking selling that started on Monday but the market could be starting to form a bottoming pattern.
I am keeping my view at neutral with a bias to the downside as the industry is back to normal operations after Isaac. At current prices the economics now favor coal over Nat Gas and there are no major weather pulls on demand.
Markets are mostly higher lower ahead of the US trading session as shown in the following table.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.
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