The risk asset markets continued to decline with oil making new six month lows and unable to mount any kind of short covering rally let alone form a bottom to the downtrend. WTI has lost 12.9% of its value in the last 12 trading sessions or $13.75/bbl. Brent has dropped $10.15/bbl or 8.5% over the same timeframe. Over the last twelve trading sessions the spot WTI contract has only closed higher on one day. This is a steep and damaging drop in oil prices that will have implications for the foreseeable future. The uptrend that was in place since late last year (mostly geopolitically driven) has been broken and all technical signs point to a sustained downward trend going forward. Certainly we will get a few short covering rallies along the way but barring any major change in the geopolitical landscape oil prices can and most likely will decline further from current levels.

Not only does the technicals point to lower prices but the fundamentals also point lower as supply is currently well supplied and projected to remain well supplied. US crude oil inventories are at the highest level since the 1990's while OECD total oil stocks are currently above the five year average. The Iranian oil embargo has not caused any interruption in global supply as it has turned out to be primarily a logistics exercise with a little help from the Saudi's who have increased production over the last several months.

Oil prices rise for one main reason... the prospects for a shortfall of supply which can be driven by an actual or perceived supply interruption and/or an imbalance caused by a surge or projected surge in oil demand. At the moment neither of these factors exist in the market. The result is a balanced or even oversupplied market. Demand for oil is growing very slowly as a result of a global economy that is going nowhere quick. Europe may not be in a recession based on the so called official definition but a major region of the world that has a growth rate of 0% is in recession in my definition. The other major developed world economy ....the US...is only doing marginally better growing at a rate of maybe 2% three years into a recovery. No matter what happens in Europe or the US over the next six months to a year oil demand in this region of the world is not going to materially change all that much.

In addition the growing cloud of uncertainty surrounding Greece and possibly the other southern EU member countries is not going away anytime soon. If the EU is able to once again kick the can down the road and keep Greece running as part of the EU it will only be a matter of time (months) when it will pop again and cover the market with uncertainly. The EU has not solved any of its problems it has just pushed them further down the road. Now with a change of sentiment coming from Europe toward more social spending and less austerity the solution that the EU leadership thought would eventually solve the problem is looking like it is at the cusp of crumbling. Europe is a mess in my view (excluding Germany) and it will take hard choices like letting Greece exit the EU to truly get this region of the world on the right track. Simply put Europe will not be an oil demand driver rather it will be a bearish driver for oil prices.

The emerging market economies or the main economic and oil growth engines of the world are also in a major slowing pattern that is not going to turn the corner overnight. Eventually it will but the easing policies that are permeating throughout the emerging market world are only in the early stages and will take time to have a major impact on each of the respective economies. Oil demand growth in this region of the world will only grow slowly for at least the next six months to even a year.

Overall I remain cautiously bearish and do expect lower prices down the road. Yes we will get some dead cat bounces but I do not see anything out there at the moment that suggests we are anywhere near a turnaround back to a sustainable uptrend. I also still expect the Brent/WTI spread and all of the other ancillary relationships that have switch over the last few years to now be in the early stages of working their way back to normal. I do not know exactly how long this process is going to take but the process has started. Today the reversed Seaway pipeline will begin pumping oil out of Cushing and into the Gulf coast. This is only the first step in making PADD 2, Cushing and the Gulf Coast one market with crude oil able to flow in both directions based on demand in each region. If I had to point to a timeline I would expect the Brent/WTI spread to be trading at more normal historical relationships some time in the second half of 2013.

Global equity markets continue to lose value as shown in the EMI Global Equity Index table below. The EMI Index has now declined by 4.4% for the week narrowing the year to date gain to just 0.4% or about where the Index was trading at during the first week of January. The Index is on the cusp of giving back all of its 2012 gains. Four of the 10 bourses are in negative territory with China now taking over as the leader in the Index. Global equities are strongly suggesting a period of slow growth at best for the global economy with bouts of panicky trading resulting from the unclear status of Greece and the rest of the southern EU states.
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Wednesday's EIA inventory report was mixed to biased to the bearish side as it showed a modest increase in total stocks, a larger than expected build in crude oil stocks but larger than forecast draws in both gasoline and distillate fuel. Total implied demand increased but distillate demand declined strongly. Refinery utilization rates surged on the week to 88.3% of capacity an increase of 1.9% in refinery run rates which will result in increased supplied of both gasoline and distillate fuel over the next several weeks. The data is summarized in the following table along with a comparison to last year and the five year average for the same week.
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Total commercial stocks of crude oil and refined products increased by 2.9 million barrels after increasing modestly the week before the previous week. The year over year surplus widened to 26.5 million barrels while the surplus versus the five year average for the same week also widened to 35 million barrels. By all measurements total oil supply in the US is still balanced to comfortable irrespective of the evolving geopolitical risk at the moment.

Crude oil inventories increased (by 2.1 million barrels) versus an expectation for a smaller build. Crude oil inventories are now well above the levels they were at during the height of the recession as well as being at the highest level since 1990. With an increase in stocks this week the crude oil inventory status versus last year is now showing a surplus of around 11.3 million barrels while the surplus versus the five year average for the same week came in around 27.3 million barrels. PADD 2 crude oil inventories increased by about 0.3 million barrels while Cushing, Ok crude oil inventories also increased by about 1.0 million barrels on the week.

Crude oil inventories in the mid-west region of the US have been building of late with stocks in Cushing now at the highest level on record. The increase in inventories this week is mostly bullish for the Brent/WTI spread. The spread has continued to widen over the last week on a combination of growing inventories in the mid-west as well as production problems in the North Sea.

Distillate stocks decreased versus an expectation for a small seasonal build. Heating oil/diesel stocks decreased by 1.0 million barrels. The combination of a robust export market and an early start to the planting season pushed distillate implied demand higher on the week. The year over year deficit came in around 23.3 million barrels while the five year average remained in a deficit of about 14.4 million barrels.

Gasoline inventories declined strongly (mostly driven by declines on the West Coast) and greater than the expectations as a result of the industry's transition to summer grade gasoline. Total gasoline stocks decreased by about 2.8 million barrels on the week versus an expectation for a build of about 0.2 million barrels. The deficit versus last year came in at 1.6 million barrels while the deficit versus the five year average for the same week was about 30.4 million barrels.

The following table details the week to week changes for each of the major oil commodities at every level of the supply chain. As shown I have presented a mixed categorization but one that is biased to the bullish side on the week as both gasoline and distillate fuel declined on the week.
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I am keeping my view to cautiously bearish after oil broke down on all fronts last week with a continuation to the downside to open trading for the week. Oil is now solidly below the trading range it has been in for the last month or so and well below several key support areas. WTI is now solidly trading in double digits with Brent currently holding up a tad better.
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I am keeping my view at neutral and keeping my bias also at neutral with an eye toward the upside. The surplus is still building in inventory versus both last year and the five year average and could lead to a premature filling of storage during the current injection season. However, I now believe that we may see other producers starting to signal a cut in production. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.

Nat Gas futures have once again captured the $2.50/mmbtu resistance level and has continued to trade above this level throughout the entire session so far. The Nat Gas market has been pretty well insulated from the global risk aversion that has permeated just about every risk asset market in the world. The main reason why Nat Gas has pretty much ignored the financial turmoil around the world is primarily because Nat Gas did not participate in any of the upside rallies in risk asset markets when the sentiment was a lot more optimistic than it is at the moment.

Also the fact that Nat Gas is principally a US based commodity (minimal impact from international LNG market at this point in time) participants can focus more on the state of the US economy which on a relative basis is one of the few steady performers in the developed world (Germany being one of the others). For example today US industrial production data came in better than expected which is a positive for Nat Gas as it is supportive of industrial consumption of Nat Gas which should result in an increase in Nat Gas demand (over time) and thus help in alleviating the huge overhang of Nat Gas in inventory.

Currently markets are lower as shown in the following table.

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