Note: Today at around 2 PM EST I will be appearing on the Fox Business TV station to talk oil.
Dominick

Quote of the Day
The best way to predict the future is to invent it.
Alan Kay
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Oil prices continue to march higher as the fighting in Libya intensified with the opposition group still maintaining control over a major portion of Libya. Forces aligned with Gaddafi have been staging various counter offenses which include air attacks against a ground based only opposition group. As I have been discussing for the last few weeks the situation looks like it will last for an extended period of time as it is showing all of the signs of a full blown civil war. Oil flow will remain suppressed from Libya for an indefinite timeframe to be determined by when the situation returns to a level of stability so that oil workers will return to the jobs. The situation in Libya looks a lot like what has occurred in Nigeria insofar as the international oil companies pulling their workers over safety and security concerns which means they are ready to sit this one out for a long time.

The shut-in of oil production in Libya is estimated (by the IEA) to be around 1 million bpd level which is likely to grow if the fighting intensifies even further from its current level. This is not a huge amount of oil that is being left behind but it is a clear indication that these types of events in the richest oil region of the world can cause much larger disruptions that will be much more difficult to overcome than losing just Libyan production for a period of time. The shut in of Libyan crude oil is not causing any major supply shortages around the world rather it is causing a logistics problem in getting the right quality crude oil to refiners that require Libyan quality oil (light low sulfur crude oil ). The Saudi's have increased production already and should provide enough of a cushion to result in solving the aforementioned logistics issues. However, the market is reacting more and more like it has already begun to price in disruptions in oil supplies from other North African and Middle Eastern countries. The big event many are focused on is what will happen on March 11th and March 20th when day of rage protests have been declared for Saudi Arabia...a country that does not permit protests.

The price of oil is now carrying a risk premium of around $20/bbl which is not likely to go away anytime soon. The market just does not know how the whole freedom protests will play out in the Middle East and what impact it could eventually have on global oil supply. There is a substantial amount of oil at risk at the moment including just about all of the available surplus capacity of crude oil which resides in Saudi Arabia. The modest overhang of global inventories coupled with the vast amount of oil in the IEA strategic petroleum reserves can offset a loss of a substantial amount of oil production for a relatively long period of time. However, if commercial and strategic inventories have to be drawn down to offset a significant reduction in oil production due to the protests the price of oil will soar to levels that would make the current price look relatively cheap. Needless to say it would be a huge negative impact on the global economy in both the developed and emerging market world. The worst case scenarios could easily put the world back into a deep recession.

For the moment the world is coping with higher oil prices but for how long will it be before the macroeconomic data starts to turn. The latest round of economic data from the around the world (including Friday's mildly positive US nonfarm payroll numbers) has been relatively positive but remember that all of the data that has been released of late is reflective of oil prices that were about $20 to $25/bbl lower than where they are now. The higher oil prices will start to be reflected in February's data and most certainly in the data for March. In addition the first quarter corporate earning reports will also reflect a higher oil price environment. Global equity markets are only just beginning to reflect a more negative impact from oil prices. In addition to the oil price surge negatively impacting equity markets today Moody's downgraded Greece's debt three notches putting Greek bonds further into junk status. Just when the world thought all they had to worry about was oil prices they are reminded that the sovereign debt issues in Europe are still not yet a thing of the past. With a higher oil price environment the debt problems in Europe may move back into center stage more quickly...especially if inflation becomes a big enough issue that the EU begins to raise short term interest rates as it indicated it might after last week's ECB meeting.

Most risk asset markets were mixed last week as the situation in Libya played out. Oil added strongly to its risk premium while financial markets were mixed on the week even after a mild recovery earlier in the week. Precious metals held higher and continued to be viewed as safe haven instruments during the current crisis. Over the last week the oil complex surged with both WTI and Brent ending the week with a gain. Brent continued to trade above the $115/bbl mark for the spot April contract. The April Brent contract ended the week with a gain of 3.7% or $4.17/bbl. WTI settled above the $104/bbl mark surging much more strongly than Brent for the week gaining $7.45/bbl or 7.68%. WTI made up some of it losses versus Brent even though both PADD 2 and Cushing, OK stocks increased strongly this past week. I believe there was as lot of short covering of the Brent/WTI spread after it hit a record high level of around $16/bbl premium over WTI coupled with the ECB signaling that they may raise interest rates as early as April which could slow the EU economy down and thus demand for Brent related crude oils.
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On the distillate fuel front the Nymex HO contract increased modestly with both diesel fuel and heating oil inventories falling on the week. The benchmark Nymex HO contract increased by 5.12% or $0.1504/gal. Gasoline prices gained ground on the week as gasoline stocks declined strongly for the second week in a row versus expectations for a build. The April Nymex gasoline price increased by 5.31% or $0.1537/gal this past week but noticeably below the gains in WTI resulting in a decline in refinery margin of around 4% on the week.

Since it is hitting the media airwaves 24/7 retail gasoline prices have continued to surge. In fact in the US retail gasoline prices have increased by the second largest amount over the last two weeks. As shown in the following table the average retail gasoline price across the US has increased by about $0.38/gal compared to a month ago resulting in the US consumer spending about $229 million dollars more per day to fill their tanks than just a month ago. Better said this is discretionary income that is not flowing into other good and service that is needed to keep the US economic recovery in tact.
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Nat Gas traded in a tight range on Friday and mostly in positive territory...albeit only marginally so. I view Friday's move so far as nothing other than a modest level of short covering ahead of the weekend. The short term weather forecasts are still calling for a modicum of cool weather but certainly nothing like what was experienced earlier in the winter. As such any periods of colder than normal temperatures during the month of March are not going to result in any major net withdrawals from inventory and nothing like the level of withdrawals seen in January and February. In addition we are now less than three weeks away from the start of spring when temperatures will continue to moderate with the daily lows rising as well as the highs.

On the week Nat Gas decreased by 5.65% or $0.228/mmbtu offsetting the previous week's modest increase. As has been the case more often than not Nat Gas prices are trading in a tight trading range irrespective as to what has been going on with the weather around the country. Based on the current forecast we can expect to see only normal withdrawals from inventory and possibly a few weeks of below above normal withdrawals for the rest of the winter heating season (ends March 31st). With 3 weeks left to the official winter heating season the return to milder winter weather and the fact that supply is still very robust significantly reduces investor/traders enthusiasm in buying the market in the short to medium term.

On the financial front equity markets around the world were mixed as the situation in North Africa and the greater Middle East deteriorated throughout the week. Global equity values went back on the defensive as shown in the EMI Global Equity Index table below. The EMI Index lost 0.6% on the week after no gain the previous week. The EMI Index is now still higher by 1.2% for the year with Brazil still the only bourse in negative territory contributing to bringing the entire Index lower. Even China was able to gain ground on the week as investor/traders are starting to view China's inflation fighting efforts as something that may help not only stabilize this surging economy but keep it on track as a major player in global economic recovery. Last week the global equity markets were a negative for oil prices as well as the broader commodity complex but it did not matter much as geopolitics remain the main price driver for oil.
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The US dollar index was marginally lower as cash moved into other safe haven instruments like precious metals. The euro gained ground on the week as the ECB signaled a possible increase in interest rates in April. The direction of currency markets was a positive for oil prices as well as the broader commodity complex last week. The global currency markets continue to be in a broad trading range which is likely to continue in the short term. Cash continued to flow into gold which increased by 1.33% on the week.

My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view to be in sync with my bullish bias for all of the reasons I have been discussing over the last week. But again I raise the caution flag that prices are still overdone and susceptible to a correction. Any event can trigger a sudden change in the direction of prices. Be cautious and use tight, trailing stops in your short term trading book. This week is likely to continue to be all about the evolving situation in North Africa and the Middle s East especially Saudi Arabia on Friday a so called for day of rage protest.

I am maintaining my Nat Gas view at neutral but moved my bias back to cautiously bearish even though I still think the Nat Gas market is still range bound but now that the market has breached another key technical support level it is likely to continue to drift lower in the short term.

Currently oil markets are higher as shown in the EMI Price Board table below.
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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com