2012 started with geopolitics taking center stage insofar as oil prices were concerned while decent manufacturing data out of China, Germany and the US (which expanded at the fastest pace in about six months) helped propel equity and other commodity prices. In addition with Europe not in the foreground yesterday was clearly a risk on trading session. Whether yesterday was mostly short covering or new longs coming into the markets is still not known. We will have to see if we get follow through in all of the main risk markets to start to view the start of 2012 as the beginning of a new uptrend pattern.

Oil prices surged first and foremost over the rhetoric that has been coming from Iran which started over the weekend during their military exercises in the Persian Gulf culminating with Iran warning the US to not bring its aircraft carrier back into the Gulf (which was moved to the Sea of Oman during the exercises). The US responded by simply saying they will continue to provide security in the region or in my words they are definitely coming back into the Persian Gulf. There is certainly reason to be concerned over the growing tensions between Iran and the west and that is why we have seen the risk premium growing in the price of both WTI & Brent over the last few days.

However, I view the situation as Iran negotiating with bluster much like Saddam Hussein did prior to the final engagement in Iraq. Iran is starting to get more and more concerned over the sanctions that are being imposed with the latest coming from the US targeting the Iranian Central Bank. In addition I think they are sending a message to the Europeans to try to discourage them from embargoing European oil purchases of Iranian crude oil when the EU meets on Jan 30th. I think the likelihood for an all out military conflict at this stage of the game is very low. I do expect Iran to try to save face and restart the negotiations (which they called for over the weekend) to try to prolong the situation as they have done for the last four or five years. That all said we will now have a risk premium in the price of oil and all of the 30 second news snippets coming from the region will act as short term price drivers for at least the first quarter of this year.

On a more positive note the macroeconomic data to start 2012 has been better than expected (so far) and has resulted in a modest short covering/new risk on rally. A lot more important data will be emerging over the next several weeks to allow the market to evaluate whether the probability of Europe and US heading back into recession is increasing or decreasing and whether or not China is likely to start to expand once again. If the latter part of last year was a guide the macroeconomic data has been improving and mostly beating the expectations for the US and to a lesser extent for Europe. China has been showing signs that the government will be embarking on a more accommodative monetary policy to foster expansion in 2012 as they remain concerned over the falling level of exports to Europe and to a lesser extent the US...their two largest customers. The big data point this week will come on Friday when the widely watched US nonfarm payroll number and unemployment rate are released. The early consensus is calling for a net gain of about 150,000 new jobs and small bump to 8.7% in the headline unemployment rate. Finally for what it is worth Europe has not been a dominant negative so far this year...but it is still early in the year.

The global equity markets have benefited by the combination of a short covering rally and a modest level of risk on trading taking place over the last twenty four hours. After declining by 15.2% for 2011 the EMI Global Equity Index (table shown below) is starting 2012 with a 3% gain. Although it is very early in the year the US is not in the top spot (for the first time in about a year) with Brazil and Germany holding the top for the moment. I view the gains in Germany, Brazil and few other places as much more a result of short covering and thus the big moves while I look at the US gain as being more in line with risk on trading and to a lesser extent short covering. At least for the moment the global equity markets have been supportive for oil prices as well as the broader commodity complex.
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At the moment oil prices are being mostly driven by the tensions building in the Middle East between Iran and the West (as discussed above) coupled with the direction of the euro and the US dollar. As such I am not sure many market participants are going to pay much attention to this week's round of oil inventory data suggesting that this week's oil inventory reports may not have a major impact on price direction. At the moment all market participants are continuing to follow the new snippets out of the Middle East and the tick by tick direction of equities and the US dollar (driven by Europe)... as they are both the primary price drivers for oil. Even with the fundamentals and geopolitics starting to impact price it is the macro trade that dominates at the moment. As such this week's oil inventory report could remain a secondary price driver at best and only impact price direction if the actual EIA data is noticeably outside of the range of market expectations for the report. The normal weekly reports get underway this afternoon when the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Thursday morning at 11 AM EST.

My projections for this week's inventory reports are summarized in the following table. I do want to caution that there could be surprises in the data as the industry adjusts their inventory levels to meet whatever their LIFO accounting objectives turned out to be for 2011. We have seen some of this already over the last several weeks. I am expecting mixed inventory data with a small increase in refinery utilization rates which should result in a neutral weekly fundamental snapshot. I am expecting a modest draw in crude oil stocks with an increase in refinery utilization rates. I am expecting a modest build in gasoline inventories and only a small build in distillate fuel stocks as winter like weather did not arrive during the report period in most parts of the US...especially the large HO market along the north east. I am expecting crude oil stocks to decrease by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 13.2 million barrels while the overhang versus the five year average for the same week will come in around 4.2 million barrels.
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With refinery runs expected to increase by 0.3% I am expecting a modest build in gasoline stocks. Gasoline stocks are expected to increase by about 1.0 million barrels which would result in a gasoline year over year surplus of around 1.3 million barrels while the surplus versus the five year average for the same week will come in around 7.5 million barrels.

Distillate fuel is projected to increase by only 0.4 million barrels on a combination an increase in production and lower than normal heating oil consumption. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year the deficit will likely now be about 22.6 million barrels below last year while the deficit versus the five year average will come in around 4.5 million barrels.

The following table compares my projections for this week's report (for the categories I am making projections) with the change in inventories for the same period last year. As you can see from the table last year experienced pretty much the same directional moves as the projections for this week's inventory report but with a significant draw in crude oil stocks. Thus based on my projections the comparison to last year will result in a minimal year over year change in refined product inventories only.
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Once again we have breached resistance and are trading in triple digits for the spot WTI contract. Mostly as a result of the increased rhetoric surrounding Iran. I am keeping my view at cautiously bullish but raise the caution flag that the market will be very volatile over the next few days and prices can easily recede back below the $100/bbl mark versus WTI.
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I am maintaining my view and bias at cautiously bearish. The surplus that is building in inventory versus both last year and the five year average is going to get harder and harder to work off until it gets cold over a major portion of the US and as such for the medium term I am still very skeptical as to whether NG will be able to muster any kind of strong upside rally absent some very cold weather for an extended period of time. Currently the NG market is higher as it is in the midst of a short covering rally as the weak shorts head to the sidelines as an Arctic blast hits parts of the US. I do not see this as a trend change as the mild temperatures will return in a few days.

The weather has turned decidedly colder for a few days as an Arctic blast hits portions of the East Coast. This has resulted in acting as a floor in Nat Gas prices at the moment with a modest amount of short covering taking place. The latest NOAA weather forecast is changing a bit with a return to more normal temperatures over the eastern half of the US by mid-month with the central part of the US still expecting above normal temperatures. This has been enough to send some of the shorts to the sidelines in a market that has been modestly oversold.

This week the EIA will release the weekly Nat Gas inventory report on its regularly scheduled day and time...Thursday, January 5th. This week I am projecting a net withdrawal of 95 BCF which is modestly below both last year and the five year average for the same week. My projection for this week is based on yet another milder than normal weather pattern over most of the country. My withdrawal forecast is based on the fact that heating related demand declined a bit last week as parts of the country experienced mostly mild conditions. My projection will be below last year's net withdrawal level of 135 BCF and below the normal five year average net withdrawal for the same week of 106 BCF. Bottom line the inventory surplus will build again in this report period.

Currently as a new day of trading gets underway in the US markets are lower.

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