Neither the European meeting nor the Iran/West meeting made much progress yesterday. On the macroeconomic front the preliminary PMI data out of China came in a tad below expectations and solidly below the expansion threshold of 50. The preliminary reading for the purchasing managers index was 48.7 versus the final April number of 49.3. Simply put China's economy like the developed world economies is slowing. For the moment not much has changed over the last twenty four hours. The EU composite PMI (services and manufacturing) declined to 45.9 in May from 46.7 in April. As with China growth is slowing and these important sectors are contracting. Aside from the usual round of short covering that is expected there is little out there to suggest that the current downtrend is likely to make a sharp reversals and send risk asset markets into a sustainable uptrend anytime soon.
Risk asset markets experienced a late day short covering run yesterday and have been relatively flat over night. That unto itself is a bit of surprise based on the negative macroeconomic data overnight and the fact that the EU has not really come up with a silver bullet to solve the Greek problem. The markets are currently acting like they are setting up for another round of short covering today. Today is likely to be the last full day of liquidity in the US as US traders start to head out for the first long summer holiday weekend. Markets in the US will be close on Monday.
Aside from short covering what are the main oil and risk asset market price drivers signaling at the moment?
- Europe is still in a state of uncertainty with no immediate solution to Greece or any of the other sovereign debt issues. There will be lots of ideas floated around the media news wires for the next several weeks with the full EU Summit scheduled for the middle of June. As it looks right now the Germans are still holding the line and showing little interest in any form of Eurobonds. While the sovereign debt talks continue the macroeconomic data out of Europe is likely to remain bearish. Overall Europe is a bearish price driver. The fact that the euro is trading at levels not seen since the middle of 2010 tends to tell it all about the lack of growth in Europe.
- The US economy is not nearly as bad as the EU economy at the moment but it is also not growing at a rate that it can operate on its own. At this stage of the recovery the US economy should be growing at a significantly higher rate than it is. Employment is still a major issue and the macroeconomic data over the last month has mostly been disappointing. The US economy is neutral at best for oil and risk asset markets.
- Asia, China, Japan and elsewhere in the Asian world are all seeing their economies slowing consistently for the last three to six months. As mentioned above China's PMI data is bearish again and is now in the longest run in contraction mode (below 50) since the recession. Yesterday's data also showed China's oil demand declined. China is still growing but not at the rates the global economy needs China to grow at to help in the recovery. At the moment I would call China a neutral to bearish bias for oil and the broader commodity complex. The neutral comes from the anticipation that the Chinese government will start to get much more aggressive in easing and providing stimulus to the economy. It is only a neutral at this point since any form of easing will take months to make a positive difference on the economy.
- On the geopolitical front the Iranian meetings with the West did not make any concrete progress but both sides are still talking. It is going to take a long time to formulate an agreement. As long as they are talking the likelihood of a military strike and a subsequent supply interruption are low. I would rate the Geopolitics as cautiously bullish but not nearly a significant enough price driver to send prices higher at this time. The rating is based on the fact that the talks could end abruptly at any time and thus change the supply risk in the region.
- Oil and most risk asset market technicals are all currently trading at critical support levels going back the end of last year in many cases and even further back than that in the case of the euro. The technical trend is still lower with most risk asset market still in a very oversold state. All of these markets are going to be susceptible to short covering rallies from time to time but the underlying technical trend is currently pointing lower.
Overall all of the above suggests to me that the markets are still susceptible to further declines with short covering days from time to time. The single biggest downside risk is Europe with the meeting with Iran the single biggest upside risk if they break down. As I have been suggesting in the newsletter I still expect some sort of recovery in risk asset values in the second half of the year as the global economy will be on life support or stimulus in just about every country of the world including the US.
The global equity markets are still marginally higher on the week as shown in the EMI Global Equity Index table below. The EMI Index is up by 0.3% for the week but lower by 1.3% for the year to date. Five of the ten bourses in the Index are now in negative territory for the year with Germany and China still holding the top spots in the Index. The UK and Brazil remain at the bottom of the Index. Overall the trading pattern of the global equity markets is consistent with the above comments on slow growth for the global economy.
Wednesday's EIA inventory report was mixed to biased to the neutral side as it showed only a modest increase in total stocks, a build in crude oil within the expectations but larger than forecast draw in gasoline while distillate fuel declined less than expected. Total implied demand decreased with gasoline demand declining strongly. Refinery utilization rates declined on the week to 88.1% of capacity a decrease of 0.2% in refinery run rates. The data is summarized in the following table along with a comparison to last year and the five year average for the same week.
Total commercial stocks of crude oil and refined products increased by 1.1 million barrels after increasing modestly the week before. The year over year surplus narrowed to 20.8 million barrels while the surplus versus the five year average for the same week also narrowed to 32.5 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 0.9 million barrels) versus an expectation for a larger 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 11.6 million barrels while the surplus versus the five year average for the same week came in around 28.7 million barrels. PADD 2 crude oil inventories increased by about 1.5 million barrels while Cushing, Ok crude oil inventories also increased by about 1.7 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 been relatively flat the last week on a combination of growing inventories in the mid-west but the fact that the Seaway pipeline is now pumping oil out of Cushing to the Gulf Coast.
Distillate stocks decreased versus an expectation for a small seasonal build. Heating oil/diesel stocks decreased by 0.3 million barrels. The year over year deficit came in around 21.6 million barrels while the five year average remained in a deficit of about 14.5 million barrels.
Gasoline inventories declined strongly (mostly driven by declines on the West Coast again) and greater than the expectations as a result of the industry's transition to summer grade gasoline. Total gasoline stocks decreased by about 3.3 million barrels on the week versus an expectation for a build of about 1.0 million barrels. The deficit versus last year came in at 8.7 million barrels while the deficit versus the five year average for the same week was about 33.7 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.
I am keeping my view at cautiously bearish after oil broke down on all fronts over the last few weeks but with the possibility for a short covering rally occurring at anytime is increasing. Oil is still solidly below the trading range it was in just a few weeks ago and well below several key support areas. WTI is still solidly trading in double digits with Brent slowly heading in that direction.
I am keeping my view at neutral and keeping my bias also at bullish 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.
Currently markets are mostly higher as shown in the following table.
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.
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