Oil has been trading in a relatively narrow trading range over the last month or so. As I suggested weeks ago oil is in a consolidation or range trading pattern with WTI trading in a range of about $101 to $106/bbl since about the middle of March. Brent has not traded much differently with its trading range of about $117 to about $122/bbl. Brent has also been slowly depreciating versus WTI since early April with the June Brent/WTI spread falling about $5/bbl since then. The oil complex is in the midst of a slowly evolving transition not only in which price drivers are the most dominant but also within all of the spread interrelationships as the Brent/WTI spread continues on a very slow path toward normality.
First and foremost the main transition that has been in place for the last three weeks or so it the movement away from a supply driven price market and toward a demand driven market. The geopolitical risk of a supply interruption in and around Iran has eased considerably ...especially since the outcome of the first meeting between Iran and the West. The next meeting is scheduled for May 23rd and the rhetoric that was prevalent in the media airwaves has turned toward constructive ideas on how to begin to develop a resolution that is favorable to both sides. While the process of diplomacy is still evolving the likelihood of military action from either side has diminished and thus the likelihood of a supply disruption has diminished.
With the supply side of the equation moving into the background (for the moment) the market has been focusing on current and projected global oil demand for guidance for the next move for oil prices. As I have discussed on numerous occasions the demand side of the equation has been tempered by the slow growth pattern of the global economy including both the developed and developing world countries. The vast majority of the macroeconomic data points to a slow growth pattern for the foreseeable future. In addition with inflation risk still present (we saw it today in the EU) Central Banks around the world are not going to be overly aggressive in easing and stimulating the economy thus resulting in the growth pattern not likely to catch a strong spurt anytime soon. The bottom line... oil demand growth will continue to slow along with the global economy (especially China and the rest of the emerging market world) and the likelihood of an oil demand driven surge in oil prices is low.
I expect oil prices will continue to drift lower (as long as there is not a flare up in the tensions with Iran) with the Brent/WTI spread also continuing to slowly narrow over the next several months. At the moment I do not see any oil price catalyst that will likely result in a strong and sustainable surge in prices to the upside (again barring more issues with Iran). I also expect all of the individual oil commodities that have been priced against Brent over the last few years to also begin the process of normalization as the main spread moves toward more normal historical values.
Over the last week the oil complex was mostly higher with the complex gaining a little over 1% for the week. The June WTI contract increased about 1.01% or $1.05/bbl. The June Brent contract ended the week with an increase of 0.90% or $1.07/bbl. The June Brent/WTI spread was about unchanged last week but has been narrowing since peaking close to the $20/bbl level in early April. The combination of the market looking toward the early start of the Seaway pipeline in mid-May (expected to move about 150,000 bpd of oil out of PADD 2 to the US Gulf) and the easing of the tensions in the Middle East has been enough to send some of the spread bulls to the sidelines. Barring any change in the current geopolitics of the Middle East I would expect the spread to gradually continue to narrow over the next 3 to 6 months as the surplus in the US mid-west continues to recede.
On the distillate fuel front the Nymex HO contract increased by about 1.36% or $0.0427/gal on the week as distillate fuel inventories decreased much more than expected last week and as US distillate fuel exports were steady on the week. Gasoline prices also increased on the week after another larger than expected decline in gasoline stocks. The spot Nymex gasoline price decreased by 1.11% or $0..03454/gal this past week.
On the week Nat Gas futures increased on a weekly basis for only the fourth time this year while remaining above the psychological $2/mmbtu level. The June Nat Gas futures contract gained 8.49% or $0.060/mmbtu on the week as it is now solidly trading with a $2 handle.
The week has seen a continuation of a very slow turn in the market sentiment as talk continued by more producers regarding cutting production as well as a continuation of coal to gas switching impacting the demand side of the equation. Demand is slowly creeping up while supply is on the cusp of being cut by those producers that can cut dry gas production. About 40% of the Nat Gas produced in the US is what is considered dry gas or Nat Gas that comes from wells that are 90% or more just Nat Gas in contrast to the gas that comes from liquids wells. It is the dry gas wells that are the least profitable at current price levels as they do not get any boost from the high valued gas liquids that are extracted from gas producing operations that have a large percentage of liquids present.
The key to a full turnaround in the Nat Gas price pattern will be for a significant supply cut. Demand will solve part of the oversupply problem but with inventories already at 61.2% of maximum workable capacity and with the Producing region approaching 78% of capacity a supply cut has to be made irrespective of the fact that coal switching demand is increasing. Even if the summer is hotter than normal supply will still have to be left behind. In my view I think the wheels are already in motion at many producing companies in laying out their plans for cutting production rather than being exposed to a forced production cut due to infrastructure restrictions as storage facilities approach maximum capacity.
As I have been indicating in the newsletter I changed my bearish perspective several weeks ago and have been slowly building a bullish winter intermonth spread position and am on the cusp of also going flat price long in the front of the market. In addition to my view of production cuts and demand discussed above I am expecting a few more weekly injection reports to continue to underperform both last year and the five year average. The spring like weather that was in place at the end of winter and early Spring has turned a bit colder than normal and injections have been underperforming for most of the season so far., Through this week's injection report this season is running about 87% of last year and as such the surplus has been narrowing a tad. I expect this pattern to continue for at least the next several weeks which would be supportive for prices in the short term.
On the financial front equity markets around the world ended mixed to mostly lower as the downside correction seemed to rear its head last week in selective locations around the world. The financial markets were mostly impacted by a series of macroeconomic data in several locations around the world that are still suggestive that the global economy is in a slow growth pattern while the ongoing sovereign debt issues in Europe have once again resurfaced but this time all eyes are on Spain and Italy. Global equity values decreased as shown in the EMI Global Equity Index table below.
The EMI Index decreased by 0.60% on the week. Over the last week the Index increased in value in the US even as the latest GDP data for the US slowed versus last quarter. The euro gained slightly on the week while the US dollar declined. Last week the global equity markets were a neutral price driver for oil and most commodity markets (although oil prices were mostly higher on the week). Last week was a risk mixed trading week for most risk asset markets.
I am keeping my view at neutral for oil as WTI remains within my predicted trading range of $102 to $107/bbl. At the moment the oil complex is still going through a spread realignment driven by a reduction in the tensions in the Middle East and thus a receding of the Iranian risk premium along with a sentiment swing in the Brent/WTI spread due to the early start of the Seaway pipeline. I am more comfortable staying on the sidelines today for the flat price market.
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.
Currently markets are mostly lower as shown in the table below.
Dominick A. Chirichella
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