Yesterday was the largest one day decline for a variety of risk asset classes this year as the ongoing headwinds finally caught up with the bulls. This was the first correction this year that can be categorized as a bit of a sentiment changer. Market participants finally started to digest the plethora of data that has been suggesting that the global economy is slowing down while inflation risk is rising as oil prices still hover near the year to date highs on the evolving geopolitical risks in the Middle East.

In spite the declines in commodities and equities the uptrend that has been in place all of 2012 is far from over as the declines are still viewed as downside corrections while all of the important uptrend lines and technical indicators remain in play. The market will now be looking for further signs about the health of the global economy with the next big event coming on Friday when the US Labor Department will release the latest monthly nonfarm payroll data and the headline unemployment rate. The market is expecting a net gain in jobs of about 220,000 while the unemployment rate is expected to hold steady at 8.3%. A miss to the downside will definitely result in another round of profit taking selling.

Oil prices declined yesterday on a combination of an easing of the tensions between Iran and the West along with help from a sell-off in equities and the euro. The west (including the US) has accepted Iran's offer to resume negotiations and Iran is now offering to allow the IAEA inspectors access to the site they prevented them from visiting when they were last in Iran a few weeks ago. For now I would say we are still clearly in my Scenario 1 which should limit the widening of the risk premium for the time being. As long as both sides are talking it pushes the potential for military action by Israel or the US further down the road. At the moment it seems that diplomacy and sanctions will be in the forefront. I must say we have to be cautious about setting any major expectations from negotiations as all previous attempts have gone nowhere.

Global equities declined strongly over the last twenty four hours as shown in the EMI Global Equity Index table below. With yesterday's almost 2% decline the Index is now 4% off of its year to date highs. The gain for 2012 is now at 10.9%. The magnitude of the correction of about 4% is the lower end of the range many analysts have been calling for with an upper range correction level at the 7 to 8%. So potentially there is more to come if the economic data does not improve going forward. Yesterday the EIA released their latest monthly Short Term Energy Outlook. Following are the highlights from the report.

EIA expects increases in global consumption to outpace production growth in countries outside of the Organization of the Petroleum Exporting Countries (OPEC) during the forecast period. World liquid fuels consumption grows by an annual average of 1.1 million barrels per day (bbl/d) in 2012 and 1.4 million bbl/d in 2013. Supply from non-OPEC countries increases by 0.7 million bbl/d in 2012 and by 0.8 million bbl/d in 2013. EIA expects that the market will rely on both inventories and increases in crude oil and non-crude liquids production from OPEC members to meet world demand growth.

Significant uncertainties could push oil prices higher or lower than projected. A number of non-OPEC countries are currently undergoing supply disruptions. Oil prices could be higher than projected in this Outlook if current disruptions intensify, new non-OPEC projects come online more slowly than expected, or OPEC members do not increase production. On the demand side, if the pace of global economic growth fails to recover in countries belonging to the Organization for Economic Cooperation and Development (OECD), or if economic growth slows in non-OECD countries, prices could be lower.

World liquid fuels consumption grew by an estimated 0.8 million bbl/d to 87.9 million bbl/d in 2011. EIA expects that this growth will accelerate over the next two years, with consumption reaching 89.0 million bbl/d in 2012 and 90.3 million bbl/d in 2013. Non-OECD countries will account for essentially all of the world's consumption growth over the next two years, with the largest contributions coming from China, the Middle East, and Central and South America

EIA expects non-OPEC crude oil and liquid fuels production to rise by 690 thousand bbl/d in 2012 and by a further 750 thousand bbl/d in 2013. The largest area of forecast non-OPEC growth will be North America, where production increases by 360 thousand bbl/d and 190 thousand bbl/d in 2012 and 2013, respectively, resulting from continued production growth from U.S. onshore shale formations and Canadian oil sands. EIA expects that Kazakhstan, which will commence commercial production in the Kashagan field in the next year, will increase its total production annually by an average of 170 thousand bbl/d in both 2012 and 2013. In Brazil, production increases annually by an average of 120 thousand bbl/d over the next two years, with increased output from its offshore, pre-salt oil fields. Production also increases in Colombia and China over the next two years, while production declines in Russia, Mexico, and the North Sea.

Several notable disruptions to non-OPEC production commenced or intensified over the last two months, leaving an average of around 1 million bbl/d offline in February. In the former Sudan, an unresolved dispute between Sudan and the newly independent South Sudan over transit fees and other issues caused the latter to shut in all of its production at the end of January. EIA now projects that total production from Sudan and South Sudan, which averaged about 430 thousand bb/d in 2011, will average 200 thousand bbl/d in 2012 and recover to 370 thousand bbl/d in 2013.

EIA expects that OPEC members' crude oil production will continue to rise over the next two years to accommodate the projected increase in world oil demand. Projected OPEC crude oil production increases by about 490 thousand bbl/d and 560 thousand bbl/d in 2012 and 2013, respectively. EIA's forecast does not factor in any potential effects that the impending European Union embargo and other sanctions may have on Iran's crude oil production because it is too early to assess the country's ability to place its supply elsewhere. However, EIA estimates that Iran's crude oil production has fallen since mid-2011 and is projected to continue to decline through the forecast period. OPEC non-crude petroleum liquids (condensates, natural gas liquids, coal-to-liquids, and gas-to-liquids), which is not covered by OPEC's production quotas, will increase by 220 thousand bbl/d in 2012 and by 60 thousand bbl/d in 2013. EIA estimates that commercial oil inventories held in the OECD ended 2011 at 2.64 billion barrels, equivalent to about 56.9 days of forward-cover (days-of-supply). Although the December 2011 inventory is slightly lower than the 2.66-billion-barrel level at the end of December 2010, the days of forward-cover are at the highest end-of-year level since 1994 because of a decline in OECD consumption last year. Projected OECD oil inventories decline slightly over the forecast, with OECD inventories falling to 2.57 billion barrels, or 55.4 days of forward-cover, at the end of 2013.

The API report showed a larger than expected build in crude oil stocks along with a larger than forecast draw in gasoline while distillate fuel inventories built versus an expectation for a seasonal draw. The API reported a large build (of about 4.6 million barrels) in crude oil stocks versus an expectation for a modest build in crude oil inventories even as crude oil imports decreased as well as refinery run rates. The API reported a modest draw in gasoline stocks and a surprise build in distillate stocks versus an expectation for a more seasonal draw in inventories.

The report is neutral with a bias to the bearish side. That said the changes overnight may not be from the API inventory report as prices are higher across the board and are being driven by the movement of the macro indicators and a bit of a rebound from yesterday's strong sell-off. The market remains tied to the evolving situation in Europe that has been unfolding along with the geopolitics of the mid-east this week as discussed above with inventory data a secondary driver. The API reported a build of about 4.6 million barrels of crude oil with a build of 2.4 million barrel build in Cushing and a build of about 2.0 million barrels in PADD 2 which is bullish for the Brent/WTI spread. On the week gasoline stocks declined by about 2.3 million barrels while distillate fuel stocks increased by about 0.9 million barrels. At the moment oil prices are still being mostly driven by the tensions evolving in the Middle East between Iran and the West (as discussed above) and to a secondary extent based on 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 news snippets out of the Middle East and the tick by tick direction of equities and the US dollar (driven by Europe & China so far this week)... 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.

My projections for this week's inventory reports are summarized in the following table. I am expecting a mixed inventory report this week with a modest build in crude oil and a decline in gasoline stocks along with a modest seasonal decline in distillate stocks along with a small increase in refinery utilization rates. I am expecting a draw in gasoline inventories and a normal draw in distillate fuel stocks as winter like weather hit parts of the US during the report period...in particular the east coast. I am expecting crude oil stocks to increase by about 1.4 million barrels. If the actual numbers are in sync with my projections the year over year deficit of crude oil will come in around 2.6 million barrels while the overhang versus the five year average for the same week will widen to around 1.5 million barrels.

Even with refinery runs expected to increase by 0.3% I am expecting a modest draw in gasoline stocks. Gasoline stocks are expected to decrease by about 1.5 million barrels which would result in the gasoline year over year deficit coming in around 0.8 million barrels while the deficit versus the five year average for the same week will come in around 6.3 million barrels.

Distillate fuel is projected to decrease by 2.0 million barrels on a combination of steady exports and a bit of colder than normal weather last week. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 15.8 million barrels below last year while the surplus versus the five year average will come in around 1.4 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 for the same week the inventory changes were in the same direction as the projections except last year experienced much larger declines in both gasoline and distillate fuel stocks versus the projections for this report. As such if the actual data in line with the projections there will be modest changes in the year over year comparisons for most everything in the complex except for crude oil inventories. WTI is still trading above its most recent support level of $104/bbl with $110/bbl the next level of resistance. Brent is also still above its support level of $120/bbl. Oil continues to be driven by the evolving geopolitics of the Mideast...in particular Iran with just about all of the other normal prices drivers taking a secondary role...including fundamentals. I am keeping my view at cautiously bullish and keeping the caution flag flying to remind all that the market is remains susceptible to further profit taking selling in the short term. I am still keeping my view at neutral and bias at bearish as once again there is not much supportive indications that Nat Gas is likely to embark on a major short covering rally anytime soon. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off even it gets cold over a major portion of the US and as such for the medium to longer term I am still very skeptical as to whether NG will be able to muster a sustained upside rally over and above a short covering rally. Currently markets are mostly higher as shown in the following table. Best regards, Dominick A. Chirichella dchirichella@mailaec.com Follow my intraday comments on Twitter @dacenergy.