Oil prices have been steady over the last twenty four hours after a short covering rally driven by a recovery in the euro and equity markets in Europe and the US after Monday's post Spanish bailout sell-off. We are now entering the major event period for the month of June with the OPEC meeting kicking off tomorrow and the Greek elections on Sunday. Also since yesterday the EIA, IEA and OPEC have all released their oil forecasts while today the EIA will release its weekly oil inventory report. Last night the API data showed a surprise build in crude oil and decline in gasoline stocks (see below for more details on all of the fundamental reports.

I am still expecting a rollover with no production cuts from the OPEC meeting. I am still of the view that the Saudi's will keep oil production high even if oil prices continue to decline. I believe part of the strategy is to add pressure on Iran with lower oil prices and thus hope that it motivates Iran and the West to eventually negotiate a deal over Iran's nuclear issues. The next Iran/West meeting is in Moscow early next week.

At the moment most risk asset markets are still in a downtrend even after a short covering rally yesterday. The technicals for all of the markets are also suggesting lower values going forward. However, event risk will take over as the main price driver for all of the risk asset markets including the oil complex as the macro correlations remain very tightly linked. I believe there is a lot of trading and investing dollars sitting on the sidelines which is likely to remain parked in bonds and money markets until more clarity emerges from the major market headwinds. Following are just some of the main questions clouding all of the markets

Who will win the Greek elections?

Will the Spanish bank bailout actually go forward?

Is Italy next on the agenda?

Will the EU move to eurobonds?

Will contagion spread around to other EU countries as well as outside the EU?

Will the EU slip back into recession?

Will the US economy continue to slow?

Will China's easing result in a growth spurt for this meteoric economy?

Will the US Fed announce another quantitative easing program at their June meeting?

What will be the outcome of the OPEC meeting...production cut or status quo?

Will any progress be made at the next round of talks between Iran and the West?

If no progress is made does it quickly increase the likelihood of military action in the region?

There are more but I trust you all get the point as to the magnitude of the event risk to all of the markets over the next two to three weeks. All of the above have implications for the market and are likely to impact the direction of the markets...at least for the short term. In addition to all of the normal technical and fundamentals approaches you use for trading and investing for the next two to three weeks you must pay close attention to not only the outcome of all of the events but the 30 second news snippets hitting the media airwaves leading up to all of the events. The only guarantee is markets will remain volatile with sudden price reversals as we saw during Monday's US trading session.

Both the EIA and IEE released their monthly oil forecasting report following are the main highlights of both of the reports:
International Energy Agency (IEA) Monthly Oil Market Report

The springtime slump in oil markets accelerated in May in the wake of the deepening euro zone crisis, mounting concern over a slowdown in Chinese growth and rising global oil supplies. Futures prices were off 20% from peak 2012 levels, with Brent last trading at around $97.50/bbl and WTI at $83.50/bbl.

A muted economic backdrop underpins forecast demand growth of 0.82 mb/d in 2012, resulting in average demand of 89.9 mb/d. A lower GDP sensitivity this month illustrates downside demand risks, but upside potential exists too, amid uncertainty over summer power sector oil demand and non-OECD stockpiling.

Global oil supply rose by 0.2 mb/d to 91.1 mb/d in May. Non-OPEC liquids increased by 0.2 mb/d to 53.1 mb/d and by 1.0 mb/d versus year ago. In 2012 rising North American supply more than offsets record-low North Sea output, as well as outages in the Sudans, Syria, and Yemen, taking non-OPEC supply growth to 0.7 mb/d.

OPEC crude supply edged lower in May, off 20 kb/d, to 31.87 mb/d, with reduced output from Saudi Arabia and Iraq offset by higher production in Angola, Nigeria, and Libya. The 'call on OPEC crude and stock change' in 2H12 is around 1 mb/d higher than the 1H12 level, at 30.9 mb/d. OPEC 2012 NGL supply rises 0.4 mb/d to 6.2 mb/d.

OECD industry oil inventories rose by 17.3 mb in April, to 2 643 mb. OECD commercial oil stocks have now narrowed the apparent deficit to the five-year average in absolute terms, while remaining 1.9 days above the five-year average. May preliminary data indicate a 20.1 mb increase in OECD industry inventories.

World refinery crude demand is set to surge seasonally by 2.8 mb/d between April's low and August, as maintenance winds down. New and returning capacity in Asia and Europe also contribute, while ramp up at Motiva's expanded US plant could be delayed. Global crude runs rise from 74.3 mb/d in 2Q12 to 75.9 mb/d in 3Q12.

Energy Information Administration (EIA) Short Term Energy Outlook

Based on the outlook from the National Oceanic and Atmospheric Administration for the current Atlantic hurricane season, EIA estimates median outcomes for total shut-in production in the Federal Gulf of Mexico (GOM) during the upcoming hurricane season (June through November) of about 4.5 million barrels of crude oil and 9.5 billion cubic feet (Bcf) of natural gas (see 2012 Outlook for Hurricane-Related Production Outages in the Gulf of Mexico). Actual shut-ins are likely to differ significantly from this estimate depending on the number, track, and strength of hurricanes as the season progresses.

Global oil markets have loosened in recent months, as world oil production outpaced consumption by 0.7 million bbl/d in the first quarter of 2012, and is forecast to exceed it by 1.2 million bbl/d in the second quarter. The oil production gains contributed to a counter-seasonal stock build during the first quarter of 2012, following the significant stock draws during 2011. Industry analysts have attributed some of the recent decline in oil prices to poor economic indicators for Europe, China, and the United States, in addition to reduced market anxiety over current and potential supply disruptions. Although EIA's economic growth assumptions are unchanged from last month, the crude oil price forecast has been lowered because of upward revisions to current and forecasted supply, primarily from countries outside of the Organization of the Petroleum Exporting Countries (OPEC), and to reflect changes in the relative strength of the upside and downside risks buffeting oil markets.

Despite the recent fall in crude oil prices, EIA expects that the average crude oil price in 2012 will be higher than in 2011. EIA expects the world oil market will tighten moderately in the third quarter of 2012 as world demand reaches its seasonal peak and total consumption exceeds production by about 0.7 million bbl/d. Additionally, spare production capacity levels are projected to be low enough to support a recovery in crude oil prices from current levels.

There are several uncertainties that could push oil prices higher or lower than projected. A number of non-OPEC countries continue to experience large and persistent supply disruptions. Oil prices could be higher than projected in this Outlook if recoveries from supply disruptions are slower than forecast, additional disruptions occur, or supply growth is lower than expected. Additionally, the effects of the impending European Union embargo and other sanctions targeting exports of Iranian crude oil and their associated payments are still uncertain. Some industry analysts believe that optimism about recent negotiations between Iran and its counterparts in the West has helped to ease prices in recent months, even though the outcome remains uncertain. EIA's projected oil market balance reflects the impacts from previous sanctions against Iran.

On the demand side, the recent negative economic news on Europe poses a risk to global economic growth. In the current Outlook, consumption in Europe is expected to fall year-over-year by 340 thousand bbl/d in 2012 and by a further 230 thousand bbl/d in 2013. If the economic situation in European Union countries deteriorates, then global economic growth could fall below current expectations and result in reduced oil demand and lower prices. Slower growth in China could also curb demand. EIA currently projects annual increases in consumption in China of about 0.4 million bbl/d in both 2012 and 2013. Recent economic indicators point to some weakness in China's economic outlook.

World liquid fuels consumption grew by an estimated 0.8 million bbl/d in 2011. EIA expects consumption growth of 0.8 million bbl/d in 2012 and 1.1 million bbl/d in 2013, with China, the Middle East, Central and South America, and other countries outside of the Organization for Economic Cooperation and Development (OECD) accounting for essentially all consumption growth (World Liquid Fuels Consumption Chart). Projected OECD liquid fuels consumption declines by 0.4 million bbl/d in 2012. In 2013, forecast OECD liquid fuels consumption remains essentially flat, with consumption growth in the United States offsetting some of the decline in Europe.

EIA expects non-OPEC crude oil and liquid fuels production to rise by 0.8 million bbl/d in 2012 and by a further 1.2 million bbl/d in 2013. The largest area of non-OPEC growth is North America, where production increases by 890 thousand bbl/d and 470 thousand bbl/d in 2012 and 2013, respectively, resulting from continued production growth from U.S. onshore shale and other tight oil formations and Canadian oil sands. In Brazil, output is projected to rise by 20 thousand bbl/d in 2012 and 120 thousand bbl/d in 2013, with increased output from its offshore, pre-salt oil fields. EIA expects that Kazakhstan, which will commence commercial production in the Kashagan field next year, will increase its total production by 160 thousand bbl/d in 2013. Forecast production also rises in China, Russia, and Colombia over the next two years, while production declines in Mexico and the North Sea.

Total consumption fell 340 thousand bbl/d (1.8 percent) last year. Motor gasoline consumption accounted for the bulk of that decline, shrinking by 260 thousand bbl/d (2.9 percent). In 2012, total consumption falls by a more moderate 70 thousand bbl/d (0.4 percent). In the first quarter, total consumption fell 700 thousand bbl/d (3.7 percent) from the same period last year (U.S. Liquid Fuels Consumption Chart) as high prices and record warm weather depressed consumption. For the second half of 2012, EIA expects a year-over-year increase of 230 thousand bbl/d (1.2 percent) in liquid fuels consumption. The bulk of that increase comes from distillate fuel because of projected economic growth and near-normal winter weather.

In 2013, total liquid fuels consumption grows by 120 thousand bbl/d (0.6 percent). Despite assumed growth in U.S. real disposable income of 1.8 percent next year, forecast motor gasoline consumption declines by a further 30 thousand bbl/d (0.4 percent) in 2013. This projection reflects continued slow growth in the driving-age population, an acceleration of the improvement in average fuel economy of new vehicles, and increased rates of retirement of older vehicles. However, consumption of all of the other fuels categories rises, led by a 90-thousand-bbl/d (2.3-percent) increase in distillate fuel consumption.

The API report showed a surprise build in crude oil versus an expectation for a draw and a surprise draw in gasoline stocks along with a build in distillate fuel inventories. The API reported a build (of about 1.6 million barrels) in crude oil stocks and outside the expectation range as crude oil imports increased while refinery run rates decreased by 0.3%. The API reported a modest draw in gasoline stocks. They also reported a modest build in distillate stocks versus an expectation for a more seasonal build in distillate fuel inventories.
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The report is bullish for gasoline, bearish for crude oil and neutral for distillates. The market has not reacted strongly in overnight trading but has been stabilizing for all commodities in the complex mostly due to short covering after yesterday's recovery rally. The market is always cautious on trading on the API report and prefers to wait for the more widely watched EIA report due out this morning at 10:30 AM. The API reported a build of about 1.6 million barrels of crude oil with a draw of 0.720 million barrels in PADD 2 and a draw of 0.344 million barrels in Cushing, Ok which is bearish for the Brent/WTI spread. On the week gasoline stocks decreased by about 0.9 million barrels while distillate fuel stocks increased by about 0.5 million barrels.

At the moment oil prices are still being mostly driven by the events discussed above along with the direction of the euro and the US dollar as well as by a view that the global economy is continuing to slow. The tensions evolving in the Middle East between Iran and the West have been easing as another meeting will take place in June. As such we may not see much of a reaction from market participants to this week's round of oil inventory data as the macro risk off momentum is currently the main concern of all market players. This week's oil inventory report will likely be a background price catalyst unless the actual outcome is significantly different from the market projections.

My projections for this week's inventory reports are summarized in the following table. I am expecting the industry to continue its aggressive campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a draw in crude oil inventories and a build in both gasoline and distillate fuel stocks as the summer planting season is over (decreasing the demand for diesel fuel) while heating oil demand is also over. I am expecting crude oil stocks to decrease by about 2.0 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 17 million barrels while the overhang versus the five year average for the same week will widen to around 36.6 million barrels.

I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery are rates are starting to increase in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $15/bbl premium to Brent level for the last few days. I am still of the view that the spread will begin the process of normalization over the next 3 to 6 months.

With refinery runs expected to increase by 0.5% I am expecting modest build in distillate stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 10.5 million barrels while the deficit versus the five year average for the same week will come in around 5.3 million barrels.

Distillate fuel is projected to increase by 1.0 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 19.8 million barrels below last year while the deficit versus the five year average will come in around 16.3 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's inventories were mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
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I am still maintaining my oil view at neutral. I am still expecting the oil complex to settle into the $80 to $90/bbl trading range basis WTI and $95 to $105/bbl basis Brent. At the moment it is not so much that the current fundamentals have changed it is more related to the fact that the market sentiment is changing as participants move into the perception mode based on more stimulus which could result in an improvement of the forward fundamentals from a demand perspective (mostly based on China easing).
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I am keeping my view at neutral to see if Nat Gas is able to hold onto the developing trading range. The surplus is still narrowing in inventory versus both last year and the five year average but 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 marginally higher as shown in the following table.
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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.

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