All of the June events so far have been mostly bearish for oil and just about all risk asset markets expect for the US dollar and bonds. There were no infusions of money printing by the US Fed while just about all of the macroeconomic data that has been released over the last month or so has been simply bearish. The global economy is slowing and there are no signs that the slow growth pattern is going to change anytime soon. In addition the evolving sovereign debt issues in Europe are still evolving with no imminent long term solution yet surfacing.
The last main event for the month of June will be the EU Ministers meeting on June 28 - 29. Leading up to that meeting will likely be many 30 second news snippets encompassing many views as to what they will or will not do at the meeting. Heading into next week Greece wants to renegotiate its deal, Spain is likely to need a larger bank bailout and it is unclear as to what Italy may or may not need. All of this simply translates to uncertainly in this region of the world. This uncertainty has been clouding all of the markets for the last three years with no clarity as to when it will finally be solved and moved to the background permanently. On top of the sovereign debt issues plaguing Europe is the other main bearish fact that the EU is in another recession and likely to remain in recession for at least the rest of the year. Europe remains in a dilemma of austerity to fight the sovereign debt issues but in need of a cash infusion or stimulus of some sorts to fight off recession. As of today it is not clear as to what the leaders of Europe will do but if they try to just kick the can again neither of these major issues are going to be solved and the global economic slowdown will likely get deeper and be prolonged.
On the US front the US Fed chose to take the easy way out for now by simply extending Operation Twist to the end of the year while it takes a wait and see approach to the upcoming round of macroeconomic data with specific interest in the labor sector. At the moment the Fed seems to be placing a lot of emphasis on the faltering jobs recovery and if the next two nonfarm payroll reports show no improvement over current levels I believe the Fed may lean toward a full blown QE3 program at their Jackson Hole meeting in August.
China's economy is continuing to also slow even as the government has reduced bank reserve requirements several times over the last few months as well as lowering short term interest rates. Energy sensitive PMI data continues to decline and is at the lowest level in well over a year. China has been the main economic growth engine of the global economy and with it slowing on top of the EU moving into recession and the US barely growing global growth is simply going nowhere quickly and could languish for months to come.
So how does all of this impact the oil complex? Simply put the oil complex has moved from being driven by the potential for supply disruptions and spot shortages of oil to a market that is now simply short of demand. Even with the July 1 official start to the EU Iranian crude oil purchase embargo global oil supply is significantly more than adequate especially with the Saudi's and OPEC overproducing. On the demand front the EU is projected to see a decline in oil consumption in 2012 as is the US with China projected to grow by about 450,000 bpd versus 2011 or about half of the total projected global oil growth (Latest EIA STEO report). With China and the rest of the world still slowing oil consumption could potentially come in even lower than the projections and thus widening the oversupply situation. Inventories are building with US crude oil stocks at the highest level since 1990 and significantly above where they were during the height of the financial crisis and subsequent recession.
Inventories are also building in other areas of the world. From a fundamental perspective oil is oversupplied and bearish.
Will the Saudi's cut production anytime soon? I am still of the view that the Saudi's will continue to overproduce as a tool to put added pressure on Iran and provide support to the west in their negotiations with Iran on its nuclear program. Saudi Arabia can stand lower oil prices for a much longer period of time than Iran. I expect Saudi production to remain at current levels at least for the next month or so. Oil prices have declined by about $31/bbl basis the spot WTI contract since peaking in early March and about $38/bbl basis the spot Brent contract. This decline coupled with some of Iran's oil left behind is impacting the Iranian economy which is almost solely dependent on its oil income. I truly believe the only reason why Iran is still at the negotiating table is because the sanctions and lower oil prices are actually impacting them. They will continue to negotiate and try to put a deal together while still saving face in the rest of the Middle East.
Based on a decline of $38/bbl basis Brent the consuming world is enjoying the sell-off in oil prices and is now paying about $3.3 billion dollars per day less than they were back in early March (basis EIA total oil consumption for Q2 of 87.89 mmbpd). Over time the lower cost for oil will work its way through the global infrastructure and act as a form of stimulus program unto itself. In fact it is a great stimulus program (if it lasts) as it is one that does not have to be paid for in the future.
Global equities have continued to be impacted by all of all of the bad news as shown in the EMI Global Equity Index table below. The EMI Index has now declined by 0.7% for the week after falling by 2.1% in the last twenty four hours. The EMI Index is now back into negative territory for the year with five bourses back in the loss column. A very oil dependent
economy...Canada now holds the bottom spot in the Index with a 4.6% loss for 2012. With the euro continuing to recede the German bourse is holding the top spot in the Index as a lower euro is very supportive of Germany's export oriented economy. Needless to say global equity markets are a negative price driver for oil and the broader commodity complex.
Overall the risk markets are exceptionally volatile and uncertain. We are the furthest away from a buy and hold market with most all traders and investors taking a very short term trading approach to the market with plenty of cash on the sidelines. This has been (and will continue to be) the main reason why all of the markets are highly correlated and are reacting to just about every single 30 second news snippet and headline. Price direction will continue to change very frequently. Most of the risk asset market lack conviction and are simply being traded for the moment. I expect this pattern to continue for the foreseeable future.
The oil complex has broken down below the trading range it has been in for weeks and is now bearish with more downside still possible. WTI can now be categorized as being in a $75 to $85/bbl trading range with Brent setting up in a $85 to $95/bbl range. The outcome of all of the upcoming events I have been discussing in the newsletter over the last several weeks have been mostly bearish for oil prices while the vast majority of the macroeconomic data that has been released is also bearish for oil.
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.
Yesterday's Nat Gas injection (see below for more details) continued its streak of underperforming versus last year and the five year average. This has been the pattern for the majority of the injection season so far and will have to be the pattern for the rest of the injection season to avoid the industry from hitting maximum workable storage capacity prematurely. The market reaction was a quick surge to the upside that I would categorize as short covering from the weak shorts in the market followed by a move lower giving back about half of the immediate inventory push higher in prices. The good news is that the injection underperformed again, the bad news is the industry continues to inch its way toward maximum storage capacity (see below).
At current price levels (as of this writing) the advantage of switching from coal to Nat Gas for power generation has dropped to just about $0.12/mmbtu based on a price comparison (only) between Nymex spot Appalachian Coal versus spot Nymex Nat Gas prices. It does not account for differences in efficiencies of basis relationships around different parts of the country. That said it is a good macro indicator that suggests to me that we are approaching a critical point when Coal switching will push utilities back to coal...especially with the high inventory levels of coal at many utility locations. Bottom line I can't see Nat Gas futures prices moving much higher from current levels in the short to medium term as it would impact Nat Gas consumption pretty quickly (this is a very price sensitive relationship) and result in weekly injections increasing relative to last year and the five year average and thus exposing the industry to hitting maximum capacity prematurely.
Currently markets are higher as shown in the following table.
Dominick A. Chirichella
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