Crude oil prices rebounded overnight as the market approached range lows yesterday and bounced higher on a round of technical buying. The trading range I have been predicting for weeks remains in place even as most oil price drivers are currently biased to the bearish side. The evolving geopolitical situation with Iran has been the main upside price driver for most of this year especially after getting a boost with the announcement of the EU Iranian oil purchase embargo on January 23rd. With diplomacy continuing some of the immediate concerns that military action in the region was imminent have eased over the last week or so.

This year's newly added sanctions seem to be getting the attention of the Iranian government as well as the Iranian people. The Iranians have approached the first round of talks with a bit more of an open mind than how they left the last round of talks 15 months ago. In fact both sides were surprisingly pleased with the outcome to schedule another round of talks on May 23rd. Most analyst believe Iran's willingness to talk is primarily due to the impact that the sanctions are starting to have on the revenue stream in Iran. This round has targeted not only direct crude oil purchase via the EU embargo but they have attacked almost everything in the chain of buying crude oil from Iran. Just this week protestors surrounded the car of the President of Iran demanding an improvement in their economy. It seems to be getting to the population as well.

Overall the sanctions seem to be having their designed impact for now. In addition with the Iranian risk premium... which surged higher after the EU embargo announcement... has been receding over the last several weeks and is now less than half of what it was when it peaked early in February. In fact the EU has even postponed for several months when EU member states will review the embargo as for now there is no economic reason for changing the embargo according to a senior EU member as reported by Reuters this morning. Even Greece has indicated that they are not having any major problems in shifting away from Iranian crude oil use. So the pressure remains on Iran and for now the upward price push from geopolitics remains a secondary price driver.

The economy is now back in the forefront and acting as one of the main price drivers for the global oil complex. The biggest risk factor is the slowing of the global economy... in particular China. For the moment the oil market has been going through a major realignment of all of the spreads that are directly and even indirectly related to the Brent/WTI spread. The spot Brent/WTI spread is off about 45% or about $13/bbl since peaking in the middle of October of 2011. At the moment the markets are consolidating with another round of spread movement likely over the next several weeks.

Back in December and into early January the spot Brent/WTI spread seemed to be stabilizing between $8 to $11/bbl and then jumped strongly higher after the announcement of the EU Iranian crude oil purchase embargo. Over the last week or so the spread has receded and is now hovering about $5 to $6/bbl above the level it was at back in December/early January. Thus I expect that the realignment will continue especially with talks continuing with Iran and an early start to the Seaway pipeline.

Today's recovery in oil prices is partially driven by technical buy signals and partially driven by positive economic data out of Europe this morning as German business confidence surprised to the upside. The global equity markets have been in a bit of a recovery mode until yesterday's modest sell-off in the US but most Asian and European markets have not followed the US (so far) as shown in the EMI Global Equity Index table below. The Index is still higher by 1% on the week...certainly not a surging recovery but the markets are still in positive territory for the week. The year to date gain is well off of the highs made back in March and currently sits at 9.4%. The markets have been fighting a battle of macroeconomic data that have been indicating that most economies are slowing versus a modicum of optimism coming from better than expected corporate earning (so far) and the ongoing fact that the global financial markets are still being infused with a tremendous amount of liquidity as most Central Banks around the world continue to operate in an easy money policy.
For the moment the global equity markets are a positive price driver for the oil complex as well as the broader commodity complex. We now seem to be back in the mode of risk on, risk off trading with most risk asset classes highly correlated to the direction of the US dollar, Euro and the global equity markets. I expect this pattern to continue over the next several weeks at least.

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 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 still keeping my view at and bias at bearish. My overall view remains biased to the bearish side. The surplus is still building in inventory versus both last year and the five year average is going to lead to a premature filling of storage during the current injection season. As such for the short to medium term I doubt Nat Gas is going to reverse the downtrend it has been in for an extended period of time. We may certainly see times when short covering rallies take hold but I do not expect a sustained trend change.

Yesterday's inventory report came in as expected (see below for more details) and did not add anything new to the equation. Nat Gas is oversupplied, remains bearish as we inch closer to filling available storage capacity...likely much sooner than normal. The only solution that will stop the current downtrend is for the producing sector to make substantial cuts in production. I have seen comments from many analysts indicating how hard it will be for the producing sector to cut production due to the drill or lose clauses on leases, due to the high value of Nat Gas liquids, etc. The fact of the matter is simple. The industry is running out of places to put the Nat Gas that is being produced. Total storage is now at 61.2 of maximum workable capacity. It is difficult to say exactly when the infrastructure problems will begin to force production cuts but it will certainly be well before the end of the current injection season.

Until something emerges from the producing sector I still view Nat Gas as bearish and expect prices to continue to drift lower heading into the summer cooling season.

Currently markets are mixed as shown in the table below.

Best regards,
Dominick A. Chirichella
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