As I mentioned in Tuesday's newsletter the rest of the week will be very volatile and the markets will be trading around the 30 second news snippets that hit the media airwaves from Europe. In addition the upcoming weekend is a long holiday weekend in the US and market participation and liquidity is going to slow down quickly as we get into the second half of the trading week. The EU news snippets quickly moved the US markets from a continuation of Monday's short covering rally back into negative territory in a very short period of time. The news that sent stocks and commodities moving lower on Tuesday was a Dow Jones report that the Greek Prime Minister said the nation is considering preparations to leave the euro currency.

Each time one starts to think that a Greek exit has been fully priced into the market one needs to always look back at the quick and decisive reaction to the downside that occurs each time a news snippets just mentions the possibility of an exit...as we saw in the last hour of trading on Tuesday. So yes some of it is priced into the market but I can almost guarantee that if it is announced that Greece is leaving the EU there will be a swift and strong sell-off. How deep it goes and how long it lasts is the unknown.

As I have been suggesting the rallies that have occurred are definitely not trend changers at this point in time. The technicals, market sentiment and sluggish macroeconomic data all support further declines in most risk asset markets in the short to even medium term. The selling will stop when the market is convinced that the uncertainty surround Greece and the rest of the sovereign debt issues in Europe are truly over and the macroeconomic data starts to improve. Short of that the other turning point for the markets will be more stimulus from the US and China. I believe it will be more stimulus and easing that will finally be the catalyst for a turnaround and sustainable rally to the upside.

Global equity markets once again moved back into negative territory for the year as shown in the following table of the EMI Global Equity Index. Yet another huge sell-off (almost 3%) in the Brazilian Bovespa accounted for a major portion of the loss in the Index over the last twenty four hours. The Index is still up 1.2% for the week but the Index moved back to a 0.4% loss for 2012. Equities remain a leading indicator for the global economy and are highly correlated to all of the major risk asset markets. The global equity markets are still suggesting a period of slow growth in the global economy for the foreseeable future.
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Wednesday's trading will have two main catalyst that will drive the major global markets. The European summit in Brussels and the Iran & West meeting in Baghdad. The market will be looking for any sign from the Brussels meeting that the Europeans might start to add some form of stimulus to the economy rather than just relying on the austerity programs enacted over the last 6 months or so. The OECD laid out four steps to start the discussions but Germany has already sent the first shot over the bow by once again indicating they had no interest in any form of Euro Bonds. I suspect this meeting will end like most of them...some progress made with a statement saying that the technocrats will be working to develop a more detailed plan for the larger EU meeting in June. Likely the markets will react negatively to such an outcome.

The nuclear talks with Iran may also be setting up for a progress made communiqué as Iran agreed on Tuesday to allow IAEA inspectors back into the country (although the official deal has not been signed yet). I think the Iranians will begin to move more toward a limited enrichment program that may be acceptable to the US and the Europeans. The Russians presented a plan that entailed enriching only to the level that is needed for power generation and medical research. I believe that is the direction that the negotiations are likely to move toward. In return the West will have to ease or even eliminate some of the major sanctions... like the EU embargo on crude oil purchases.

If diplomacy makes real progress the geopolitical risk to the Middle East will fall even further and thus result in another sell-off in oil prices. If a real deal looks likely Brent crude oil could possibly even test the $100/bbl level with WTI falling back in the $80's. Of course the outcome of these situations are nearly impossible to predict with a high degree of accuracy as what looks a like a situation heading in the right direction can change in heartbeat and the meetings could end abruptly raising the geopolitical risk quickly. I would not trade based on an anticipated outcome rather I would sit back, watch and enjoy the show and digest the outcome before moving forward.

The API report showed modest build in crude oil that was within the range of expectations but another much larger than expected decline in gasoline stocks and another small draw in distillate fuel inventories. The API reported a build (of about 1.5 million barrels) in crude oil stocks bit within the expectation range as crude oil imports decreased slightly as did refinery run rates which decreased by 0.1%. The API reported a large draw in gasoline stocks which was mostly on the West Coast with gasoline actually building east of the Rockies. They also reported a small draw in distillate stocks versus an expectation for a more seasonal build in distillate fuel inventories.

The report is bullish for gasoline and neutral for crude oil and distillates. The market has not reacted strongly in overnight trading but has been drifting lower for all commodities in the complex. 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. The API reported a build of about 1.5 million barrels of crude oil with a build of 0.5 million barrels in PADD 2 and a build of 0.5 million barrels in Cushing, Ok which is bullish for the Brent/WTI spread. On the week gasoline stocks decreased by about 4.5 million barrels while distillate fuel stocks decreased by about 0.2 million barrels.
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At the moment oil prices are still being mostly driven by 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 tomorrow (see above for more details). As such we expect more market participants to pay attention to this week's round of oil inventory data suggesting that this week's oil inventory reports could also start to impact price direction. This week's oil inventory report could move to being a primary price driver especially 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 an across the board build in inventories this week with a modest build in crude oil, a modest build in gasoline inventories and a small build in distillate fuel stocks along with an increase in refinery utilization rates. I am expecting a build in gasoline inventories and a build in distillate fuel stocks as the summer planting season is winding down (decreasing the demand for diesel fuel) while the heating oil demand is over. I am expecting crude oil stocks to increase by about 1.0 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 11.7 million barrels while the overhang versus the five year average for the same week will widen to around 28.8 million barrels.

I am also expecting a modest build in crude oil stocks in Cushing, Ok as the Seaway pipeline did not start pumping unit the weekend or after the inventory report period. This would be bullish for the Brent/WTI spread in the short term which is still trading around the $16/bbl premium to Brent level for the last few days. That said 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 a modest build in gasoline stocks. Gasoline stocks are expected to increase by about 1.0 million barrels which would result in the gasoline year over year deficit coming in around 4.4 million barrels while the deficit versus the five year average for the same week will come in around 29.4 million barrels.
Distillate fuel is projected to increase by 0.5 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 20.8 million barrels below last year while the deficit versus the five year average will come in around 13.7 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 inventories were mixed. As such if the actual data is in line with the projections there will be a modest change in the year over year comparisons for most of the complex.
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I am keeping my view at cautiously bearish after oil broke down on all fronts over the last few weeks but with the possibility for a short covering rally occurring at anytime is increasing. Oil is still solidly below the trading range it was in just a few weeks ago and well below several key support areas. WTI is still solidly trading in double digits with Brent slowly heading in that direction.
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I am keeping my view at neutral and keeping my bias also at bullish 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.

Currently markets are mixed heading into Asian trading.
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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.

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