Refined products are drifting lower while WTI is about unchanged to start the last trading session of the week. The price battle lines that have been in play for the last month or so are still driving the direction of oil prices. On the bearish side the slowing of the global economy and subsequent slowing of oil demand growth (see IEA highlights below) have continued to be supported by the vast majority of macroeconomic data hitting the media airwaves from around the globe. On the other side of the equation the evolving geopolitical risk to supply along with the regional tightness of refined products have also continued to be in play as the situation with Syria and Turkey is not going away while inventories of distillate fuel continue to decline during a period of time when they are normally still in a winter building mode (see inventory discussion below).

All of the above said both WTI and Brent remain in a wide trading range and have been in this trading range since the middle of September. Both WTI and Brent are currently hovering near the upper end of the trading range (resistance level) as the current refined products fundamentals combined with the geopolitics of the middle east have slightly been outpacing the negativity from the slowing global economy. In fact as of this writing both WTI and Brent are likely to end the week with their first weekly gain after three straight weeks of losses. Unless the geopolitics ramp up in the middle east I would expect oil prices to remain within the trading range for the short term as even the gasoline situation on the US west coast seems to be improving now that refineries are coming back on stream and the more stringent summer gasoline specs have been temporarily waived by the California Air Resources Board.

That said we must keep a close eye on the overall distillate fuel situation as winter is right around the corner and distillate fuel inventories remain at the lower end of the normal operating range. The EIA focused on tightness in this market sector in their Weekly Petroleum Report. Simply put time it is time to watch the evolving fundamentals of distillate fuel going forward as this sector could have a significant impact on the overall pricing relationships within the oil complex. On a global basis 52% of the growth in oil demand is from gasoil/diesel fuel (latest OPEC Monthly Oil Report). This is could be the single most impacting product category especially with inventories at below normal levels for this time of the year. Some of the key highlights from the EIA Weekly Petroluem Report follow.

As the northern hemisphere prepares for winter, the demand for distillate fuels is typically strong as consumers fill tanks in preparation for the heating season. This year, as has been the case for the last several years, the seasonal increase in demand is occurring against a backdrop of tight global distillate markets in which supply and demand centers are geographically mismatched. Europe and Latin America produce less distillate fuels than they consume and have been relying on supply from the United States, mostly exports from the U.S. Gulf Coast. This trade has been mutually beneficial because it has provided U.S. refiners with an attractive market that has encouraged high refinery utilization, which also has supported the production of additional gasoline.

The tightness in global distillate markets is reflected in both the futures market prices and inventory levels in the United States. While U.S. distillate production is high, the global supply-demand balance for distillate fuels has created a price structure that has not encouraged inventory builds. In recent weeks, prompt prices for distillate fuel have risen compared to prices for fuel delivered in future months. For the week ending October 5, distillate inventories in the U.S. Northeast (PADDs 1A and 1B) were 28.3 million barrels, about 21.5 million barrels (43 percent) below their five-year average level (see chart below). Distillate inventories have historically been used to meet normal winter heating demand but are also an important source of supply when demand surges as a result of unexpected or extreme cold spells. The low distillate inventories could contribute to heating oil price volatility this winter. In addition, outages at several major refineries, notably Petroleos de Venezuela's Amuay Refinery, Shell Oil's Pernis Refinery in the Netherlands, and Irving Oil's Saint John Refinery in Canada, have added to the fundamental market pressures in the Atlantic Basin.

Market tightness could be exacerbated by a regulatory change in New York state, which starting this heating season limits the sulfur content of home heating oil to 15 parts per million (ppm), matching the sulfur content limit for ultra-low sulfur diesel fuel (ULSD). This change results in an estimated additional 70,000 barrels per day (bbl/d) of ULSD demand on an annual basis, but in times of peak demand - such as during sustained cold temperatures - could be as high as 170,000 bbl/d. The specification change also eliminates an equivalent amount of demand for high-sulfur heating oil, which is the specification currently used in other northeastern states. This demand shift could be significant because ULSD is less available globally than is high-sulfur distillate fuel and the major production center for ULSD is on the U.S. Gulf Coast.

The IEA just released their latest oil monthly market forecast. Following are the main highlights of this report.

Crude oil prices traded in a narrow range in September, as renewed concerns about the economy blunted the effect of escalating tensions in the Middle East. Brent averaged $113.03/bbl and WTI $94.56/bbl, a gain of about $0.40/bbl. Brent rose a further $2/bbl in early October, to $115/bbl at the time of writing.

Estimates of global demand growth were revised down to 0.7 mb/d for 2012 (to 89.7 mb/d) but kept at 0.8 mb/d for 2013 (to 90.5 mb/d). The IMF's downward revision to its forecast of economic growth – to 3.3% in 2012 and 3.6% in 2013 – had been anticipated and does not affect our forecast.

Non-OPEC output growth is expected to bounce back to 0.7 mb/d in 2013 (to 53.9 mb/d) after outages cut growth to 0.4 mb/d (to 53.2 mb/d) in 2012. Both estimates are up by a marginal 10 kb/d since last month. Supply recovers by 0.6 mb/d (to 53.6 mb/d) in 4Q12, from maintenance and hurricane disruptions in 3Q12.

OPEC crude oil supply fell to an eight-month low in September, down 510 kb/d to 31.17 mb/d. Higher supplies from Iraq and Libya failed to offset reduced output from Nigeria, Iran and Saudi Arabia. Weak demand cut 'call on OPEC crude and stock change' by 400 kb/d for 3Q12, to 30.7 mb/d.

OECD industry stocks declined by a counter-seasonal 11.2 mb in August led by a stronger-than-seasonal draw in the US after Hurricane Isaac disrupted production and imports end-month, but preliminary data suggest stocks rebounded by 13.0 mb in September. Forward demand cover stands at 58.8 days, 0.1 days lower than July.

Global refinery crude demand estimates have been revised up by 140 kb/d for 3Q12, to average 75.8 mb/d. Robust refinery margins lifted runs in Europe, more than offsetting lower-than-expected US runs in September. In contrast, 4Q12 throughputs have been lowered by 250 kb/d, to 75.4 mb/d, on outages and a lower demand outlook.

Wednesday's EIA inventory report was mostly bullish as total commercial stocks declined on the week. Overall I would categorize the report as biased to the bullish side as total commercial stocks decreased modestly even as crude oil inventories increased as crude oil imports rose on the week. Refinery utilization rates decreased on the week down to 86.7% of capacity.

The data is summarized in the following table along with a comparison to last year and the five year average for the same week.
Total commercial stocks of crude oil and refined products decreased by 4.3 million barrels after decreasing by about 2.5 million barrels the week before. The year over year surplus narrowed to 20.9 million barrels while the surplus versus the five year average for the same week narrowed to 35 million barrels.

Crude oil inventories increased (by 1.7 million barrels) and within the market expectations. Crude oil inventories have been increasing steadily for most of this year and are still well above the levels they were at during the height of the recession as well as being at the highest level since 1990. With the increase in stocks this week the crude oil inventory status versus last year is still showing a surplus of around 28.7 million barrels while the surplus versus the five year average for the same week came in around 34.6 million barrels. Crude oil imports increased modestly on the week.

PADD 2 crude oil inventories increased by about 0.7 million barrels while Cushing, Ok crude oil inventories increased by about 0.3 million barrels on the week. Crude oil inventories in the mid-west region of the US are off of their record high levels as the Seaway pipeline is now pumping oil out of the region as well as refineries running at over 90% of capacity (temporarily lower from Isaac). The increase in crude oil inventories in both PADD 2 and Cushing are bullish for the Brent/WTI spread. The Nov spread is trading around the $23/bbl level.

Distillate stocks surprisingly decreased (versus and expectation for a build) as refinery run rates decreased by 1.5%. Heating oil/diesel stocks decreased by 3.2 million barrels after declining by 3.6 million barrels in the previous week. The year over year deficit came in around 33.1 million barrels while the five year average remained in a deficit of about 30.3 million barrels.

Gasoline inventories decreased versus an expectations for a small build. Total gasoline stocks decreased by about 0.5 million barrels on the week versus an expectation for a build of about the same size. The deficit versus last year came in at 14.2 million barrels while the deficit versus the five year average for the same week was about 9.3 million barrels.

The following table details the week to week changes for each of the major oil commodities at every level of the supply chain. As shown I have presented a bullish categorization on the week as inventories for everything was bullish on a macro or inventory draw. Overall this week's report was biased to the bullish side as total stocks are once again back to declining.

The oil complex has breached all of its current support levels and as such I am keeping my view at neutral for today as crude oil continues to trade within a wide trading range (see above for more comments). The battle continues between the negativity from the slowing of the global economy compared to what global stimulus programs might do to the economy going forward while geopolitics has continued to remain an issue for market participants.

I am keeping my Nat Gas price view at neutral with bias to the bullish side as the fundamentals and technicals are quickly catching up the current price levels. As I mentioned above the market appears to be moving into a buy the dip mode

I must say yesterday's Nat Gas injection report was a surprise to me and one that is slowly starting to change my view that Nat Gas may now have additional upside potential. I still think the price of Nat Gas is overvalued but what I am changing my opinion on is an overdue round for profit taking selling may not be as deep as I have been expecting nor is it likely to last as long as I was expecting. We are now about a month or so away to the end of the inventory injection season and with next week's injection almost certain to underperform versus both last year and the five year average the overhang in inventory is going to continue to narrow further. With this week's injection the overhang versus last year is down to 6.8%. Based on my model projections for the rest of the injection season total ending inventories may end the season at just 1.7% above last year or only about 70 BCF above.

With the latest projection by NOAA calling for about an 18 to 20% colder winter season than last year Nat Gas consumption is almost certain to be well above last year's winter consumption level. With inventories likely to be only slightly above last year the inventory overhang that plagued the market last year is not likely to be an issue and as such prices will be less susceptible to a sustained downtrend over the next 4 months or so. I am becoming a bit more biased to the bullish side and expect the market to be more in a buy the dip mode rather than a sell the rally mode. I do not expect that prices are going to surge higher unabated.
However, I think we may now be entering a mild uptrend that could find both fundamental and technical support.

Markets are mostly lower to start the US trading session as shown in the following table.

Best regards,
Dominick A. Chirichella
Follow my intraday comments on Twitter @dacenergy.


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