Quote of the Day
Discovery is poetry to genius.
William Mocca

The chaos and fighting continues in Libya as Gaddafi loyalists retook a key oil port overnight. Forces loyal to Gaddafi regained control of a key oil port on the coast of the rebel-held eastern half of the country. Gaddafi and the forces loyal to him seemed to have gained ground but may be pushing the country to an all out civil war. It is now looking like the turmoil in Libya is going to last for a much longer period of time than expected just last week and the likelihood of a civil war is also increasing. Even though Gaddafi has lost his very tight grip on the country he is still surviving and hanging onto to power at the moment. The US has moved ships and military personal into the region in the event they are needed to support the opposition group. Sanctions have been placed on Gaddafi and his family and close circle but sanctions tend to have little if any impact in these kind of situations.

In the rest of the region the risk of contagion is still a major overhang in the market sentiment as the Saudi Arabia's stock market declined for the 13th session as concern rises over the planned day of rage in Saudi Arabia on March 11 and March 20th. Tensions still exist in Yemen, Bahrain. Algeria and Iran where several opposition leaders have recently been detained as the Iranian government works to aggressively put down any attempt to protest that autocratic government. The situation in North Africa and the Middle East is more and more looking like it will be around for an extended period of time resulting in a high degree of uncertainty as to the overall supply of oil from this very important oil region. As such we can expect to see the risk premium remaining in the price of oil throughout the process for however long it takes (another unknown). On a daily basis the risk premium is going to rise and fall with each 30 second news snippet that hits the media airwaves discussing conditions in any of the affected countries with any negative Iranian or Saudi news likely to result in huge price moves due their importance as major oil producing nations as well as power players in the region. For the moment the world has already built in a risk premium that is reflective of a modest level of oil flow interruption (from Libya) and is beginning to add to the risk premium in anticipating that we will see a spread to other key oil producers and result in some sort of larger oil supply interruption.

The uncertainty surrounding these key oil producing nations is resulting in oil prices hovering over the $100/bbl mark which is resulting in a negative impact on global equities as shown in the EMI Global Equity table below. All of the ten bourses in the EMI Index have lost value over the last twenty four hours as the fear of higher oil prices resulting in inflation risk and thus putting the brakes on the global economic recovery is resulting in a risk off trading mentality once again. The Index is now lower by 0.6% on the week as well as the year to date after ending last Friday at breakeven for the year 2011. The London FTSE joined Hong Kong in the losers column as inflation fears are now starting to drive the developed world bourses.
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Since early 2009 the equity markets have been the main catalyst driving oil prices higher as the perception trade took hold. The perception that rising equity prices (which is correlated to rising GDP which is correlated to rising oil consumption) will result in an improvement in the supply, demand and inventory situation and thus a reason to buy oil and other commodities for that matter. Now that geopolitics is the main driver the perception trade is still in place but this time oil prices are not the result but the cause of the market moves. Surging oil prices are now perceived to have a negative impact on the global economy and thus a negative driver for equity prices. The massive price surge in 2008 is still clearly in the minds of investor, traders and consumers and each time the price of oil ventures above the $100/bbl mark all of the markets get a bit spooked with more and more players looking to now reduce their risk exposure in all asset classes.

Late yesterday afternoon the API released their latest inventory assessment. The API report was surprisingly bullish. The API reported across the board declines in oil stocks at a time when the market was starting to like the fact that a huge surplus exists in the US in light of the turmoil in the Middle East and North Africa. The API reported a crude oil inventory draw of about 1.1 million barrels as refinery utilization rates increased by 0.3% to 78.4% of capacity. The API also reported a decline in crude oil imports. They also showed a huge draw in gasoline stocks of about 4.9 million barrels while distillate fuel stocks declined by about 1.4 million. The results of the API report are summarized in the following table. So far the reaction to the API report has been mildly bullish as prices have increased in overnight trading but the vast majority of the gain in oil prices is more related to the turmoil in Libya. If todayâ€TMs EIA report is in sync with the API report I would view it as modestly bullish as everything was outside the market's projections. The overall oil decline is definitely in the right direction in reducing the overhang that still exists in the US…especially in the mid-west region however, it is coming at a time when the world is in the midst of supply disruption price shock.
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My projections for this weekâ€TMs inventory reports are summarized in the following table. I am expecting a mixed report with an overall build in total commercial stocks of crude oil but a marginal decline in refined products inventories as refinery runs likely declined marginally on the week. I am expecting crude oil stocks to decline by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil would come in at 6.7 million barrels while the overhang versus the five year average for the same week will be about 16.6 million barrels.

With runs expected to increase by about 0.2% and with imports expected to hold steady I am expecting a modest decline in gasoline stocks. Gasoline stocks are expected to draw by about 0.5 million barrels which would result in gasoline stocks still hovering around 20 years highs for this time of the year. This week the gasoline year over year surplus is projected to narrow to around 5.9 million barrels while the surplus versus the five year average for the same week will narrow to about 12.6 million barrels.

Distillate fuel is projected to decrease modestly by 0.7 million barrels on a combination of some weather related demand as well as a decline in production. The latest NOAA weather forecasts are now showing a significant portion of the US expected to experience colder than normal temperatures for the first half of March. On the surface that is a positive for heating oil especially after the last several weeks of less than bullish inventory reports. However, the offset to the current short term weather forecast is the fact that there is just not much time left to the winter heating season and the start of the lower demand shoulder season.
With the vast majority of the winter heating season now in the history books heating oil stocks may also start to perform much like diesel stocks have been over the last several months and that is to start into a premature inventory building pattern during the projecting moderation of temperatures during the second half of February. In fact heating oil stocks actually built in last week's EIA report. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 7.5 million barrels above last year while the overhang versus the five year average will be around 24.6 million barrels. Refiners are continuing to try to manage the overhang of crude oil by converting it into refined products and moving products into inventory. Net result the US continues to remain well oversupplied of just about everything in the oil complex with supply expected to remain robust for the foreseeable future.

As usual do not overreact to the API data as the EIA report will be released in a few hours. The API report more often than not it is not in line with the more widely followed EIA data. If the EIA report is within the projection I would expect the market to view the results as neutral as total commercial stocks of crude oil and refined products combined are likely to have decreased only marginally. However, if the EIA data is more in line with the API data the market will embrace the results and view it as bullish likely resulting in another push up in prices as it will instill additional fear into the market sentiment that ongoing supply disruptions may turn out to be more of a problem than originally expected if the inventory cushion is declining. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on with the evolving situation in North Africa and the Middle East as well as in the financial markets and how much the macro issues will offset any of the individual micro drivers like supply & demand.

My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my overall view to be in sync with my bullish bias for all of the reasons I have been discussing over the last week. But again I raise the caution flag that prices are a bit overdone and susceptible to a correction. Any event can trigger a sudden change in the direction of prices as we saw over the last few trading sessions. Be cautious and use tight, trailing stops in your short term trading book.

I am maintaining my Nat Gas view and bias at neutral as I think the Nat Gas market is still range bound but now trading near another critical technical support level of $3.85/mmbtu.

Currently markets are mixed as shown in the EMI Price Board table below.

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Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com