Monday Morning February 28, 2011

Quote of the Day
Let freedom never perish in your hands.
Joseph Addison
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Today is the last trading day of the month so on top of all of the volatility associated with situation in Libya and the rest of North Africa and the Middle East there will be the usual expiration of refined oil products futures contracts as well as the normal end of the month window dressing trading done by the fund managers. Over the weekend the situation in Libya has deteriorated further...especially insofar as Gaddafi's grip on the nation. The opposition group announced a leader of their revolution over the weekend with more and more people around Gaddafi continuing to defect to the other side. Now that most countries like the US have gotten their citizens out of the country the international community is not only condemning Gaddafi and calling for him to step down but in conjunction with the US they are freezing he and his family's assets squirreled in banks and investments around the world and adding other sanctions. They have even indicated that everything is on the table including a military response.

As I have been indicating all of last week Libya is well beyond the point of no return and it is only a matter of time as to Gaddafi and his entourage leave Libya voluntarily or even involuntarily as the opposition movement continues to gain momentum and take control of larger and larger areas of the country. The oil situation seems to be deteriorating further with more workers fleeing. The British Special Forces just extricated about 150 oil workers over the weekend. It is difficult to determine how much oil is flowing or not flowing but it seems that more and more is being shut in on a daily basis either intentionally or even simply because more and more ships are unwilling to dock in Libya for fear of safety, reprisals or just getting stuck there as dock workers strike or flee. A major portion of Libyan oil moves to Europe and many refiners in that region of the world are operating in crisis mode as they look to make up for the loss of Libyan oil directly or via exchanges of sour for sweet grades as the Saudi's have increased production by about 700,000 bpd but the quality is not nearly as desirable and not a direct replacement for Libyan oil. There is chaos in the oil region with no indication when it will stabilize let alone return to normal. Spain a large importer of Libyan oil is so concerned that the government instituted reduced speed limits beginning March 1st to reduce consumption.

The biggest question is will the freedom or democrat revolution not only gain more momentum in countries where it is already under way but will it spread to other oil rich regions in the Middle East and elsewhere like Venezuela. If Gaddafi falls (which I believe he will) it is likely to energize citizens in all of the other autocratically ruled countries possibly accelerating the toppling of more despots like Gaddafi and resulting in even more chaos in the international oil markets. No matter what happens in the very short term the situation in region will never be back to what it was. Even in countries where revolutions do not occur it will likely result in more freedoms for the citizens as all of the dictators of the world are looking at what has transpired with a whole lot of concern for their longevity.

There are no massive shortages of oil yet in the world although the loss of Libyan production is resulting in a significant logistics challenge as refiners scramble to not only get the oil they need to keep their systems running but to get the right quality crude oil that can be run in their refineries. The scrambling and the fear of contagion is likely to keep a minimum risk premium in the price of oil for the foreseeable future. In addition each time another country in the region looks like the freedom or democracy momentum is building the oil price risk premium is likely to expand quickly. The oil complex is not so much in uncharted territory as prices have been in this range before (2008) so there is also a technical basis for some of the price and trading activity we have seen so far and likely to continue to see going forward. However, what is driving the price is a huge dynamic variable that has very little predictability from day to day. The market is almost exclusively being driven by the geopolitics of the region and the 30 second news snippets hitting the media airwaves that come out all day long.

Now that the Saudi's have increased production... and according to the CEO of Aramco they have met all incremental needs of their customers... I would suspect that the media airwaves will continue to be filled with comments coming from the various leaders of the world like Obama, and others regarding their support for the people of Libya as well as their ability to release Strategic Oil Reserves if and when it is needed. But for now the market is likely to remain at elevated levels with a large price risk premium embedded in the value of oil for the short term as market participants await more clarity on the protests as well as getting a better understanding as to the ramifications of further losses of Libyan oil supplies and possibly oil supplies elsewhere.

Most risk asset markets were hit with a strong round of selling but recovered some lost growing by the end of the week as the situation in Libya played out. Oil maintained most of its risk premium while financial markets lost value on the week even after a mild recovery move on Friday. Precious metals held higher and continued to be viewed as safe haven instruments during the current crisis. Over the last week the oil complex surged with both WTI and Brent ending the week with a gain. Brent continued to trade above the $110/bbl mark for the spot April contract. The April Brent contract ended the week with a gain of 9.4% or $9.62/bbl. WTI settled below the $100/bbl mark but was in positive territory for the week gaining $9.11/bbl or 8.17%. WTI continues to lag Brent as inventories in PADD 2 increased this week and remain at record high levels.
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On the distillate fuel front the Nymex HO contract increased modestly with diesel fuel inventories falling on the week while HO stocks actually increased after milder than expected weather. The benchmark Nymex HO contract increased by 7.52% or $0.2049/gal. Gasoline prices gained ground on the week as gasoline stocks declined strongly on the week versus expectations for yet another build. That said gasoline inventories in the US are still at the highest level since 1990 for this time of the year. The April Nymex gasoline price increased by 5% or $0.1304/gal this past week and noticeably below the gains in both crude oil and HO suggests that RBOB is very overvalued versus everything else in the oil complex. RBOB is very susceptible to a value correction especially versus the rest of the oil complex.

The new Nymex spot April Nat Gas contract spent most of the session in positive territory as a modest amount of short covering dominated trading. The April contract ended its first session as the spot contract up 3.6% or $0.138/mmbtu higher on the day and the first time the spot Nat Gas contract traded above the psychological $4/mmbtu level since February 10. Whether or not the market will be able to hold this level for any extended period of time is a big question as nothing has changed in the Nat Gas world over the last twenty four hours. The short term weather forecasts still project a relatively mild to normal temperature pattern for the next several weeks and one that suggests that withdrawals from inventory for the next several weeks is going to be normal at best and possibly below normal as we saw this past week.

On the week Nat Gas increased by 2.53% or $0.099/mmbtu offsetting the previous week's decline. As has been the case more often than not Nat Gas prices are trading in a tight trading range irrespective as to what has been going on with the weather around the country. Based on the current forecast we can expect to see only normal withdrawals from inventory and possibly a few weeks of below above normal withdrawals for the rest of the winter heating season (ends March 31st). With 4 weeks left to the official winter heating season the return to milder winter weather and the fact that supply is still very robust significantly reduces investor/traders enthusiasm in buying the market in the short to medium term.

On the financial front equity markets around the world traded declined as the situation in North Africa and the greater Middles East deteriorated throughout the week. Global equity values went back on the defensive as shown in the EMI Global Equity Index table below. The EMI Index lost 1.9% on the week after increasing strongly the previous week by 2.7%. The EMI Index is now at the breakeven point for the year with Brazil and Hong Kong still the only bourses in negative territory contributing to bringing the entire Index lower. Even China was able to gain ground on the week as investor/traders are starting to view China's inflation fighting efforts as something that may help not only stabilize this surging economy but keep on track as a major player in global economic recovery. Last week the global equity markets were a negative for oil prices as well as the broader commodity complex but it did not matter much as geopolitics remain the main price driver for oil.
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The US dollar index was marginally lower as cash moved to other safe haven instruments like precious metals. Both the euro and yen gained ground on the week. The direction of currency markets was a positive for oil prices as well as the broader commodity complex last week. The global currency markets continue to be in a broad trading range which is likely to continue in the short term. Cash continued to flow into gold which increased by 1.49% on the week.

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 few days. 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 already today with WTI already trading in a about a $3/bbl trading range and currently well off of the highs made when the market first opened on Sunday night. 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 and Friday's gains were mostly short covering as evidenced by prices being back on the defensive already this morning.

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

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