So much for the Spanish Bank bailout rally that began on Sunday night and abruptly ended by mid morning on Monday during US trading hours. There seems to be very little confidence in the ability of the EU to stem and solve all of the growing sovereign debt problems. The Spanish bailout program left a lot of details yet to be determined which made market participants very nervous and uncertain as to whether or not the program will go as billed over the weekend.
In addition even with Spain's banks seemingly being backstopped the market is once again refocused on all of the June events that I have been discussing in detail for the last several weeks. The next major market moving event is the Greek elections on Sunday. Concerns are rising that the anti-bailout party could be energized heading into the elections as the Spanish bailout program may not come with as many conditions and restrictions as the Greek bailout program. On top of those two issues the market is also looking at Italy as the next major problem area.
In a nutshell Europe is looking more messy as each day goes by as contagion is growing and the ability to solve all of the problems is becoming more challenging each day. The markets have not only reversed the overnight rally but most all risk asset markets are below last Friday's levels and trading as if the Spanish bailout did not even occur. At this point in time I am not sure what it will take to regain the confidence of the market that the EU is able to solve all of the problems. In addition with the Greek elections just a week away I do not see market participants get overly involved in the market...especially from the long side until more clarity emerges next week.
I still expect oil to remain in the $80 to $90/bbl trading range for WTI and $95 to $105/bbl range for Brent. However, if the Greek election swings to the anti-bailout party than I would expect a strong sell-off around the globe with oil prices trading well below the aforementioned trading ranges. Oil prices are trading well below the lows made on Friday before talk of a weekend Spanish bank bailout. Part of the issue or headwind for oil and the broader risk asset markets is even if the EU can get through all of its sovereign debt headwinds the global economy is still weak at best.
The debt problems in Europe and slowing of the US and European economies is certainly the main risks facing all of the major risk asset markets around the world. Yes China is very important but the size of its economy is significantly smaller than the US or EU. However, China is the main growth engine for oil demand growth with about half of all of the projected demand growth in 2012 expected to come from China. Both the US and the EU regions are both projected to experience a decline in oil consumption (this week we get updated projections by the EIA on Tuesday and IEA on Wednesday). More aggressive easing by the Chinese government should be a positive for oil consumption and thus a positive for oil prices. However, if the developed world economies continue to slow and possibly move into contraction any new oil consumption growth out of China could be further offset by declines in the developed world.
Global equity markets started off the week in positive territory only to reverse during US trading hours as show in the EMI Global Equity Index table below. The Index is now down by 0.1% after the first twenty four hours of trading and heading into Asian trading hours. With the strong sell-off during US hours I expect Asia will also be hit with a strong round of selling as all eyes remain on Europe and whether or not they are going to be able to reign in the contagion. The Index is now down by 1.9% for the year with 5 bourse in negative territory and 5 in positive territory. I suspect the count will move toward the negative side by the next newsletter. Needless to say global equities are a bearish price driver for oil and the broader commodity complex.
This week's oil inventory reports will be released on time with the API data to be released Tuesday afternoon while the EIA data will hit the media airwaves at 10:30 AM EST on Wednesday. At the moment oil prices are still being mostly driven by the events discussed above along with 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 in June. As such we may not see much of a reaction from market participants to this week's round of oil inventory data as the macro risk off momentum is currently the main concern of all market players. This week's oil inventory report will likely be a background price catalyst unless the actual outcome is significantly different from the market projections.
My projections for this week's inventory reports are summarized in the following table. I am expecting the industry to continue its aggressive campaign of converting a portion of the surplus crude that has been building for the last several months into refined products... in particular gasoline and distillate fuels whose inventories have been in decline. I am expecting a draw in crude oil inventories and a build in both gasoline and distillate fuel stocks as the summer planting season is over (decreasing the demand for diesel fuel) while heating oil demand is also over. I am expecting crude oil stocks to decrease by about 2.0 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil will come in around 17 million barrels while the overhang versus the five year average for the same week will widen to around 36.6 million barrels.
I am also expecting a modest draw in crude oil stocks in Cushing, Ok as the Seaway pipeline is now pumping and refinery are rates are starting to increase in that region of the US. This would be bearish for the Brent/WTI spread in the short term which is now trading around the $15/bbl premium to Brent level for the last few days. 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 modest build in distillate stocks. Gasoline stocks are expected to increase by 1.0 million barrels which would result in the gasoline year over year deficit coming in around 10.5 million barrels while the deficit versus the five year average for the same week will come in around 5.3 million barrels.
Distillate fuel is projected to increase by 1.0 million barrels. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 19.8 million barrels below last year while the deficit versus the five year average will come in around 16.3 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's inventories were mostly in the same direction as the projections. As such if the actual data is in line with the projections there will only be a modest change in the year over year comparisons for most of the complex.
I am still maintaining my oil view at neutral. I am still expecting the oil complex to settle into the $80 to $90/bbl trading range basis WTI and $95 to $105/bbl basis Brent. At the moment it is not so much that the current fundamentals have changed it is more related to the fact that the market sentiment is changing as participants move into the perception mode based on more stimulus which could result in an improvement of the forward fundamentals from a demand perspective (mostly based on China easing).
I am keeping my view at neutral to see if Nat Gas is able to hold onto the developing trading range. The surplus is still narrowing in inventory versus both last year and the five year average but 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. We may still see lower prices (thus the basis for my bias) but I think the sellers are losing momentum.
Nat Gas never got caught up in the global Spanish bailout rally nor is it currently getting hit with the sell-off as the rally faded this morning. Nat Gas is still reeling after last week's 6 BCF greater than the expected injection report. Not much has changed in the Nat Gas market over the last week or so. We are now in the summer cooling season with the eastern half of the country to experience mostly normal to above normal temperatures with the west coast continuing to expect below normal temperatures. I would call the current 6 to 10 day and 8 to 14 day forecasts as neutral for Nat Gas as although there will be some cooling demand for Nat Gas it does not appear that the weather will be as severe as it was last year at this time. As such it means that we will not likely see much of an impact on Nat Gas demand from the next few weeks of the summer cooling season on the weekly Nat Gas inventory injections.
The market is currently hovering near the lower end of its trading range and struggling to bounce off of this level. It seems that the market sentiment is continuing to move toward a bearish bias with many participants starting to look to a test of the $2 to $2.10 level and thus an extension of the trading range that has been in the process of forming. The main concern in the market is the risk of hitting maximum storage capacity limits prematurely.
Normally the injection season runs until the end of November and even into early December depending on how early the winter heating season gets underway. With storage currently at 69.9% of capacity (Producing region at 80.7%) weekly injections are going to have to underperform for the next several months to avoid inventory capacity issues. The first three months of the season has seen injections running between 70 to 73% of last year's injection levels. Now that we are in the cooling season the temperatures are going to have to be not only much above normal but also much above last year which experienced a very hot summer (first half of summer).
Bottom line it is looking more and more like the producing sector is going to have to ramp up their production cuts (over and above what has already been cut) to avoid a logistics mess. If the industry is going to avoid what could be a disorderly operating period if inventory capacity is filled and companies are forced to cut production based on where the pipelines and storage facilities dictate rather than the companies getting ahead of the problem and more economically optimize their individual systems. I still think we may start to see additional cuts prior to inventory hitting capacity.
Currently markets are lower as shown in the following table.
Disclaimer: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.
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