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Follow my intraday comments on Twitter @dacenergy.
NOTE: I will not be publishing the Energy Market Analysis on Monday, May 30 in observance of Memorial Day in the US
Dominick
Friday Morning May 27, 2011
Quote of the Day
Each man is a hero and an oracle to somebody.
Ralph Waldo Emerson
As I and many other Americans get ready to celebrate the long Memorial Day holiday weekend in the US amid the many parades honoring our soldiers, barbeques and parties I am writing today's newsletter with questions rather than answers. This has been a tumultuous month for most all risk asset markets with oil on the top of the list of volatility, huge moves and many, many intraday reversals. Uncertainty as to where oil prices will go in the short and longer term is still not easily predicted. Although I have been mostly neutral over the last week or so the market is starting to feel like it is getting ready to make a move. The market sentiment is forming, the big traders are beginning to stake out a position (like GS) so it is a good time to sit back and analyze as we get ready to hit the ground running next week.
Let's start with some of the reasons that have been supporting higher prices (not in any special order and certainly not all inclusive).
Just about all of Wall Street has come out over the last week or so predicting higher prices for oil going forward. Some of the bullish WS companies are Goldman Sachs, Morgan Stanly, JP Morgan., Barclays to name just a few. In addition several of them like GS are also bullish on most raw materials once again while being bearish on eh USD (GS again). Unrest in MENA has continued with fighting still raging on in Libya. In Yemen there is the risk of a tribal civil war unless Saleh leaves. Just today there are reports of the Yemini air force bombing armed tribesmen. Syria is still experiencing protests. At the moment there is no imminent risk of losing any additional supply from the area but the potential is still there for future disruptions in supply. Loading/production problems continue in the North Sea with several cargoes delayed and other completely dropped from the June loading program. The loss of some North Sea oil added to the loss of Libyan oil is slowly starting to impact the overall supply & demand balances and thus the resultant inventory levels. China is experiencing a huge drought and as such has lost a noticeable amount of hydroelectric power generating capacity. This has resulted in an increased need for imports of diesel fuel to make up some of the difference. The drought is projected to continue and as such we can expect China to continue to import above normal levels of diesel fuel for the foreseeable future. Diesel fuel inventories in both the US and Europe have been declining during a period of time when distillate fuel in general is already in a building mode for the upcoming winter heating season. There is a growing view that the loss of Libyan oil will continue for an extended period of time and over time this will impact global inventories (reducing them) thus be a positive for oil prices.Now let's look at some of the reasons that have been supporting lower prices (not in any special order and certainly not all inclusive).
Although I have listed Libya on the support side above Reuters is just reporting that Russia now believes Gaddafi has lost his legitimacy and Moscow is prepared to mediate to facilitate his departure. This is a big shift from Russia and one that could be telling. As I have said on numerous occasions the oil risk from Libya is a Gaddafi exit which will likely result in oil prices falling by $5 to $10/bbl if he finally agrees to go. Whether or not the decline will be sustainable will be dependent on if a Gaddafi exit does result in peace in Libya and oil beginning to flow. Global economic growth is slowing in both the emerging market world due to monetary tightening as well as the advanced economy world even though countries like the US are still stimulating their economy. Yesterday's 1.8% first quarter US GDP certainly does not look like an economy that is surging ahead in fact the current growth rates is well below where this economy has normally been at this point in an economic recovery. The EU sovereign debt issues are getting worse not better and have been putting pressure on the euro once again. This is resulting in budget and austerity measures in all of the PIIGS while the IMF just today indicated that they doubt they will give Greece the next rate from the general rescue fund. The above evolving situation in the EU points to further euro weakness which will eventually translate to US dollar strength as a safe haven and thus turn out to be negative for oil on two fronts. First a weak euro/strong USD scenario is simply a negative for oil prices as the inverse correlation between the USD direction and oil prices is still very high and widely followed. Second with more austerity measure likely to evolve in the EU their economic growth is likely to slow even further reducing their overall oil consumption and thus another negative for oil prices going forward. Not all... but the majority of the macroeconomic data for the US has been negative and pointing to further slowing of the number one economy and the number one oil consumer in the world. Although the US has certainly not been the oil consumption growth engine of the world (that would be China) the oil risk coming from the US is a slowing and a resultant decline in consumption and thus a negative for oil prices. Higher prices have started to take a toll on US gasoline consumption as elasticity of demand has set in. A recent poll indicated that about 63% of American consumers said they would change their driving habit if retail gasoline prices hit $4/gal. They have already been at that level and even with the recent retracement in oil prices the current national average is only about $0.19/gal below the $4/gal threshold. Any further recovery in oil prices off of the lows is likely to result in a continuation of the US consumer changing their driving habits. With inflation still raging ahead the emerging market world led by China and India are going to continue to tighten their high flying economies and this tightening is eventually going to result in a slowing of these economies and thus a slowing in the growth of their oil consumption.In addition to the above the technicals of the oil complex are a bit uncertain also especially for WTI. As I have been discussing for about a week WTI is mired in a technical triangular or consolidation pattern and as of this writing has still not broken out in either direction. That said over the last three sessions (including this morning so far) the market has showed signs of trying to break out to the upside. But so far it has failed. I am not sure what to expect today as volumetric activity will be below normal ahead of the long holiday weekend in the US. Nor would I put a lot of emphasis on a breakout today on low volume. So for the moment the technicals are still a neutral looking for a reason to move in either direction.
The above comments are meant to serve as food for thought as many of us in the US enjoy a long holiday weekend. I think the market is still laden with uncertainty and market participants are still widely divided on the view going forward. Whatever your individual view there is a high risk of reversals and changes in market sentiment at any time. The trading time horizon is still very short term making it even more difficult to get comfortable with a view and thus a flat price position to go with your view.
My individual market view is detailed in the table at the beginning of the newsletter. As I have been discussing the market is in a technical consolidation pattern with a low predictive level for the very short term time horizon. Prices remain within the technical triangular or consolidation pattern that has been in place for the last several weeks. However, as discussed WTI may be on the cusp of breaking out of the triangular pattern to the upside. If so we could see higher prices in the short term. For the short term I am keeping my overall view at neutral and as wells as my bias at neutral until the market breakouts out of the triangular consolidation pattern.
I am maintaining my Nat Gas view at cautiously bearish but keeping my bias to neutral as I still expect Nat Gas prices to make an attempt to test the $4/mmbtu level in the foreseeable future especially after yesterday's bearish EIA inventory report.
Currently asset classes are mixed as shown in the following table. We are at a long holiday weekend in the US as well as the end of the month which will result in window dressing continuing to come from the funds which could result in a continuation of the short covering rally in risk asset classes that seems to have begun yesterday.
Enjoy the three day weekend as the US kicks off its unofficial start of summer.
Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
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