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The Greece debt crisis dance continues with the market slowly starting to believe there will be a new bailout program and the EU, et all will have kicked the can down the road for the second time. Today Greece's government face a vote of confidence with a decent chance that the government will survive and if so it will likely open the door for the next batch of bailout money to flow into Greece. As I have been indicating for days a resolution of the Greece situation is likely and will quickly change the market sentiment toward a more favorable outlook of risk asset classes as we have seen over the last few days already. Since the end of last week we have seen some modest short covering rallies in global equity markets, a reversal in the oil complex as prices move back toward the key technical resistance level as well as a move back toward US dollar weakness.
Does this mean that oil and other risk asset markets are now in the beginning stages of the next up leg? I don't think so as it is way too early to come to any upside conclusion based on an improved outlook over the never ending Greek and broader EU sovereign debt saga. The uncertainty surrounding the Greek bailout over the last few weeks has served to elevate the core problem facing most all risk asset markets...a slowing global economy. Whether or not a Greek bailout flows today, tomorrow of sometime in the near future the developed world economies are growing at a snail's pace while the emerging market world continues to intentionally tighten the reins on its economies. As discussed in yesterday's newsletter the risk in the oil complex is still one of underperformance on the demand side of the equation and over performance on the supply side in the short to medium term...irrespective of the outcome around Greece.
For now and likely for the next few days the oil complex will be very susceptible to short covering rallies as we started to see late yesterday and into overnight trading so far. The market is currently positioning itself for the outcome of the US Fed FOMC meeting which starts today and ends tomorrow with another presser from Chairman Bernanke. In addition the weekly oil inventory cycle gets underway this afternoon which is setting up for another potential draw in crude oil stocks (see below for a more detailed discussion). So what are the main headwinds and tailwinds we can expect in the short term and the ones we need to watch closely throughout the upcoming trading sessions?
Greece will be in the news for at least the rest of this week. I continue to expect a deal to be agreed upon and announced possibly as early as Friday or Saturday. As the week progresses I think Greece will move from being one of last week's major headwinds to this week's (and into next week) mild tailwind but more from the perspective of a relief move rather than a view that the EU debt problems are gone for good. Greece will return in the future (or Spain or Portugal, etc.). A positive around Greece will likely result in a short covering rally in the euro which will add further pressure on the US dollar. This will be a positive for oil prices as well as most risk asset markets in the short term but again not a structural move rather a relief move. This week's US Fed meeting will result in the FOMC saying everything it can to try to convince the market that they will continue to follow an easy money policy short of initiating QE3. They will leave short term interest rates at near zero for an extended period of time and continue to run with an inflated balance sheet. Bernanke will likely put as much of a positive face as he can that the US economy is only in a soft patch and growth will begin to pick up in the second half of the year while inflation remains transitory. Barring a major QE surprise (not very people are expecting it) the outcome of the meeting will mostly be a neutral as it will end as most expect it to end. On the fundamental side the current forecasts for inventories is neutral to supportive for crude oil and could provide a short term floor in prices for the next few days (see below). The supply side risk for oil is biased to the downside as the main news that is likely to hit the media airwaves will be more supply from the North Sea, a return of lost supply from Bonny Light in Nigeria in August and more oil flowing into the market from Saudi Arabia over the next several months. The potential outperformance on the supply side could outweigh any positives from the weekly inventory reports. The fighting in Libya rages on with no indication that Gaddafi is yet ready to leave. Yesterday the opposition group cut off pipeline supplies to a refinery that feeds the Gaddafi side which could result in an intensification of the fighting. The IEA indicates that Libyan oil will not return back to its 1.6 million bpd pre-civil war production level for at least a year or more. That said if Gaddafi does exist some amount of oil will begin to flow in the short term as money is the key issue for both sides. Technically the market is hovering around key resistance levels for both WTI and Brent. The July WTI contract expires today so all focus should be on the August contract. As of this writing the August WTI and Brent contracts are both within about a $1/bbl or so of the next key technical resistance level (around $96/bbl for Aug WTI & about $113.25 for Brent). There are enough short term tailwinds (as discussed above) that we should see a test of resistance this week. Whether or not we can solidly breach these levels and embark on a new up leg is a big question mark and one I am not overly positive on at this point in time.With the markets looking for oil price direction we may see the weekly inventory reports have a directional impact yet again this week. At the moment with all of the financial uncertainty permeating around the global markets it is difficult to say when this week's report will impact the market (if at all). The normal weekly reports get underway late this afternoon when the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Wednesday morning at 10:30 AM (EST). My projections for this week's inventory reports are summarized in the following table. I am expecting a mixed report with a modest decline in crude oil stocks as a result of another week of reduced imports and a small increase in refinery utilization rates. I am expecting a modest build in both gasoline inventories and distillate fuel stocks. I am expecting crude oil stocks to decline by about 1.3 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil would move into a small deficit of about 0.9 million barrels while the overhang versus the five year average for the same week will also narrow to 20.8 million barrels. My projection risk for crude oil is to the upside as stocks could have actually built depending on the combination of how much additional crude oil came through the Keystone pipeline versus the level of refinery runs in PADD2.
If the inventories are in line with the projections I would expect to see another decline in both PADD 2 and Cushing crude oil stock levels which would potentially impact the Brent/ WTI spread. Since peaking around June 15th the spread has narrowed by about $4.50/bbl. As I discussed in last week's newsletter I expect the spread to continue to narrow. With the WTI contango not very economical for storing oil and with US refiners gradually increasing refinery utilization rates... inventories in this region are looking like they are entering a destocking pattern. PADD 2 stocks are now back down to earlier year levels when the spread was trading in a range of $12 to $14/bbl premium to Brent. If stocks continue to decline I would expect the low double digit level as the next target for the spread during what looks like the correction phase.
With refinery runs expected to increase by about 0.2% I am expecting a modest build in gasoline stocks as demand likely decreased while imports possibly increased. Gasoline stocks are expected to build by about 1.0 million barrels which would result in the gasoline year over year deficit narrowing to about 1.5 million barrels while the surplus versus the five year average for the same week will widen to about 7.2 million barrels. All eyes will be focused on the gasoline number once again this week after last week's surprise build in stocks for the fifth week in a row.
Distillate fuel is projected to increase modestly by 0.5 million barrels on a combination of no weather demand as well as an increase in production. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 15.6 million barrels below last year while the overhang versus the five year average will be around 6.2 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 saw across the board builds in inventories for everything other than gasoline stocks versus this week's projected mixed report. In fact the builds last year are much greater than this week's projections so in general the fundamentals may gain some ground versus last year for the second week in a row.
On the equity front global equities have stages a modest short covering rally over the last twenty four hours as shown in the EMI Global Equity Index table below. The Index is now up by 0.4% for the week resulting in a narrowing of the year to date loss to 6.8%. For the first time in a long time all ten bourses in the Index gained ground over the last twenty four hours. That said seven of the ten bourse in the Index are still in the red for 2011 to date with the US Dow still holding the top spot with Brazil continuing to lag the pack significantly. In the very short term equities and the US dollar have both turned mildly supportive for oil prices as well as for most risk asset classes. However, as discussed above this is a short term move that so far is mostly based on short covering and not yet a structural change in the ongoing market sentiment.
My individual market view is detailed in the following table. For today I am moving my bias back to neutral as I think there are more indications that expose the market to further short covering in the near term. I expect the Brent/WTI spread to continue to narrow and if a short covering rally continues on the crude oil side I would expect the cracks to take a modest hit in the short term.
I am maintaining my Nat Gas view and bias at cautiously bearish. I am closely watching the $4.40/mmbtu level which is now my resistance/stop level for a short position.
Currently most risk asset classes are higher as shown in the following table.
Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.
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