Last week was all about the surprise announcement by the IEA
to release 60 million barrels of oil during the month of August
with 30 million coming from the US. In addition the uncertainty
surround the Greek bailout program added further volatility in
the market. The net result was a broad sell-off with Brent
leading the market lower. For all of the reasons I discussed in
last week's newsletter this was an action very similar to what
occurred in the past when various government have intervened in
the foreign currency markets. It is now happening with oil and
the IEA is acting as a Central Bank on behalf of the IEA member
countries like the US. The market is still in sell mode this
morning with Brent once again taking the lead to the downside.
Since the announcement last week the spot Brent/WTI spread has
narrowed by about $6/bbl and is clearly on its way to moving back
into the range I predicted about a week or so ago of $10 to
$12/bbl premium to Brent.
Needless to say many OPEC members are angry over the IEA's
actions with Iran continuing to criticize the IEA suggesting that
the market should set prices not the IEA. Interesting that these
comments are coming from one of the most adamant price hawks in
OPEC. The reaction by OPEC may be a warning sign that OPEC
(especially the price hawks) may in fact slow production down if
prices continue to slide. In addition Saudi Arabia may find that
it is not necessary on their part to increase production any
further setting the market up for a bit of a price standoff in
the coming month or two.
Whether or not the price of oil falls strongly from current
levels or stabilizes the fact that the IEA is trying to force 60
million barrels of oil into the market at time when it is not
really needed should have an impact on the shape of the forward
curve and how much of this added oil simply moves from government
controlled storage to trader controlled commercial storage in
contango trades. The following chart captures what I am calling
the Contango Watch as the forward curve has already changed shape
as the contango is moving in the direction of storage. The chart
looks at the Sep/Dec spread for WTI, Brent, NYM HO and ICE
Gasoil. In all cases the spread is in a contango but not quite
enough to justify opportunistic storage trades at this point in
time. With the exception of the NYM HO all of the other three oil
commodities have seen a widening of the contango since the IEA
announcement with the Brent forward curve changing dramatically
over the last several days.
With the exception of heating oil the other three oil commodities
are not yet ready for a storage trade. I used a 2% per annum
interest rate (adjusted for four months of storage) as a premium
over the current Libor rate. The last column in the table shows
the maximum one can pay (over and above the cost of money) to
store the oil for four months. As shown depending on the
facilities (on land or floating storage) it is getting closer and
thus I would say more interesting to the trading community. I
will update and publish this table from time to time to gauge the
developments for opportunistic storage trades going forward.
Oil and financial market prices will not only be driven by the
ongoing IEA action but also by a plethora of macroeconomic data
that will hit the media airwaves...including measures of the
state of the energy intensive manufacturing sector. Last month
PMI data from around the world strongly suggested that
manufacturing was slowing. Last week the preliminary data out of
China indicated that the slowing may be continuing. Data will
also be released on consumer spending in the US...always an
important data point as over 70% of US GDP is based on consumer
spending.
In addition to the potential market impact from this week's
round of macroeconomic data the Greek Parliament has to vote on
the five year austerity plan with two key votes coming on
Wednesday and Thursday. Needless to say there will be many 30
second news snippets hitting the media airwaves this week which
will definitely impact the short term direction of the currency
markets as well as the financial and commodity markets.
Risk asset markets were in sell mode last week with the energy
complex leading the way lower especially during the latter half
of the week. Both oil and Nat Gas depreciated in value on the
week. The geopolitical based oil risk premium is still in place
but the way oil has been trading (basis WTI & Brent) a major
portion of the risk premium has receded back the level it was at
earlier in the year...thanks to the IEA announcement. Financial
markets were mixed on the week on an overall slowing of the
global economy sending negative signals to the market sentiment
along with the evolving sovereign debt issues in Europe. Equity
markets were lower in both the developed and some developing
world markets...led by the Asia economies as inflation fighting
continues in that region of the world followed by a slowing in
the developed world. Precious metals were hard hit ending the
week with strong losses.
Over the last week the oil complex decreased strongly with Brent
leading the way lower. The spot WTI contract appreciated strongly
versus Brent even as crude oil inventories built in PADD 2.
However, the announcement by the IEA releasing at least 30
million barrels of light low sulfur crude oil sent the Brent
contract in free-fall last week. WTI traded and ended the week
solidly below the key technical support level of $94.50/bbl level
while the spot Brent contract closed below the $110/bbl mark. The
Aug Brent contract ended the week with a loss of 7.15% or
$8.09/bbl. WTI decreased by 2.4% or $2.24/bbl. WTI lost about
$6/bbl versus Brent this past week. The spread actually traded at
a record high differential just two weeks ago.
On the distillate fuel front the Nymex HO contract decreased
strongly as distillate fuel inventories increased modestly versus
an expectation for a small seasonal build. Spot Nymex HO
decreased by 7.81% or $0.2330/gal. Gasoline prices experienced a
decline on the week as gasoline stocks increased for the seventh
time versus an expectation for a small build. The spot Nymex
gasoline price decreased by 5.75% or $0.1694/gal this past week.
The modest decline in WTI prices resulted in the 3-2-1 crack
spread losing about 20% on the week.
Nat Gas was under pressure for the latter part of the
week...especially after breaking down technically. The spot Nat
Gas contract is now trading below the $4.40/mmbtu technical
support level leaving the door wide open for a test of the
technical and psychological $4/mmbtu level. Nat Gas lost 2.2% of
its value or $0.096/mmbtu.
The latest weather forecast out of NOAA are projecting above
normal temperatures over a large area of the eastern half of the
US but not yet into the large population center along the east
coast. Yes cooling demand is likely to increase over the next
several weeks but how much of the additional cooling demand will
translate directly to Nat Gas is still a big question. The
nuclear situation has continued to improve over eh last several
days. As of today the gap between shut down production this year
versus last year has narrowed to 2,600 MW while the gap versus
the five year average for the same week also narrowed to 2,900
MW. Thus I would expect a major portion of the additional cooling
related demand to be met from nuclear power generation and only
marginally form Nat Gas capacity over the next several weeks. If
this pattern continues than injections into inventory are likely
to outperform over the same timeframe.
On the financial front equity markets around the world ended
the week marginally higher even as an economic slowdown continues
to umbrella the investing world. Global equity values recovered a
bit as shown in the EMI Global Equity Index table below as the
market started viewing lower oil prices as a positive for
equities. The EMI Index gained 0.5% on the week after a strong
loss the previous week. The EMI Index is still lower by 6.7% for
the year with seven of the ten bourses still in negative
territory. The US Dow is still marginally in the top spot of the
winner's column...but barely above Germany. 2011 has certainly
been a poor equity investment climate so far. However, last week
the global equity markets were a neutral to even marginally
positive for oil prices as well as the broader commodity complex.
The US dollar index was higher on the week as the EU sovereign
debt situation remained unclear as to how the main players will
structure the Greek bailout. The currency markets are still in
the midst of a major realignment as I have been warning for
weeks. Cash flowed out of gold (and the rest of the precious
metals complex) which decreased by 2.48% on the week.
My individual market view is detailed in the following table.
For today I am maintaining my bias at cautiously bearish. I still
think there are more indications that expose the market to a
period of choppy trading but with a downside bias. Technically
the market remains below key technical support levels indicating
a potential for lower prices in the short term. We remain in a
high risk/low reward environment for flat price trading in the
short term. As mentioned last week I still favor shorting
calendar spreads during the period when the SPR oil will be
released. As I have outlined for over a week the risk in the oil
complex is underperformance on the demand side and over
performance on the supply side. That view still holds and has
been bolstered by the IEA actions from last week.
I am maintaining my Nat Gas view and bias at cautiously bearish
as prices are now pointed toward the lower support level of about
$4/mmbtu. The market seems to be setting up for a test of the
$4/mmbtu technical and psychological support level.
Currently most risk asset classes are lower as shown in the
following table.
Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.