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Oil prices holding after failed OPEC meeting

Yesterday's OPEC meeting turned out to be a complete surprise outcome as OPEC concluded they could not come to a consensus and in essence it turned out to be a rollover agreement by default. The Saudi's and other GCC members pushed for a 1.5 million barrel per day increase in production but to no avail as seven of the 12 OPEC member countries voted against the increase. The Saudi Minister described this as the worst meeting he has ever attended in his 16 years as the Saudi Oil Minister. The more I think about the outcome of the OPEC meeting the more it makes logical sense to me. According to the May EIA STEO report (issued this week) only Saudi Arabia, Kuwait and UAE have any surplus crude oil capacity. So if OPEC agreed as a group to raise production then prices would go lower and everyone's revenue stream would decline. However, for the three countries that have surplus capacity they would make back some of the lost revenue as their volume exports would increase. So yes Saudi Arabia said they will increase production anyway but at least all of the other countries will not be sanctioning an action that will result in a lower revenue stream for the majority of the OPEC countries and until the market actually see's additional barrels of Saudi crude prices are not likely to decline very much(and in fact have risen post meeting).

Since the meeting the Saudi oil minister has repeatedly said that Saudi Arabia stands ready to supply any requirements but has not given a specific volume that they would increase production. He in essence said they will meet any new oil requirements that are brought to them. He indicated the Saudi concern was to not negatively impact the global economic growth as he sees more demand coming down the road and the Saudis are willing to meet that demand as much as they can. This all seems to me to be the Saudi's now making a decision to go it alone as they are the only ones with substantial surplus capacity (albeit not the highest quality crudes) and the most aligned with the consumer world than just about any other OPEC country.

It also suggests to me that OPEC as an organization was made less relevant after this meeting as the quota system has pretty much been thrown out of the window. With most OPEC countries producing at maximum capacity I certainly do not see the relevance of OPEC . As global demand continues to grow and with none of the OPEC countries (with the exception of Saudi Arabia) seemingly investing in bringing on new capacity (increasing their surplus capacity) they are going to simply produce at their current maximum levels unless the price of oil falls precipitously. With the call on OPEC crude projected to grow into the second half of this year the likelihood of a price collapse is very low.

Even if Libya comes back on stream the additional demand growth over the next year will still require a higher level of OPEC production than what is currently being produced by about 1.5 million barrels per day or so. In conclusion this may turn out to have been a very historic OPEC meeting. A meeting that could signal the beginning of the end of OPEC as we know it today. The outcome of the OPEC meeting was bullish in the short term from the perspective that no new oil seems likely to flow anytime soon. It is unclear as to when additional Saudi oil will hit the market. Based on the Saudi minister's comments that they stand ready to meet demand growth suggests to me that the market will not see a significant increase in Saudi production until we get well into the second half of the year. For now it is status quo.

Yesterday's EIA inventory report impacted the direction of oil prices and supported the post OPEC meeting market sentiment after a significantly larger than expected decline in crude oil stocks that dominated the view and offset the negative sentiment from the build in refined product inventories. Although the market mostly embraced the EIA report the fundamentals were an overall negative in that total commercial stocks (crude oil and refined products combined) increased modestly resulting in the sixth weekly gain in stocks out of the last seven weeks. It is certainly looking like the inventory destocking pattern that has been in place is coming to an abrupt halt. In fact in the last six weeks total commercial stocks in the US have increased by about 33 million barrels. The inventory trend is definitely back into a building pattern.

The market did react strongly to Wednesday's EIA inventory report as a result of most other drivers remaining relatively quiet and after the surprise outcome from the OPEC meeting. The market viewed the report as biased to the bullish side with prices for everything mostly increasing immediately after the data was released. For the sixth week in a row investor/traders garnered price direction guidance from outside the umbrella of the normal macro events like the geopolitics and the falling USD... only this week it was to the upside (at least up until this morning so far). Overall Wednesday's EIA inventory was biased to the bearish side (irrespective of how prices evolved on the day). The inventory report showed a large increase in total stocks, a small increase in implied demand, a modest increase in refined products inventories along but a strong decline in crude oil stocks. With refinery margins still holding (last week) refinery utilization rates increased on the week to 87.2% of capacity an increase of 1.2% in refinery run rates. The EIA oil inventory report was overall bearish across the complex (except for crude oil). The data is summarized in the following table along with a comparison to last year and the five year average for the same week.

Total commercial stocks of crude oil and refined products increased on the week... by 1.5 million barrels. The year over year status of total commercial stocks of crude oil and refined products remain in a deficit position for the twelfth week in arrow. The year over year deficit narrowed strongly to 27.2 million barrels while the overhang versus the five year average for the same week widened to 23.6 million barrels.

Crude oil inventories decreased strongly versus most expectations for a modest decline due to a projected increase in refinery runs and a big drop-off in imports related to the temporary shutdown of several key pipelines out of Canada. The main one...the Keystone pipeline has been restarted and we should see an increase in imports in next week's report. The crude oil inventory overhang versus last year narrowed to around 7.5 million barrels while the surplus versus the five year average also narrowed to 26.1 million barrels. PADD 2 stocks decreased strongly as did Cushing stocks but again all due to the temporary shutdown of several key pipelines out of Canada. Basis this week's data suggests that there should be a bit less market pressure on the WTI/Brent spread. However, with production problems expected to persist in the North Sea (Forties in particular) and with the restart of the Canadian pipelines I do not expect WTI to continue to appreciate significantly versus Brent.

Distillate stocks built for the first time this year and modestly more than the market expectations. Heating oil/diesel stocks increased by 0.8 million barrels versus an expectation for a build of around 0.5 million barrels. The year over year deficit widened to 13.9 million barrels while the five year average overhang narrowed to 8.6 million barrels. The big story on the distillate front is the additional flow of distillate fuel to China as their hydroelectric power capacity has been severely impacted by an ongoing drought. This has resulted in distillate fuel from all over the world heading in that direction as they continue to increase their imports. In addition as I discussed in an earlier newsletter this week the economics of strong distillate fuel is marginal at best so even now that distillate fuel has built I would expect the injections into inventory to continue to underperform until the contango widens further from current levels.

Gasoline inventories increased strongly on the week versus an expectation for a modest build in stocks. Total gasoline stocks increased by about 2.2 million barrels on the week versus an expectation for a draw of about 0.8 million barrels. Over the last three months or so gasoline stocks are now higher by about 0.6 million barrels. The deficit versus last year narrowed to 4.5 million barrels while the surplus versus the five year average for the same week widened to 6.0 million barrels. With gasoline demand still depressed and refinery runs and imports on the rise it certainly looks like there will be plenty of gasoline for the upcoming driving season which is now in play in the US.

The following table details the week to week changes for each of the major oil commodities at every level of the supply chain. As shown I have categorized everything in the complex as bearish except for crude oil which I would say is temporarily bullish as supply is likely to increase next week as pipeline oil is back to flowing from Canada to the US. However, I still have to call the overall report biased to the bearish side.

Now that the vast majority of the fundamental news has hit the market and is in varying stages of being digested by the market we have to once again turn our attention to some of the external drivers that have been impacting the price of oil. The US dollar has been under pressure for most of the week as the euro has recovered some of its losses as it now appears that the EU will kick the can a bit further down the road insofar as Greece's sovereign debt issues are concerned. A falling US dollar is supportive for oil prices and is partly contributing to the pop we have seen in prices over the last few days.

On the equity front global equity values continue to lose value as shown in the EMI Global Equity Index table below. The Index is now down by 1.6% on the week widening the year to date loss to 4.9% resulting in the EMI Index being at the lowest level of the year. Only three of the ten bourses in the Index are still in positive territory for the year... US, Germany and Paris. With China expected to raise short term interest rates yet again and/or raise bank capital reserve requirements we are likely to see additional losses in equity value coming from China and possibly bleeding into the global equity markets as well as being a negative for oil prices and the broader commodity complex. China releases it trade balance data tomorrow and its CPI data on Monday. The expectations are for inflation to still be growing with many expecting further tightening by the government any day now. Equities continue to be reflective of a slowing global economy and are thus a negative for oil prices.

My individual market view is detailed in the follwoing table. For today I remaining neutral for my oil view and bias. The oil complex is very choppy and I think we will get a post OPEC meeting push lower as I view yesterday's reaction as more short covering related than a new conviction to buy at current levels. That said I also do not expect much of a push to the downside and I think going forward we may be back to moving into a buy the dip mode. At this point I am not sure where a dip can bring us yet. Technically we could go as lows as around $98/bbl. For today I am remaining on the sidelines until all of the fundamental events have been fully digested by the market.

I am keeping my Nat Gas view at neutral and my bias at cautiously bullish. The market has broken out of its technical breakout with the $4.70 to $4.71/mmbtu level now a new support level. If one does go outright long and the market does move higher (as it did yesterday) you should trail the aforementioned stops upward with the market move.

Of note early yesterday evening the spot Nymex Nat Gas contract experienced a mini flash crash in that prices declined about 8% in about 15 seconds likely the result of the algo traders. That said was this a pre-warning that Nat Gas may be getting toppy and getting ready for a downside correction from current levels? With EIA stocks set to hit the market at 10:30 AM EST be on caution alert as all projections are calling for an underperformance in injections. If there is any bearish deviation from that view we could be in for a wild ride to the downside today.

Currently asset classes are mixed as shown in the following table.

Best regards,

Dominick A. Chirichella

dchirichella@mailaec.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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