Crude Oil Prices - July 29

[dan_s]

Oil prices wil be driven by the externals this week
By Dominick Chirihella - Sun 29 Jul 2012 04:42:30 CT
Related Keywords: Energy Share on emailShare on printShare on facebookShare on twitterShare on google_plusone Last week was all about jawboning out of Europe. First from ECB President Draghi followed up by comments from Germany's Merkel reinforcing Draghi's main comment that the ECB will do everything to support the euro. Support for this type of comment from Merkel is very important as Germany is where the money is. For now the jawboning was enough to send many risk asset markets into a modest end of the week short covering rally. However, we can't lose sight that these type of comments have been coming out of Europe for the last three years and so far the sovereign debt issues are still not solved.

The big question is will the bold comments finally be converted to actions.. especially this coming week as the ECB holds its monthly meeting on Thursday August 2. Will the ECB initiate a bold solution that puts the EU problems on the back burner once and for all which has not been the case for the last several years. Will they simply lower short term interest rates and issue the usual support of the euro comments or will their actions include stimulus and some form of bond backing or buying of bonds from the troubles EU member states? Whatever the ECB decides to do this week the market is now expecting actions that will support the debt problems and drive down the bond yields of the problem countries as well as send the euro into a much longer lasting rally that goes well beyond a simple modest short covering rally like we saw the last two trading days of last week. With the market now trading over the last few session with a strong ray of hope that the ECB and the EU will finally get a handle on the problems any disappointment next week will result in a huge push to the downside in the euro as well as in global equity markets.

Who said August is a quiet and sleepy time for global risk asset markets? Yes many participants are at the peak of the summer vacation season coupled with the London Summer Olympics at its peak but that is not going to prevent the markets from potentially active and volatile trading over the upcoming week and possibly for the rest of the summer. In addition to what is setting up to be a major ECB meeting on Thursday the US Federal Reserve FOMC will meet on Tuesday and Wednesday with many expecting the Fed to embark on a new round of quantitative easing of some form. The US economy has slowed to just a 1.5% growth rate a decline of 0.5% from the first quarter. The employment situation is not getting any better and the plethora of economic data that has hit the media airwaves over the last month or so has been supportive of further slowing of the US economy.

Is there enough negative data to support the Fed taking action now (as a recent WSJ article suggested) or will the Fed take a wait and see of what comes out for the ECB on Thursday while it awaits more data points like Friday's latest nonfarm payroll data? A new round of easing out of the US Fed is not a slam dunk at this meeting in my opinion. I think there are many reasons why it will be prudent for the Fed to wait another month or two before initiating a new round of easing that many believe will have limited success in bolstering the US economy and spurting the private sector hiring process. I do not think the Fed will act at this meeting and save their next so called silver bullet until the end of August at the Jackson Hole symposium (possibly mentioned in Bernanke's speech) or until the mid September FOMC meeting.

On top of the market volatility from the outcomes of the two the world's two major central bank meetings this week the US Labor Department will release the latest nonfarm payroll data and the headline unemployment number. This data is not only important for the QE followers but it will play into the upcoming election in the US. The current market consensus is for a 100,000 new net jobs created with the unemployment rate holding steady at 8.2%. The last several months the jobs data has come in well below the market expectations. In addition to the end of the week jobs data there is a full schedule of macroeconomic data out of the US this week...Chicago PMI, Consumer Confidence, construction spending, auto sales and factory orders all of which could be market moving data points as the market evaluates the data versus how it may impact the Fed's decision regarding more QE.

So what happens to oil this week. Both the WTI and Brent markets recovered a modest portion of their earlier week losses (see below for a more detailed discussion) but still lost value on the week across the entire oil complex. Aside from the very dynamic situation in Syria the geopolitical risk in the rest of the middle east region has been mostly quiet and will likely remain quiet for the next week or so. The main exposure area that could bolster oil prices will be a significant deterioration in the situation in Syria especially regarding the chemical weapons stockpiles in that country.

On the fundamentals side the global oil complex is comfortably balanced with supply still outstripping demand as we saw with the across the board builds in oil inventories in the US this past week. The current oil fundamentals do not support the current price levels and as such the current fundamentals are not the main price drivers of the global oil complex. I do not expect this situation to change in the short to even medium term.

Which brings me back to the macro relationships of oil and the so called externals or financial and economic data points that are currently the primary price drivers for the oil complex as well as the broader class of risk asset markets. How oil trades this week will be directly impacted by the outcome of the FOMC meeting as well as the ECB meeting and Fridays jobs reports. Oil market participants are now back in the perception trade or what will the forward fundamentals be if the US and EU central banks embark on more easing as well as more stimulus from China. All of these are money printing actions that will eventually have an impact on inflation and thus be viewed as bullish for oil and other commodities. The macro markets are all once again highly correlated and oil will likely move very much in sync with the US dollar, euro and global equities. This week (and possibly beyond) oil will move more directly with the externals and less so from the its own current fundamentals and geopolitics.

In spite of the short covering rally on Thursday and Friday the oil complex still ended the week in negative territory with RBOB gasoline leading the way lower. WTI declined more than Brent this week as US crude oil inventories continue to build even with refinery run rates at the highest level in several years (93% of capacity). The September WTI contract decreased by about 1.43% or $1.31/bbl while the September Brent contract ended the week with a decrease of 0.34% or $0.36/bbl. The Sep Brent/WTI spread widened by about $0.95/bbl for the week as the normalization process is still interrupted by lower loadings out of the North Sea. I still expect the spread to gradually continue to narrow over the next 3 to 6 months as the surplus in the US mid-west is also starting to recede from a combination of exports of crude oil out of the region through the Seaway pipeline coupled with refinery utilization rates at the highest level in months.