Last week was the third week in a row that oil prices declined. As I have discussed on numerous occasions the main price drivers have been geopolitics, fundamentals and the state of the global economic recovery. None of the three price catalysts have been overly bullish over the last few weeks including the number one price mover...the evolving geopolitics around Iran.
Over the last few days the rhetoric has inched up a notch as the April 13th/14th meeting between Iran and the West scheduled for Istanbul moves closer. President Obama tightened up the economic sanctions on Iran's Central Bank in a hope to motivate them to come to the negotiating table with a more open minded view than they had during previous face to face negotiations. Secretary of State Clinton is in the region over the weekend for other meetings and has mentioned to the media that the US is only interested in a strategy of prevention and not a containment policy for Iran. She also went on to say it soon will be clear whether Iran's leaders are prepared to have a serious, credible discussion about their nuclear program. It is up to Iran's leaders to make the right choice. She further warned Iran (via the press) that the window for diplomacy is closing quickly.
I would say that the market is likely approaching a floor (at least temporarily) in oil prices as the 30 second news snippets floating around the media airwaves over the next several weeks are likely to increase the fear and uncertainty level of most market participants. I also believe that the meetings will not result in a black and white peaceful solution with only minimal progress being made. The market may interpret that type of an outcome as one that could result in the Israeli's becoming more impatient and thus increasing the likelihood of some sort of military strike.
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I am expecting the geopolitical risk to still be high enough to result in oil prices starting to set up into a trading range with current prices or possibly a bit lower setting the floor and with the early March highs as the upper end of the trading range. Certainly if the lead-up and the outcome from the meeting is more positive that I am currently expecting them to be than the geopolitical risk will diminish quickly and oil prices will once again follow the fundamentals, technicals and global economy which at the moment are all still biased to the bearish side. I believe we are entering a period of high volatility with the market being very susceptible to sudden price reversals on each and every comment hitting the media airwaves on this topic.
Over the last week the oil complex was modestly lower across the board as participants continued to focus on the oil fundamentals as well as the global economic recovery. The Nymex WTI contract led the complex lower (after a huge build in US crude oil inventories) with Brent lagging WTI resulting in the Brent/WTI spread widening on the week. The May WTI contract decreased about 3.6% or $3.85/bbl adding to the losses from the previous week. The May Brent contract ended the week with a more modest decline of 1.8% or $2.25/bbl. The May Brent/WTI spread widened by $1.60/bbl and is once again approaching the highs it was out after breaking out when the tensions in the Middle East and Nigeria raised the risk of an interruption in supply with the market placing that risk premium more on Brent than on WTI.
On the distillate fuel front the Nymex HO contract decreased even as distillate fuel inventories surprisingly declined last week and as US distillate fuel exports declined on the week. The spot Nymex HO contract decreased by 1.69% or $0.0546/gal. Gasoline prices also declined on the week even as gasoline stocks declined more than the projections. The spot Nymex gasoline price decreased by 1.8% or $0.0608/gal this past week.
On the week Nat Gas futures declined strongly as the inventory injection season continued to outperform the historical data for the same time period. The spot Nat Gas futures contract declined another 10.4% on the week or $0.247/mmbtu. Have I said that Nat Gas is bearish? Yes it is still bearish after yet another fundamental snapshot that was bearish on all fronts. The downtrend remains solidly in play as the newly anointed spot Nymex contract declined by 5.8% on its first day of trading as the spot contract. As I mentioned in previous newsletters I expected the May contract to follow the footsteps put in place by the expiring April contract and that is exactly what it did on Thursday. There is nothing to change my view that Nat Gas futures contracts are destined to trade with a $1/mmbtu handle sooner than later. Yesterday's inventory report only added strength to this view with an injection level was above all of the market projections and historical trends for this time of the year.
At the current rate of inventory injections so early in the shoulder season the moment of truth could be arriving for the producing sector even earlier than I had originally expected. At the current pace of injections so early in the season inventories are likely to hit maximum working capacity (max capacity estimated by the EIA to be around 4.1 TCF) well earlier than normal. Simply put unless something significant changes on the demand side of the equation very soon (not very likely in my view) production cuts will have to be announced much sooner than I think the producing sector was planning on. Irrespective of the flat price of Nat Gas or the depth of the growing contango in the forward curve the industry is simply going to run out of places to store the unneeded Nat Gas sometime during the next 5 to 6 months. With the market in a classic glut it actually surprises me that the price of Nat Gas is not already below the $2/mmbtu level.
On the financial front equity markets around the world ended mixed to lower as the third week of retracements continue. The financial markets were mostly impacted by a series of macroeconomic data in several locations around the world...in particular China that indicated that economic growth may be slowing. The US was the only country whose economic data last week was still supportive of the gradual growth pattern that has been in place in the US for most of the last several months. Global equity values decreased as shown in the EMI Global Equity Index table below.
The EMI Index decreased by 1.2% on the week as shown in the following table. Over the last week the Index decreased in value even as the euro increased modestly while the US dollar declined marginally. Last week the global equity markets were a bearish price driver for oil and most commodity markets.
So far this has been an interesting investing/trading year with most risk asset markets gaining ground unlike the trading pattern that was in place for most of 2011. The outcome for the first quarter is shown in the EMI Investment Leader Board below. Natural Gas was the biggest loser on the board with the Nymex RBOB gasoline contract showing the largest percentage gain for the first quarter of 2012. Metals and agricultural commodities were mostly higher (except corn) while equities were higher in most places around the world. With all of the liquidity still coming from the US Central Bank the US dollar has continued to decline this year by almost 2%.
Gold ended the quarter in positive territory starting the twelfth year with gains in a row increasing in value by 6.61%. Silver soared past gold gaining 16.48%. Copper was up 11.44% even though the number one consumer of Copper...China is experiencing a slowdown in its economy. Copper is an industrial metal that is highly dependent on the Chinese economy (to a lesser extent other emerging market economies). China and the rest of the emerging market economies were lackluster in 2012 so far and thus the surprise gain in copper prices.
What a difference a new year makes less crops, a little more demand and Wheat and Soybeans end the quarter very strongly while Corn drifted lower by 0.39% for the quarter. Wheat was higher by 1.23% while Soybeans soared by 17.1%.
In the energy sector oil was able to hold onto positive gains across the board for the first quarter in the range of 4 to 26% with RBOB gasoline leading the complex higher as several US refineries shutter. In 2012 oil fundamentals played a bit of a supporting role in firming prices but the number one price driver has been the evolving geopolitical issues in the Middle East...in particular Iran. As discussed previously if the geopolitical situation surrounding Iran truly begins to ease than the fundamentals and the status of the recovering global economy will return to playing the major price driving role. For now those price drivers are biased to the bearish side.
On the other end of the energy complex...natural gas... the fundamentals have been the prime price driver and they continue to simply be bearish. Nat Gas has traded below the $3/mmbtu level throughout all of 2012 (sp far) with a strong possibility that it will be trading below the $2/mmbtu level sometime during the second quarter of this year. Nat GAs lost 28.9% of its value over the last three months with more downside yet to come.
On the equity front 2012 staged a strong recovery after a down year in 2011. As shown in the EMI Global Equity Index gained 11.5% after ending last year with a loss of 15.2% and just a 3.5% gain in 2010. China held the bottom spot of bourses in the Index Japan at the top of the list mostly driven by the declining value in the Yen. The US Dow and the Nasdaq both ended the quarter in positive territory as the US economy was the best performing developed world economy (at the moment)... albeit a very slowly growing economy. All in all it turned out to be a great quarter for equities which was mostly a positive for energy prices and the broader commodity complex (except for the last week or so).
Even though the spot WTI contract has now breached its key support level of $104/bbl that has been in play since mid-February we could be close to a temporary bottom as discussed above. I am continuing to keep my view at cautiously bearish with a big emphasis on the word cautious. If the market does in fact continue to decline the next level of support is now around $102/bbl and if this level is breached it could be an early signal that prices may be headed back to the pre-EU embargo levels.
I am still keeping my view at and bias at bearish. My overall view remains biased to the bearish side. The surplus is still building in inventory versus both last year and the five year average is going to get harder and harder to work off with only weeks until the start of spring. As such for the short to medium term I doubt Nat Gas is going to reverse the downtrend it has been in for an extended period of time. We may certainly see times when short covering rallies take hold but I do not expect a sustained trend change.
Currently markets ended the week mixed as shown in the table below.
Best regards,
Dominick A. Chirichella
dchirichella@mailaec.com
Follow my intraday comments on Twitter @dacenergy.
*Disclaimer: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed therein constitutes a solicitation of the purchase or sale of any futures or options contracts.
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