Crude Oil Commentary

Oil futures prices edged lower Tuesday, but remained north of $100 a barrel, as traders awaited further word on Europe’s debt crisis ahead of a key summit later this week. Light, sweet crude for January delivery on the NYMEX settled up $.29 at $101.28/bbl. Brent crude on ICE Futures Europe traded up 32 cents, or 0.3%, to $110.13 a barrel.

Trading remained cautious following an announcement from Standard & Poor’s late Monday that the ratings agency had placed 15 euro-zone nations on review for credit downgrades due to the deepening political and economic crisis. Reports of the announcement surfaced shortly before Monday’s close and squelched a rally that had earlier sent NYMEX futures surging above $102 a barrel.

Headlines out of the euro zone have been dominating trading in the oil market for the last several months, amid worries that the currency zone’s sovereign-debt crisis could trigger a broader economic slowdown that would curb demand for crude oil.
NYMEX crude futures have climbed from lows at less than $80 a barrel since early October, while Brent has surfaced from below $100 a barrel, largely on optimism that Europe will find a way to save the single currency zone from collapse.

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Outlook Today

The natural gas market view and bias is cautiously bullish, but watchful of how price activity plays out over the next several trading sessions from Thursday’s bullish gas storage report and last Friday’s monthly jobs report. The market appears to be slowly moving into a mild uptrend and will remain in that pattern as long as the weather moves toward more normal conditions.

WTI crude oil is still trading above the key technical support level of the mid- $94’s/bbl and along with the changing fundamentals and geopolitics, the market is moving its view and bias back to cautiously bullish. The cloud of uncertainty got slightly smaller in Europe, but support is now coming from the ongoing geopolitical risk in the Middle East.

Earlier risk asset prices were mixed, as shown on the chart below.

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Outlook Today

The natural gas market view and bias is cautiously bullish, but watchful of how price activity plays out over the next several trading sessions from today’s expected bearish gas storage report and Friday’s monthly jobs report.  The market appears to be slowly moving into a mild uptrend and will remain in that pattern as long as the weather moves toward more normal conditions.

WTI crude oil is still trading above the key technical support level of the mid- $94’s/bbl and along with the changing fundamentals and geopolitics, the market is moving its view and bias back to cautiously bullish.  The cloud of uncertainty got slightly smaller in Europe, but support is now coming from the ongoing geopolitical risk in the Middle East.

Earlier risk asset prices were mixed, as shown on the chart below.

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World Economy

Europe remains the main risk asset price driver, but other things are happening around the world and some of these are also working their way into the mix as a market price driver. Overnight the Chinese government cut bank reserve requirements by 0.5% from December 5th onward as China now seems to be moving toward an accommodative monetary policy. The move by China was welcomed in the market place as China now seems to be joining the developed world economies and slowly starting to stimulate the largest economic growth engine in the world.

European Finance Ministers agreed yesterday to guarantee as much as 30% of new bond sales from problem member countries to enhance the regions bailout fund and to enhance its ability to cap yields by also buying bonds. In addition the Finance Ministers are seeking a larger role for the IMF and the ECB in fighting the debt problems. Europe is continuing to move forward in trying to solve their debt issue problems with the market still somewhat skeptical that it is even a solvable problem in the short term. But at least for the moment the panic mentality has been somewhat abated. The cloud of uncertainty remains in place, but it is not getting any larger at the moment.

On top of all of the economic issues around the world, the geopolitical risk in and around the greater Middle East is continuing to widen. At the heart of the problem is the evolving nuclear situation in Iran and the ramifications of many direct and indirect actions slowly taking place by the West. A new round of sanctions by the U.S. is moving forward that are designed to make it more difficult for Iran to receive payment on its crude oil sales. China, Japan and India, along with the EU region, are the main buyers of Iranian crude oil. In addition to the U.S. sanctions, the EU Foreign Ministers are meeting tomorrow to discuss the issue of Europe embargoing Iran crude oil from the region. Whether or not they will do it remains to be seen, but if they do impose such an embargo, we can expect the Saudis to step up and replace those barrels. It is not likely to see a sustainable price spike in the event that the Europeans embargo Iran, as Saudi oil will offset and solve the logistics. However, if the Saudis do not step up to the table (a low probability) then of course we will see a price spike of some magnitude.

Even with protesters moving into the UK Embassy yesterday, oil prices have been relatively calm with only a minimal risk premium currently embedded in the price. The fact that Iran and Syria have moved further into the forefront of events that could result in a potential supply disruption they will at a minimum keep a floor on any major price selling at this time.  Also with the fragility of the global economy, especially Europe, along with the growing geopolitical risk in the Middle East, the December 14th OPEC meeting is going to be very interesting to say the least. We are likely to see a clash of perspectives between those calling for a cut back to pre-Libyan civil war levels and those suggesting no change. It is likely there will be no change at this time, especially with Brent still well over $100/bbl and WTI within shouting distance of a triple digit price level.

Natural Gas Commentary

January natural gas futures prices started its run in the lead position today on an upswing, with weather support and revised outlooks for this week’s storage report helping to build support back under the market following sharp losses for the expired December contract and the fresh front-month ahead of its first day in the lead. Spanning $3.525 to $3.633/MMBtu through the session, the contract settled up $.108 at $3.633/MMBtu, gaining momentum as traders look to colder winter weather, stronger demand and expectations of an upcoming string of pulls from natural gas inventories to drive stocks down from their current historically high levels. Technical support for January natural gas is seen at $3.50, $3.25, $3.00 and $2.75, while resistance is marked near $3.75, $4.00, $4.25, $4.50 and $4.75/MMBtu.

You will note the profound uptick in the near month gas futures price in the chart below as January took the near month position today.

Short-covering ahead of the arrival of colder air to key heat-consuming regions bolstered the market. As temperatures cool, the market expects stronger demand will begin to draw stocks down after a 9-Bcf injection reported in the week to Nov. 18 drove working gas inventories to a record-high 3,852 Bcf. But before the onset of steady storage withdrawals, the market anticipates another smallish build in stocks for the week to Nov. 25, as mild weather is expected to have combined with the Thanksgiving holiday to deflate demand.

While early forecasts called for a storage build of about 10 Bcf when the EIA releases its data at 10:30 a.m. ET on Dec. 1, revisions are taking that number lower as traders assess the likely impact of some chilly weather on storage building. While forecasts run widely from modest draws to a build of up to 20 Bcf, most outlooks now suggest a build of about 8 Bcf, which will compare bearishly to a 29-Bcf five-year-average withdrawal and a 21-Bcf pull reported in the corresponding week last year.

Day-ahead, spot markets were being supported by colder weather as higher demand was expected on regional power grids Nov. 30. Deals at the benchmark Henry Hub in Louisiana were up about $.30 on average in deals indexed near $3.40, while action at Transco Zone 6 NY in the Northeast lifted about $.42 into the $3.70s/MMBtu.

Natural Gas Commentary

December natural gas futures prices were slightly higher after the release of U.S. Energy Information Administration (EIA) gas storage data Thursday, Nov. 17.   While rising to a $3.479/MMBtu high following the midmorning release of the data, the contract settled up $.066 at $3.410/MMBtu, supported by a significant miss in the forecasted build in stocks for the week to Nov. 11. Technical support for December natural gas is seen at $3.20, $3.00 and $2.75, while resistance is marked near $3.50, $3.75, $4.00, $4.25, $4.50 and $4.75/MMBtu.

The sustainability of any price advance remains in question as the market eyes a storage injection above both the year-ago and five-year averages that should take inventories to levels heretofore unseen. The EIA reported a 19-Bcf storage injection that while above both the 10-Bcf five-year average build and the 1-Bcf withdrawal reported in the same week in 2010, was well below consensus estimates coming into the day, formed near 29 Bcf and within the wider range of outlooks from 20 Bcf to 32 Bcf. The build still brought stocks to a fresh all-time record high at 3,850 Bcf, 14 Bcf above last year and 224 Bcf above the five-year average of 3,626 Bcf.

Despite the record high storage, traders sold into the market amid oversold conditions as the storage miss was enough to spark the waiting bulls into action. But upside momentum remains limited by the overwhelmingly healthy supply of natural gas in storage combined with outlooks for ongoing mild weather and additional storage builds through the end of November.

Additional gas price downside risk continues from weather that refuses to recognize the calendar as temperatures across most of the country are expected to remain above average, generating limited demand for either heating or cooling.

At day-ahead, spot markets, prices for next-day gas delivery to key hubs across the United States varied as regional demand support shifted by changes in weather drove gains in some regions and losses in others. At the benchmark Henry Hub, the Friday product moved in ranges near unchanged on the day amid a lack of substantial changes in demand, while futures moved off the downside of the prior session to trade higher on Thursday. Deals spread from the upper $3.00s to $3.10s with a bias to the downside. At Transco Zone 6 NY however, the market was sharply higher as some cooling was expected to lift demand on regional power rids. Deals at the hub spread from the $3.50s to low $3.60s advancing about $.11 on average on the day.

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Crude Oil Market

The main feature in the oil complex was the Seaway acquisition announcement followed by Enbridge indicating they planned to reverse the direction of the pipeline flow, likely to send about 150,000 barrels per day from Cushing, OK to the U.S. Gulf by mid-2012. This announcement triggered a massive unwinding of the Brent/WTI price spread, which was already in the process of slowly unwinding since peaking around $28/bbl back in mid-October. After the announcement, the spread narrowed by about $4/bbl in less than an hour, resulting in the near month WTI contract breaching the $100/bbl mark and remaining above this psychological level for the remainder of trading (and into today so far). By the end of the session, the price spread recovered a bit of its earlier losses with selling resuming once again this morning as the near month price spread is now trading around $8.20/bbl.  Many are now forecasting the price spread will drop to around $6 to $6.50/bbl in the not too distant future with a return to normal (WTI over Brent) sometime down the road.

The oil market seems much more convinced that the spread will return to a more normal relationship soon. PADD 2 inventories have been destocking since peaking back in early April. Stocks in this region of the U.S. have declined by almost 16 million barrels during the same period and are now only a few million barrels above last year at this time. Last year at this time, the price spread was trading around a $2/bbl premium of Brent over WTI. With inventories in PADD 2 still in a destocking pattern, we can expect the spread to retrace closer to even or possibly back to WTI trading at a small premium to Brent within the next two to three months.

Oil is flowing out of the Cushing, OK region by other means other than the pipeline. PADD 2 stocks are currently about 4 million barrels below the level they were at when the price spread was last trading with WTI at a premium to Brent, while Cushing stocks are about 5 million barrels lower. Thus the U.S. Midwest crude oil inventories are not surplus and are not the driver of Brent trading at a premium. At current inventory levels, the spread should already be trading with WTI at a premium over Brent. The Enbridge announcement is just another added bearish driver of the price spread.

So what else is driving the spread? Libyan oil is still underperforming and will so for a considerable period of time. The IEA expects Libyan oil production to return to about half of its pre-civil war level by the end of the year. This coupled with North Sea production operating at near normal levels along with the European economy barely growing (and talk of further refinery cutbacks), provide little reason why Brent should be carrying a premium over WTI for much longer. Thus most of the factors suggest that the price spread should return closer to normal, historical levels possibly within the next few months if not sooner.

Aside from the Brent/WTI storyline, the markets have been dominated by the situation in Europe after Fitch issued a report late in the day indicating that the large U.S. banks had exposure to Europe, but were basically ok for now as long as the Europeans solve the problems quickly. This report sent most risk assets markets into a massive sell-off in the last hour of trading in the U.S. It is almost impossible to pay attention to anything else in the market as what will happen with Europe outweighs any and all price drivers for oil. In spite of relatively positive economic data and bullish fundamentals (like yesterday’s EIA oil inventory report), the market sentiment has been bearish and remains bearish with oil and everything else trading as if the entire European Union is still on the cusp of collapsing (which it could).