Crude/Products:
The complex drifted back down overnight toward the $50 mark as it continues to trail daily swings in the equity markets as well as shifts in the US dollar, particularly the relationship between the US currency and the Euro. We look for this comparatively close correlation to be maintained through the rest of this week that will be shortened by Good Friday. This price consolidation in nearby crude futures is mimicking similar patterns in the stock market that appear to be digesting exceptionally strong gains of the prior 4 weeks at this early stage of a new quarter and amidst a week in which the economic calendar will prove relatively light. Following an expected sideways trade at around the pivotal $50 level today, the energy futures will shift attention to tomorrow’s weekly EIA stats that could force a brief price response to the crude as well as some shifts in the various spread relationships. At current crude price of around $50, we are having difficulty building a case for more than a $5 move in either direction. We look for bearish underlying energy fundamentals to continue to encounter a formidable offset in a much improved economic outlook. This more optimistic view has recently found reflection in some better than expected financial releases and an associated pop of more than 20% in the various stock indexes. While we are currently favoring the long side of the crude futures from a trading perspective, we feel that the probability of achievement of upside objectives in the $54-55 zone will be considerably reduced by a close below the $50 mark during the next couple of sessions.
As the complex has shifted into a sideways type trade within last week’s boundaries, we would also note that the crude curve has been weakening considerably with nearby May WTI futures expanding its discount against both the June futures as well as the longer dated portion of the curve. For instance, the front switch has stretched out toward $2.50/bbl while the one year portion of the curve has expanded to around $13/bbl. This widening reflects a combination of both burdensome crude supplies and improved expectations for oil demand later this year and next. The crude supply overhang appears more pronounced in the US than in most overseas regions as highlighted in highest level of domestic crude cover in almost 16 years. As a matter of fact, a build of more than 3 mb in tomorrow’s EIA stats would push crude supplies to highest levels since 1990. Although our ideas and average street forecasts favor a crude stock hike of about 1 ½ to 2 ½ mb, surprises are apt to fall toward the bearish side since we are leaving open the possibility of a jump in crude imports toward 10 mb/d.
As a result of the current crude surplus in the US, nearby WTI values are establishing a renewed discount against Brent futures. We would also note that the heavy downside price pressure at the front of the WTI spread curve is expanding the crack spreads that are stretching out toward highest levels since last October per May 3:2:1 differentials. Any decline in refinery activity per tomorrow’s data could widen the cracks further. We still feel that the gasoline cracks have the greatest potential for expansion and that the heating oil to crude differentials remain vulnerable to further narrowing in view of the substantial distillate supply overhang that will likely increase with the EIA statistics. The gas cracks were supported in yesterday’s trade by a couple of refinery issues and we would reiterate that any additional snags could have significant impact on the gasoline market with refinery activity currently downsized appreciably relative to recent years. Finally, we would note today’s release of the EIA’s Monthly Short Term outlook. Although this report usually doesn’t prompt much of a price response, we expect another downward revision in demand expectations across 2009 to occupy some media space that could prompt some selling, especially if the US dollar remains well supported in today’s trade.
Price Outlook: We generally look for price consolidation this week across much of the financial spectrum with the stock market and oil complex digesting strong gains from the prior 4 week period. Meanwhile, we still view the $47-55 zone per nearby crude futures as expected price parameters that could remain intact through most of this month. Despite the price pullback seen thus far this week, we are still not ruling out an advance in May WTI to the $54-55 area where we would look to accept profits out of any longs established within the $47-50 zone.
Natural gas:
This market appears content to trail the oil and equity markets probably through the rest of this week given lack of significant fundamental guidance from other inputs. Although cursory or anecdotal evidence of some production slippage and slowing of industrial demand deterioration is providing some support to a bullish case, these shifting supply and demand trends don’t yet appear capable of precluding fresh lows in this market. Although we have suggested taking profits out of short May positions, a price rally to our preferred $4 area where we would like to reestablish shorts could prove to be a stretch unless the oil complex is able to spike up by some 5-10%. Otherwise, this market will remain in the doldrums at this early stage of the “shoulder” period in which weather guidance will be replaced by a heavier focus on weekly storage figures and spillover from other financial and commodity markets. We would reiterate that the natural gas is more apt to follow the petroleum lower rather than higher since any sizable oil price advances are likely to be driven by a weakening in the US dollar, a factor that should theoretically exert little impact on the natural gas. We are maintaining a bearish trading posture for now but would continue to caution against approaching the market at current levels from either the long or the short side. We still feel that this price down move is too advanced and too deep to warrant fresh shorts within the range of the past couple of sessions. Conversely, fundamentals are skewed so decidedly toward the bearish side that we are also cautioning against longs at current levels. Consequently, we will simply await a potential rally toward the $4 area as an opportunity to participate once again on the short side.
Looking out through the balance of this week, we look for the connection between oil and gas prices to remain intact for a couple more sessions until Thursday’s storage report provides additional guidance. We will repeat our view that supplies have bottomed seasonally and that injections will be forthcoming going forward. Regarding Thursday’s EIA numbers, we feel that a storage increase could approximate the 5 year average build of around 13 bcf. While this doesn’t sound too exciting, we would note that the likelihood of a further expansion of almost 30 bcf in the year over year supply surplus given last year’s storage draw of 16 bcf. This trend toward an expansion in the supply overhang is one that appears sustainable through the rest of this spring and into the early summer period until production declines become more pronounced and weather events could potentially slow the injection process. In the meantime, this market will experience significant difficulty in sustaining price rallies, particularly to above the $4 mark. While a dramatic price up spike as was seen last month is always a possibility given the huge net short holdings on the part of the fund community, we would look for such a development to again prove brief. While conceding that the current 32% supply surplus against last year has already been discounted, we also feel that the major part of the bearish case for this market lies ahead since storage injections could easily exceed the year ago pace by as much as 80-90 bcf per month going forward through the spring and early summer period. It is this anticipated dynamic of a further sizable expansion in an already hefty year over year supply surplus that keeps us in a bearish frame of mind.
Price Outlook: We are content to maintain a sideline stance for now and will await price rallies to a $4 handle before looking to re-establish a bearish position. We expect additional consolidation going forward given a lack of significant weather influence and we continue to have difficulty in building a case for fresh lows without substantial assistance from a major plunge in petroleum values.
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