The Energy Space



 | Jan 11, 2013 | 9:15 AM EST
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Energy Price Outlook

The oil market finally broke out from its week-long consolidation range yesterday, but the breakout was anything but impressive. Western Texas Intermediate settled in the middle of the day's trading range while Brent ended near the day's low.

While those settlements provide little in the way of positive forward guidance, other signs are more bullish. Support will be offered from the growing appearance of improving economic data in Asia and Europe, Thursday's fresh five-year high in the S&P 500 and weakness in the dollar. Pressure will be offered by the potential that Germany's local elections on Jan. 20 local will hurt Chancellor Angela Merkel's coalition. Pressure could also come from weakness in U.S. oil demand, as well as Tuesday's monthly report from the Energy Information Administration, which showed 2014 supply growth outpacing demand 1.7 million to 1.35 million barrels per day.

The ramp-up of the higher capacity Seaway pipeline should narrow the spread between Brent and WTI, and a fresh update regarding the startup of the line's higher levels is expected any day. We favor holding our June WTI-Brent trade, entered on Jan. 4, at -$14.25, with a target at -$8.

WTI finished up $0.72 per barrel Thursday, while Brent settled up $0.13. Most of the strength in both markets was witnessed early in the session, before both gradually weakened in the afternoon. A sense of enthusiasm took hold early after Chinese trade data showed gains in imports of refined oil products and iron ore. Oil imports were down only 2% month over month, but they maintained the general uptrend that's been in place since the Chinese economy hit its weakest point last summer. Also positive Thursday was the expectation that central banks in China and Japan will soon be adding more stimulus.

Oil markets were also supported by enthusiasm in Europe. Spain, for instance, witnessed strong demand for 5 billion euros in debt, offered in its first auction of the year. The yield on Spanish 10-year bonds fell below 5% for the first time since March of last year.

The European Central Bank followed with an unchanged verdict in its policy meeting. Instead of seeing dissents in favor of an interest-rate cut, the vote was unanimous to leave rates unchanged. Afterward, ECB President Mario Draghi said stabilization and confidence are returning to financial markets and that he's pleased tail risks have been removed. He said a normal situation is returning from a financial viewpoint, but that there are no grounds for exuberance yet.

The euro acted exuberantly, however, gaining more than 2 points against the dollar on the sense that the worst of the European debt situation is now behind us. The U.S. followed the European lead, with continuing jobless claims data falling to a four-and-a-half-year low. These data points helped push the S&P 500 to a new five-year high, and the Dow to a three-month high. Fundamental support came from reductions in oil production by Saudi Arabia and Syncrude Canada.

It appears downside risks are being put aside in this environment of semi-euphoria, and while they can be ignored for some time, they may continue to build. Wednesday's inventory report from the EIA showed that total U.S. demand for oil nearly matched its weakest level in at least two years. This first report of this new year has allowed us to observe the five-year average of demand fall in each of the last six years.

Future increases may thus appear impressive, but against what base of comparison? In Tuesday's monthly EIA report, the first estimate of 2014 demand growth came in at 1.35 million barrels per day. While that's stronger than demand growth in 2012 and estimates for 2013, it was outpaced by daily supply growth of 1.7 million. So demand increases are more than being met by higher oil production, which will allow inventories and spare capacity to grow in the Organization of the Petroleum Exporting Countries (OPEC).

Again, another potential negative is the Jan. 20 local elections in Germany. Chancellor Merkel remains popular and is not expected to have any issues, but her Free Democrats coalition partner is seeing falling support and could thus take the wind from the sails of European reform.

Natural Gas

Natural gas futures settled $0.08 higher after a strong rally tied to the weekly inventory report. The EIA numbers showed a draw of 201 billion cubic feet, which compared to expectations of around 186 Bcf. The reported draw was near the extreme end of analyst expectations, and may thus have been taken lightly by the market. Despite what appeared to be a very bullish number, prices failed to move above Wednesday's high by $0.016.

The number was also somewhat of a surprise, because the degree day count was 238 vs. last week's 212, which came amid a 135 Bcf withdrawal. Similar degree day counts from 2011 yielded inventory draws of between 209 and 233 at the time. That came without the benefit of the increased shale production that has been boosting stocks in the past year.

Prices may rally for a day or two, but the trend still appears to be to the downside. The market appears likely to continue lower until there's significant and lingering cold weather in the forecast. On Thursday afternoon's map from the National Oceanic and Atmospheric Administration, there's a shrinking pool of below-normal temperatures in eight-to-14-day outlooks.

A longer-term negative could also come from the potential that forthcoming fracking regulations do little to inhibit future drilling. According to a Los Angeles Times blog Wednesday evening, Mark Nechodom -- California's nominee for conservation chief -- is receiving pushback from lawmakers because of loopholes in new regulations that force drilling companies to disclose the chemicals used in drilling. Nechodom "said regulators were trying to strike a balance between public transparency and the state's trade-secrets law, which he noted protects the recipes of products like Coca-Cola (KO)." He said Governor Jerry Brown's administration was "moving forward with proposed rules that would make the state a leader in environmental protection and public health."

This could become a longer-term negative for natural gas, in our view: Government bodies that are at the forefront of regulation usually tend to become templates when national legislators come calling. That may imply the anti-fracking lobby may still fail to achieve the disclosure they seek, and that fracking may be allowed to continue unabated



Global Economic and Dollar News

● Spain witnessed strong demand for three instruments auctioned Thursday in its first sale of the year. The 10-year yield on Spanish bonds fell below 5% for the first time since March. Demand was 5.82 billion euros for 5 billion euros' worth offered.

● The ECB left rates unchanged at its policy meeting. ECB chief Draghi said that stabilization and confidence are returning to financial markets, and that he's pleased tail risks have been removed. He also said a normal situation is returning from a financial viewpoint, but that there are no grounds for exuberance yet. He added that Europe may see a positive contagion from the economic improvement in the same way that negative contagion had previously been an issue.

● Initial Jobless Claims totaled 371,000 vs. the 365,000 expected, and last week's 367,000 (revised down from 372,000). Continuing claims totaled 3.109 million vs. last week's 3.236 million (revised down from 3.245 million), reaching a 4-and-a-half-year low.

● Job openings were at 3.676 million vs. 3.665 million previously, according to the Job Openings and Labor Turnover Survey (JOLTS)

Energy News

● In December, Chinese oil Imports came to 5.6 million barrels per day -- down 2% from November's 5.71 MB/D and up 8% year over year. Refined products imports came to 986,639 in December, up 15% from the prior month's 855,167 and up 3%. Other import data were mixed, with iron ore gaining 7.8%, copper falling 6.6% and aluminum falling 8.8%.

● Iraq resumed crude exports to Ceyhan, a Turkish port, after a fault in the pipeline. The line was shipping 425,000 B/D prior to the shutdown.

● December saw Saudi Arabia cut its oil output 5% to a 19-month low of 9.025 MB/D.

● Syncrude Canada cut its Jan production forecast to 10 million barrels -- down 600,000 from the prior 10.6 million. No reason was specified for the reduction, but November production was reduced due to a failure at a crusher near the mine.

● Oil from the North Dakota Bakken formation is getting moved to the East Coast, which is causing receiving capacity to grow to around 900,000 B/D, according to Bloomberg. The Association of American Railroads said rail-transportation capacity from Bakken was forecast to triple in 2012 to 391,000 B/D. The cost to ship oil from North Dakota to the East Coast will be around $17 per  barrel, per Marathon Petroleum (MPC) estimates. That makes it still nearly $10 cheaper per barrel than Nigerian Bonny Light transported by tanker ship.

● Natural Gas Inventories were down 201 Bcf vs. the expected decline of 186 Bcf. Inventories sank 61 Bcf from year-earlier levels, and are only 308 Bcf (10.68%) above the five-year average vs. the 389 Bcf (12.44%) gap last week. 

Upcoming Events

Tuesday: American Petroleum Institute inventories (4:30 p.m. EST)

Wednesday: Iran -- International Atomic Energy Agency Meeting

Wednesday: EIA weekly oil inventories (10:30 a.m.)

Thursday: Natural Gas Inventories (10:30 a.m.)

Friday: International Energy Agency's monthly report

 Jan. 20: German Local Election

Jan 29-30: Federal Open Market Committee meeting

Feb. 12: EIA's short-term outlook

Feb. 24-25: Italian election

March 1: Sequester Begins

May 31: OPEC Meeting

Grains Commentary

Published Thursday morning, Jan. 10.

The overnight markets are somewhat subdued as now we all wait until 12 p.m. Friday to see what shoe drops. The markets have responded slightly to another massive sales announcement this morning of nearly 600 mt of beans sold to both China and. The beans have turned from negative to positive since this announcement but only by a few cents.

The markets will wait to see the U.S. Department of Agriculture report to be released at its new time Friday. The expectations are for the corn CO to increase slightly with the average guess coming in around 660, the bean CO is also expected to show a slight increase pushing near 135 vs. 130 last month. The question will still be what the harvested acres were in corn. Some believe that there was still 2 million to 3 million acres lost, but it seems that even if this occurs, the yield will account for the acreage loss and production will still be in the area of 10.7 billion. The bean balance sheet is still tight and will remain that way for the next few months. But if one is to look toward new crop, the balance sheet looks more like a corn balance sheet than beans, with CO figures of 13/14 that could approach 400.

The demand sector for corn is torn from the improvement that's begun in domestic off take as export markets remain nonexistent. The ethanol margins have improved slightly in recent days, and given both hogs and the poultry sector, we believe the domestic markets will remain robust. The export market only accounts for 15% of the entire consumption -- and, as of now, it doesn't seen as if this will be achieved. The South Australia harvest is under way, and while the U.S. is still higher priced vs. SA, the spread has narrowed in recent weeks -- and that could promote some increase in the export channels.

The outside markets should also help the bulls, as some recent economic data from China was viewed as bullish. Crude oil is up more than $1.20 early this morning, the Matif markets -- that have been on fire recently -- have cooled off with rapeseed down more than 4 euros this morning. The DCE corn is under $10 again, and all the soy markets are also lower.

The OI spiked higher in corn Wednesday, increasing by 15177. Wheat increased by 4855, beans were down 1780, meal increased by 4516, and oil increased by 8207.

The options will do what they typically do going into a report, and catch a bid Thursday -- and will most likely take it all out and then some Friday at 12:01 p.m. The February options have increased throughout the entire weeks to levels that are pricing in a significant move Friday. The downside bean puts throughout the curve have a positive curve and look more like equity than a bean. Where is the Chinese seller? The CU-CZ spread is trading at roughly +20. If the U.S. gets off to an early planting season similar to last year, this spread will quickly collapse. For those who think that this will happen, look at buying CZ 550 straddle vs. selling CU 550 straddle.

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