*On December 27th, we posted the 2013 outlook for crude oil and natural gas. If you would like to review it please click here.

*Inventory report schedule during the holidays:

API report will be released at 4:30 pm EST Thursday Dec. 27 and Jan. 3

EIA petroleum report will be released at 11 a.m. EST Friday Dec. 28 and Jan. 4

EIA natural gas report will be released at 10:30 a.m. EST Friday Dec. 28 and Jan. 4

 

Energy Price Outlook

Our view of the oil markets is generally unchanged today from the outlook we made yesterday. Prices could continue higher over the next week or so, but we remain cautious about the ability of the rally being maintained. Support will come from yesterday’s favorable API data, fund buying in COT data, signs of improved economic conditions, and Wednesday’s breakout in S&Ps to new 2 1/2 month highs. Iran is conducting military exercises in the Strait of Hormuz this week and Venezuela’s Hugo Chavez appears to be on death watch. A note of caution is warranted in oil, however, based on weakness in oil product demand, the recent upswing in oil prices, and the increased taxes that could drag on the economy. The best trade may be the Seaway pipeline, which would is ramping up to 400 kb/d next week. Cushing stocks should begin to fall as we analyze below, and could boost WTI prices against Brent. The WTI crack spread could weaken, and the WTI contango could narrow. We favor buying WTI vs. Brent in the June futures at -$14.25 with a target at -$8.00.

 

WTI finished 20c/bbl lower yesterday while Brent ended down 33c/bbl. The market began the day slightly lower in a corrective tone from Wednesday’s advance, but eventually moved slightly higher on the day by mid-session. The resolution of the fiscal cliff late on Tuesday helped, as did the reported improvement in China’s non-manufacturing PMI and the ADP payroll report. Prices fell somewhat in the last 30 minutes of the pit session due to the FOMC minutes, which showed that “several members” believed that the Fed should slow or stop purchases of treasury bonds “well before the end of 2013.” The statement caused risk to be taken off the table, as the prospect of endless amounts of “easy money” suddenly seemed to be limited. Background pressure was given by the higher dollar and the possibility that yesterday’s strong ADP report overestimates today’s payrolls. The first print of the January ADP has overestimated the last two January payroll reports by an average of 149K, which could set up potential disappointment around today’s report. The inability of oil prices to maintain Wednesday’s rally yesterday wasn’t too much of a surprise, as the analog with the first trading day of 2012 showed a similar strong gain on day one followed by moderation on day two.

 

A key development for the oil market was reported on Wednesday evening by Enterprise Products Partners and Enbridge which are 50/50 owners of the Seaway pipeline that runs south from Cushing Oklahoma to Freeport Texas. The pipeline was reversed early last year from a northerly flow to a southerly one, as the price of WTI had remained considerably weaker against Brent (chart 1). The pipeline has carried 150 kb/d since that time and has been upgraded in the last few months to carry 400 kb/d. Higher-rate service will start next week according to the press release. The change should pressure Brent prices and boost WTI as WTI is more able to compete with seaborne Brent. The contango in WTI through the July contract may ease. Gasoline prices should fall as well, since national prices tend to be based on Brent inputs.

 

The question will become how much of a trading opportunity develops from the pipeline expansion. The second chart below shows a very loose correlation between the Brent-WTI spread and the amount of working storage capacity at Cushing that’s being used. Working capacity data is available starting Sep 30th, 2010 and shows that utilization of that capacity reached 91% in March 2011. Cushing stocks were close to 42 MB at the time while capacity was 46 MB. The growing storage glut could be alleviated by either reducing shipments of growing shale production, or increasing storage capacity. Both seemed to take place in 2011, as the utilization rate fell to 51%. The utilization rate increased again in late-2012 as BP’s Whiting refinery caused more oil to be diverted to Cushing. The latest storage total was 49 MB vs. capacity of 64 MB.

 

 

The ramp-up of the pipeline expansion should offer an effect on storage levels, as an additional 250 kb/d in capacity totals 1.75 MB extra per week. In order for Cushing stocks to get back to the 15-35 MB range that was normal prior to 2010, it would take only 8-20 weeks. The Brent-WTI spread could narrow on such a development even without the BP Whiting refinery being restarted, in our view. Shipping rates are around $3.82/bbl, which could represent a theoretical maximum for the spread. The biggest risk is if production in the upper Midwest and Canada ramps up to take advantage and fills Cushing faster than it can be emptied. Currently, Bakken is priced at a $3/bbl discount to WTI, but syncrude is trading at a $2/bbl premium. We favor buying WTI vs. Brent in the June futures at -$14.25 with a target at -$8.00.

 

 

Natural Gas

February futures ended 3.5 cents lower in yesterday’s trade to settle at $3.198/mmbtu. The market fell once again due to prospects for above-normal temperatures through these typically coldest weeks of winter. NOAA’s 8-14 day outlook showed above-normal readings from the central plains all the way eastward to the Atlantic states. The outlook is similar to what the CPC predicted in its one-month outlook for Jan made on Dec 31st (right). NOAA also recently had said that 2012 may overtake 1998 to become the warmest year on record in the U.S. Expectations are growing that the market will exit the withdrawal season with a higher inventory trough than last year's 2.369 tcf. Inventories are currently 3.652 tcf after peaking at 3.929 tcf.

 

The weather is becoming an increasing concern and may continue to weigh on prices until cold returns. The prospect of a record high stocks level at the end of the withdrawal season has forced funds to continue their liquidations. The most recent COT data show that managed money accounts fell 26,590 contracts last week to reach the largest net short since May 1st '12. Non-commercials sold 17,060 last week to reach the largest net short since Jan 17th '12. These factors suggest that a "sell the rallies" approach may still be warranted until there's any significant cold in the forecast.

 

 

 

 

Analysis

EIA Inventory Preview

The EIA may report a mild drop in oil inventories of 0.5 MB in our view, as the data round out the last reporting week of the year. The report will be released on Friday at 11:00 am EST. Last week's data was telling for the inventory situation, as the huge surge in demand reported in the prior week was undone. Oil production gained yet again and approached 20- year highs. Weak demand and elevated oil production could follow-through this week and will be additive to inventories. Imports may reduce oil stocks, on the other hand, as they typically fall through the end of the year as refiners tend to liquidate oil stocks.

 

Despite refiners' intentions to liquidate stocks through year-end, they tend to do it more through lowering imports than increasing refinery utilization. The rate of utilization usually trends in a flat direction in the last three weeks of the year before a sharp fall is witnessed in the first week of the new year. This could lead to similar gains in product stocks that were seen in last week's data, and we anticipate increases of 3.5 MB for gasoline and 2.5 MB in distillates. The latter may also be supported by warmer-than-normal weather conditions.

 

Natural gas inventories may decline 136 bcf in Friday's 10:30 am EST report. The forecast is based on NOAA's degree day calculations that totaled between 212 & 220 degree days and weather which was generally above-normal in the central portion of the country. A wide area that spanned from Texas north to the Great Lakes was above-normal, while the east coast south of New York City was generally normal or below-normal. The west coast was slightly below-normal. A similar degree day reading published last year resulted in a draw of 192 bcf, however, higher production levels in place now and qualitative issues with the distribution of cold weather cause us to put little faith in the analog.

 

Editor’s Note: Daily Energy Report readers who are equity investors/traders only can gain access to the energy space through the following exchange traded funds (ETFs).

WTI Crude OIL

United States Oil (USO, quote)

Power Shares DB Oil Fund (DBO, quote)

Brent Crude Oil

United States Brent Oil Fund (BNO, quote)

Natural Gas

United States Natural Gas Fund (UNG, quote)

United States 12 Month Natural Gas Fund (UNL, quote)

First Trust ISE-Revere Natural Gas Index Fund (FCG, quote)

Coal

Market Vectors Global Coal Index (KOL, quote)

Power Shares Global Coal Portfolio (PKOL, quote)

 

About OTC Global Holdings

Formed in 2007, OTC Global Holdings is headquartered in Houston and New York, with additional offices in Chicago, Jersey City, London and Louisville. It is a leading independent interdealer broker in over the counter commodities and the largest liquidity provider to CME ClearPort and ICE Clear U.S. Through its subsidiaries the company holds a dominant market share in the U.S. and Canadian natural gas markets, the U.S. power markets, crude oil and crude oil options, crude oil products and crude oil product options, agricultural and soft commodities, as well as structured weather and emission derivatives. The company serves more than 250 institutional clients, including 45 members of the Fortune 500, and transacts at over 150 different commodity delivery points. To learn more about the company, please visit http://www.otcgh.com or go to http://bit.ly/OTCYouTube.

 

IMPORTANT NOTICE:  Trading of commodities and commodity futures and options, and other commodity derivatives has substantial risk of loss, and is not suitable or appropriate for all persons.  Past results are not necessarily indicative of future results.  The information in this piece is based on sources that are believed to be reliable, but it is not warranted to be accurate or complete, and no performance or results from use of the information are warranted.  This piece is not a solicitation or offer to purchase or sell commodities or commodity derivatives. Opinions expressed herein are subject to change without notice.