What Will Santa Bring Traders On Thursday?

Jim Brown
Printer Friendly Version

The EIA reports inventories on Thursday and this will be the next to last accounting for the year. The last one covering the week ended on 12/31 will be on January 5th.

The news this week is full of comments about the accounting games played by the refiners ahead of year-end. Everyone is getting a new education on LIFO accounting and why it makes sense for refiners to dump inventory ahead of year-end.

Basically the Last In, First Out (LIFO) method was approved for crude inventories back in 1930. President Obama tried to eliminate it in the January 2009 budget but was unsuccessful. According to the congressional Joint Committee on Taxation, a nonpartisan panel, the LIFO method is the most accurate measure of income for financial statement purposes.

As prices rise for raw materials and commodities those companies using them are assumed to eliminate the higher priced, latest arrivals first and leave the lower cost inventory from the past on the books. For companies that stock large volumes of physical inventory like lumber, ore, oil, etc, in many cases the last in products are actually stored on top of on in front of the older inventory. It did not make sense early last century to move the current inventory to get to the older inventory unless it was perishable. Non perishable goods can remain in inventory for many years if the back stock is never used up.

That is the same way we account for that inventory on the books. The latest arrival are used first and taken off the books first.

For refiners with millions of barrels of oil in storage they could be carrying their oldest inventory as low as $30 because they never actually use up all their inventory.

Texas and Louisiana, the two states with the most refiners and oil in storage, add another reason to skinny inventories. They put a property tax on the fair market value of oil as of Jan 1st. They wised up many years ago to the LIFO games and changed their taxation to the fair market value not what it actually cost.

This has forced the refiners to lower inventory levels in 27 of the last 29 Decembers. Inventory levels rose in four of the last five Januaries.

U.S. oil imports in the week ended Dec 17th were 8.74 mbpd and 22% below the level in July when usage was strong. Imports for the week ended Dec 10th were the lowest since September 2008.

Because of the long shipping times from the Middle East the refiners can stage their orders for December to deliver back to back in early January. This way they know the oil is coming and just in a holding pattern offshore.

Thursday's EIA inventory should show another decline but the following week should be flat with future weeks posting solid gains.

The blizzard in the Northeast will create more demand for heating oil but it will take a couple weeks for it to show up in the system. In New York there is a 7-10 day backlog for deliveries because everyone is ordering heating oil even if their tanks are not empty. A little cold weather suddenly reminded consumers that winter is real and trying to skate through a light winter with half a tank might be a little risky.

Crude prices did not hold their gains on Monday after multiple OPEC oil ministers talked about $100 oil. This suggests the rally from mid December may be getting a little stale and it will be up to year-end fund flows to revive it. If enough traders begin to smell weakness we could see a pile on by the shorts with a target of $88.

Jim Brown

This newsletter is only one of the newsletters produced by OilSlick each day. The investment newsletter is also produced daily and contains the current play recommendations in the energy sector. Stocks, options and futures are featured. If you are not receiving the "Play Newsletter" please visit the subscribe link below to register.

Subscribe to Energy Picks Newsletter

See a list of our closed plays from 2010 here: Closed Positions