Inventories, Refining and Downgrades

Jim Brown
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It was not a fun day in the market and definitely not a fun day in the energy sector. When investors decide the market is under attack they move to the sidelines in a hurry. Sectors that have posted nice gains recently are the first to be dumped.

The administration took aim at banks and financial institutions this morning but instead of a single well plae bullet it was a barrage of negativity and potential regulation. Although "fat cat bankers" were officially targeted the collateral damage was wide spread.

Because energy stocks had gained so much from the December-January rally they were quickly dumped on worries the market would not stop declining and "big oil" would be the next sector in the administrations sights. In a firefight it is best to keep your head down even if you are not being targeted.

On the inventory front I was shocked to see a minor decline of 400,000 barrels of crude rather than a 5-7 million barrel build. Imports fell -335,000 bpd from the prior week. I am amazed and it suggests refiners are so far underwater they are simply not buying any oil other than their long term minimum contracts.

Refiner utilization plunged to 78.4% from 81.3% on continued weak demand and early maintenance cycles. The refiners typically take units offline in March for maintenance but low demand and even lower crack spreads appear to have encouraged some refiners to take units offline earlier to make upgrades and ger ready for summer gasoline blends.

Gasoline inventories rose by +4 million barrels pushing the increase over the last three weeks to 11.5 million barrels. Gasoline is accumulating much faster than it is being used. This suggests future refinery utilization could fall even lower.

The Houston ship channel has been closed for two days for fog and that should reduce inventory levels next week.

The MasterCard Spending Pulse report on Wednesday showed that gasoline demand in the prior week jumped +3% according to charges processed by MasterCard. Since gasoline inventories are spiking I think there was a timing issue related to pay cycles rather than a sudden increase in driving. People charge more in the week before they are paid. If you are a 1st/15th pay cycle and pushing the limit then you are probably running out of money around the 10th and need to put some gasoline on credit. That is just a theory on my part based on past personal experience and raising a family of four kids in the 70/80s.

The coal sector was downgraded by Citi Investment Services and it was brutal. Massey, Alpha Natural Resources, Patriot Coal and Consol Energy were cut and the stocks declined from 6% to 13%. The analyst said alternative energy like natural gas and wind were taking market share from coal. I would agree with that in principle but I believe it will be a slow process of erosion and nothing that will hurt them in the short term.

We did see the impact of the recession on coal and the railroads when CSX reported earnings earlier this week. Their earnings fell sharply because coal demand was down due to fewer requirements for electricity with factories offline or running shortened schedules.

The good thing about a broad market decline is the entry points. I am expecting crude prices to bounce slightly then continue a decline into February. If the market is declining as well then we should get some great entries on some long-term positions.

Jim Brown