Crude Prices Rebound Sharply

Jim Brown
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WTI crude prices traded down to $104.84 intraday, down from $109.95 on Friday. Buyers immediately bought the dip pushing WTI back to $107.09. Is the profit taking over?

Obviously there is no way to know for sure but the strong rebound is the type of sign we are looking for. There is intraday resistance at $107.25 and a continued move over that level would be a buy signal.

Nothing has really changed in the market. Gasoline demand declined somewhat last week as a result in the spike in prices but this is not a high use period anyway. Demand in late February and early March is normally light.

The big hit to crude prices today was the monster bounce in the dollar after the ECB LTRO-2 created another $712 billion in new euros for European banks. Adding to that drop in the euro, rise in the dollar was testimony by Ben Bernanke that did not contain any hint of a possible QE3. The testimony was not specifically bullish and he did say low rates would still be needed until 2014 but it was what he did not say that spiked the dollar. Some people believed the Fed would launch a new QE program as early as March to add a little more fuel to the recovery. The operation Twist program ends in June and interest rates are sure to rise without further Fed intervention. If the Fed wants to keep rates low after June they will have to announce some new program or at least extend the old one.

The Dollar Index jumped +63 basis points to 78.73 after hitting a low of 78.10 earlier in the day. The dollar closed at a four day high. The euro fell off a cliff after European banks lined up at the LTRO-2 window to withdraw another $712 billion (euro 529 Bn) in three year loans. This money printing by the ECB crushed the euro. Evidently analysts were hoping for a lower participation rate given the ramp higher by the euro over the prior two weeks. The first LTRO in December loaned $657.9 billion (euro 489 Bn). That makes a total of 1.018 trillion euros in 90 days. ($1.37 trillion) That is a lot of money sloshing around in the European banking sector and it should force sovereign debt rates significantly lower.

Dollar Index Chart

Euro Chart

Another reason for the early morning drop in crude prices was the +4.2 million build in inventories. However, that was tempered by the third consecutive decline in distillates with a -2.1 million barrel decline. Gasoline inventories declined by -1.6 million barrels. Refinery utilization declined despite the sharp rise in gasoline prices. Utilization will be choppy over the next few weeks as more capacity is shutdown for spring maintenance. The drop in utilization reduced oil demand by refineries by -282,000 bpd and that was responsible for some of the spike in inventories. Imports rose by +100.000 bpd.

Crude oil inventories are supposed to rise from February through early June as refineries add to supplies in anticipation of the summer driving season.

Crude Oil Inventory Chart

Distillate demand (diesel, heating oil and jet fuel) rose by +349,000 bpd. Distillate inventories are down -11.1% from the same period in 2011.

The decline in gasoline inventories was not due to increased usage. Demand fell by -270,000 bpd. The combination of lower demand and the planned liquidation of winter blends prior to the start of summer blend refining were responsible for the drop in inventories. Gasoline imports also declined by -246,000 bpd.

Inventory Snapshot

The MasterCard Spending Pulse report released on Tuesday showed a -7% decline in gasoline sales as prices spiked. The average U.S. price for gasoline rose to $3.73 per gallon and diesel is now $4.05. That is a record high for gasoline prices for February and suggests much higher prices for summer. The high for all of 2011 was $3.98 in May.

Gasoline Demand Chart

The risk to the economy for gasoline prices over $4 is severe. Deutsche Bank claims a 25-cent rise in gasoline prices reduces consumer spending by up to $30 billion a year and lowers GDP by 0.2%. The price of gasoline averaged $3.51 in 2011. If prices move well over $4 as expected this summer that could remove $60 billion from the economy.

As prices approach $4 we can expect stores like Wal-Mart, Target and Kohl's to begin warning on lower sales. At $4.50 per gallon the average family would lose about $1,000 of their already tight discretionary spending budget.

Most Americans are ignorant of economics but they can relate to the pain at the pump from high gasoline prices. A move much over $4 could spell real trouble for president Obama's reelection chances. Regardless of whose policies caused the problem it is the person in the oval office at the time of the price hike that gets the blame.

The high gasoline prices of 2008 are widely credited with causing the great recession. People were falling behind on their mortgage payments because gasoline for commuting was taking too much out of their budget. While I don't personally think that was the only cause I do think it was an additive factor. Writing loans to people who could not make the payments was the real problem. It was made worse by the higher fuel prices. I remember paying $4.95 per gallon on a trip to California and it was painful. If prices nationwide rise to $4.50 as many analysts expect there will be a lot of pain to go around.

Secretary Clinton testified today that the U.S. was making significant progress on curtailing Iran's ability to sell oil. The financial penalty sanctions for any country or bank doing business with Iran's central bank went into effect today. This is the start of a list of stronger sanctions that will increase in severity as we head into summer.

Clinton said the administration had held a series of "blunt" discussions with India, China and Turkey and those countries were cutting back on oil purchases a lot more than they publicly admit. Clinton said the frank discussions with numerous countries about U.S. intentions to act on anyone found dealing with Iran was producing significant results. She said the U.S. has had ample time to compile a significant list of institutions who are continuing to do business with Iran and they were acting to educate those institutions on the hazards of doing it in the future. Anyone dealing with Iran after today can be locked out of the global funds transfer network called SWIFT. That would be a death sentence to quite a few firms if they could no longer transfer money electronically.

Eventually the combination of these sanctions and others still to come will slow Iranian oil sales significantly by July 1st. This will reduce the available excess capacity worldwide at the same time as demand should be increasing from a rebounding global economy.

The three day decline in crude prices knocked several points off most of the stocks in the energy sector. I warned over the weekend to expect some serious volatility. Having the equity market decline at the same time created a little panic among those who had built up sizeable profits over the last month.

I see no reason to worry about the dip. Consumers may have postponed a trip out to eat or combined a couple errands into one trip to save gasoline but we are still early in the cycle and these cost saving measures will fade quickly. As the weather improves those with a case of cabin fever will begin to venture forth into spring and that involves transportation. Just the start of baseball season will generate untold additional miles driven as hundreds of thousands of fans head to the ballparks everywhere every day.

Thirty teams playing 162 games each over seven months averaging 5.3 games per week. Since it takes two teams to play a game that means 79.5 games per week. If only 30,000 people attended each game that would be 2.38 million people per week traveling to ball games. Most will travel with a friend so that is not 2.38 million individual trips but you get the idea. Assuming two people per trip and 15 mile average each way that is 35.8 million miles traveled per week. Assuming 15 miles average per gallon in the commuting car that equates to 2.5 million gallons of gasoline per week in additional consumption. Obviously some will take public transportation but some will also drive a lot farther than 15 miles each way. That equates to $10.5 billion dollars at $4.25 per gallon. Compared to the cost of tickets, hot dogs, popcorn and beer that is only a drop in the budget bucket.

Plan on paying higher prices regardless of where you are driving this summer.

Jim Brown

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