Spanish Oil Demand Dropping?

Jim Brown
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You would think from the decline in oil prices over Spain's economic worries that they were a big consumer of oil. That is not the case with daily demand of only 1.5 mbpd. Still, concern over Spain and and its impact on Europe is weighing on prices.

The mainstream market reporters are whipping themselves into a frenzy over the problems in Spain and Italy. Worries over a failed bond auction in Spain followed by a domino effect in other countries has become the main story for stocks.

In theory if Spain's 10-year auction on Thursday does not go well the ECB and IMF will be forced to come to Spain's rescue on future auctions. Since Spain has a serious need for public funding for the rest of 2012 that rescue effort would be expensive. Secondly, if Spain were to qualify for support from the ECB and IMF then Italy would also qualify. The bond vigilantes will continue to go down the list country by country and there is not enough money in the EU, ECB, IMF (troika) coffers to rescue everyone.

The problem this week is not just Spain but the implied result on the rest of the EU weaklings if Spain worsens. Spain amplified the problem this week by warning many of their banks may not be able to find enough capital to remain in business. Most of those banks own far too much sovereign debt that has to be marked to market and that makes the Spanish debt sales doubly important. Even if there are plenty of buyers if the yields spike higher and prices lower then those banks will have to mark their loans down even further. It is a vicious circle attacking several of the weaker EU countries and there is little or no hope of it being resolved without significant funding from the troika.

The problem for the energy sector is that the economic conditions in Greece, Spain, Italy, Portugal, etc are rapidly imploding. With the governments in severe austerity mode anything that is not a critical government service is being cut. That puts more people out of work, which limits the amount of money that can be spent on consumption, which puts more businesses out of business, which limits the amount of taxes the government can collect, which further limits future spending and forces more cuts to social programs, etc. It is a downward spiral that has no solution other than years of pain and recession.

The end result is lower demand for oil in those countries. Fortunately none of the countries involved are big consumers of oil but that does not prevent the decline in expectations based on the general principle.

The Iran problem is also pushing prices lower. The P5+1 nuclear summit turned into only a social meet and greet and nothing was accomplished other than set a new date of May 23rd for the next meeting. The "positive" press about the "constructive" meeting deflated some of the tensions surrounding the Iran sanctions. Iran got to restate its position that nothing would ever change and the UN would have to end its sanctions before they would agree to future talks. The P5+1 countries got to brag about the constructive meeting so oil prices would ease and gasoline prices would not be such a hot topic in an election year. Everybody got what they wanted out of the first meeting except the Israelis. They immediately blasted the U.S. and the other members of the P5+1 for giving Iran a pass and allow the can to be kicked farther down the road without a resolution.

Adding to the price pressure on oil was the attack by President Obama on evil speculators manipulating prices for profit and forcing everyone to face more pain at the pump. It is immaterial that numerous commissions and agencies have investigated the speculation angle since the 2008 highs and nobody found anything remotely related to manipulation. This is an election year and the president is under fire over high fuel prices. The president wants to increase the number of employees at the Commodity Futures Trading Commission (CFTC) by 600% and dramatically increase the amount of margin required to trade energy futures. Democrats attached an amendment to an unrelated bill to implement Obama's recommendations. It immediately died with a vote of 261-160 with all but one republican and 25 democrats voting against it.

Despite the recommendations being DOA in Congress we can expect to hear the "I have recommended sweeping reforms to limit speculation and manipulation in the energy markets" phrase in every presidential campaign speech for the rest of the summer. In election years it is all about appearance rather than substance.

Oil inventories continued to rise with about two weeks left before the supply/demand curve switches to higher refinery utilization. Crude inventories rose +3.9 million barrels. However, gasoline -3.7 mb and distillates -2.9 MB, continue to decline as refiners deplete winter fuel blends. Once the tanks are depleted of those winter blends they will kick the refining process into high gear to flood the system with the summer blend fuels. We are about two weeks away from that switch. Obviously every refiner will have a different restart date depending on maintenance schedules and the quantity of refined supplies on hand. The EPA has specific dates for mandatory fuel conversions typically starting on May 1st.

Inventory Snapshot

In the charts below you can see the current trend (red) is following the historical trend. The oil inventories are the most extreme with inventories right at the upper edge of the five year historical range. For the last year inventories have been holding at the high end of the range and I expect the end of April numbers to continue pressing the boundaries.

Distillates are right in the middle of their five year range but they are a multiyear lows today. Demand for distillates, especially diesel and jet fuel, appears to be strong and that conflicts with the weak economy concept. Distillate inventories are down -19.4% from year ago levels.

Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

WTI futures expire on Friday and today's decline could be impacted by the impending expiration. Inventories at Cushing are rising ahead of the anticipated opening of the Seaway pipeline to send oil from Cushing to the Gulf Coast refiners. The initial volume will be only 150,000 bpd and eventually rise in 2013 but it is the idea that counts. Traders are focused on that May start date as though the WTI/Brent spread was going to magically narrow to zero just because of that 150,000 bpd route south.

Halliburton (HAL) reported earnings for Q1 that rose +22.7% thanks to the rush to drill for oil in North America. HAL benefitted from the rush to natural gas drilling in recent years and now the rush to oil and NGLs is creating a boom in other parts of the country. HAL said oil production is a more intensive process than drilling and producing natural gas. That allows HAL to charge higher fees for its well service business. CEO Dave Lesar said the switch to oil was very positive for Halliburton profits. HAL reported earnings of 68-cents or $627 million on revenue of $6.87 billion. HAL said it took a $300 million charge to reserves because of pending litigation over the BP disaster in the Gulf. HAL performed the cementing services on the Macondo well and most commissions looking into the disaster suggested the cement did not hold and that helped to cause the disaster.

McMoran Exploration (MMR) reported earnings that beat the street by 10-cents and continued to brag about their wealth of new ultradeep discoveries in the shallow water Gulf. Multiple wells have reached their total depth with major discoveries but completion efforts are on hold until lessons learned from the Davy Jones 1 can be implemented. Shares declined 30-cents on the day. Investors were hoping for some positive news from DJ1 but the company is holding to the prior statement. The well will be perforated and put into production in Q2. All equipment is ready and onsite waiting for the removal of some failed perforating guns and implementation of the new perforating equipment.

BP and the attorneys for more than 100,000 people and businesses presented Judge Carl Barbier with the finalized settlement in the class action suit. The group asked Barbier to approve the settlement so disbursements could begin. BP will pay about $7.8 billion to resolve thousands of claims but there are thousands that could opt out of the class action settlement and try to go it alone against BP. That would be an expensive proposition. Barbier is expected to hold a "fairness hearing" on the settlement before approving it.

BP and its contractors RIG, HAL, CAM, WFT, etc still have to deal with the various government claims regarding the spill. The judge has set May 3rd as the date to discuss the plans for proceeding to trial over those claims, which will also run into the billions of dollars. All the contractors claim indemnity by BP in their contracts and the judge has ruled multiple times in the BP-RIG preliminaries hearings that BP did indemnify RIG so the outcome of the trial is probably going to rest solely on BP. I am sure BP is holding out hope that RIG will give into the risk of trial and settle before the case is actually heard.

Energy investors need to remain patient because the long term fundamentals remain firmly positive. Remember, oil prices are still in the $105-$125 range and not $65-$75. The long term trend is still up.

Our biggest risk is that high gasoline prices will push the U.S. back into a recession. We will have to watch the economic numbers closely over the next 60-days to see if the trend is changing. The drop in nonfarm payrolls and rise in weekly jobless claims may be a sign of further weakness ahead.

Jim Brown

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