Cheap Oil is Back

Jim Brown
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If you call $92 oil cheap then cheap oil has returned. Along with the drop in oil prices has been a decline in gasoline to $3.73 per gallon and a -23 cent drop since early April. In only 11 trading days the price of U.S. oil has fallen from more than $106 to a six month low of $91.81. When oil prices crash they don't move slowly.

The constantly rising dollar continues to take the blame for the commodity cash. The Dollar Index has rallied +3.6% since the May 1st low. That is an epic move for a currency and it came without any pauses. The dollar has rallied vertically while the euro has plunged -4.3% in the same period.

Oil, gold, silver, copper, etc have all crashed. Anything denominated in dollars has been crushed including the U.S. equity market. The stock market has been down 11 of the last 13 days with the indexes closing at three month lows today.

I am depressed about the constant decline in the oil market but in reality it is not just the oil market. Equities and other commodities are equally depressed. It is just that the oil market reacts so violently to the dollar and to the events in China and Europe. That has caused a -13% correction in oil prices only a couple weeks ahead of the U.S. driving season.

I do believe there are signs this decline is about to end. The EIA said crude inventories rose by +2.1 million barrels. However, that was the smallest increase since early March. Distillates and gasoline continue to decline.

Most notable in this week's release was the spike in refinery utilization to 88.3% and the highest number since last year. The summer refining runs have finally begun and we should see that number increase to 90% in the coming weeks.

Also, oil demand is rising. In the table below oil demand by refiners has risen for five consecutive weeks. The 15.04 million barrels is the highest refinery demand since the week of December 2nd. This suggests the maintenance period is over and the winter blends have been sold out to allow the stockpiling of summer blends. This is also a good sign that economic activity may be picking up in North America.

Part of the inventory build is the stockpiling of crude at Cushing, which set a new all time high last week. This rising stockpile is in preparation of the opening of the Seaway pipeline south to the Gulf. Traders and suppliers expect WTI prices to move more in line with Brent once the pipeline opens. However at only 150,000 bpd it is a very small pipe. That will be upgraded to 450,000 bpd later in the year. When the pipeline is opened it will take 2.5 million barrels to fill it. That will relieve some of the pressure at Cushing and then the million barrels a week moving down the pipeline will also help relieve the inventory pressure.

Cushing Inventory Chart

Crude Inventory Chart

Inventory Snapshot

Gasoline demand also rose to 8.97 mbpd and the highest level since Oct-7th last year. Gasoline inventories are now -0.8% below year ago levels. Another week of declines and the current levels could decline below the five year average range. However, with refiners ramping up utilization I suspect the inventory decline is about over.

Gasoline Inventory Chart

Distillate inventories declined by -1.0 million barrels and the smallest decline in six weeks. The 119.8 million barrels is the lowest inventory since June 13th, 2008. Distillates are headed for a serious price spike if the inventory decline continues and economic activity improves quickly. There are only 32.1 days of supply on hand compared to 38.1 this time last year.

Distillate Inventory Chart

We are moving steadily closer to the Iran nuclear summit on May 23rd. Staff preparing for the meeting met with Iranian emissaries on the 14th/15th and both sides said there was a good exchange of views. The pre-meeting was designed to test Iran's readiness to address specific questions at the May 23rd meeting. Both sides are planning on meeting again next week, two days before the actual summit.

Previously Iran had always shown up at the talks with an agenda of its own that did not match the agenda of the P5+1 nations and the IAEA. Sources said Iran appeared keen for an agreement on a so-called "framework" or "structured approach" for a plan to deal with the IAEA questions later this month. However, Iran is still demanding an end to sanctions before they will agree to allow inspections or formalize an agreement. Access to the Parchin military test site is still specifically forbidden. Iran countered claims that they were sanitizing the Parchin site ahead of the talks "childish and ridiculous."

All of this foreplay is likely being used by Iran to structure their responses and prepare alternate points of contention to distract from the real questions. Iranian negotiators have proven to be very skilled at evading direct questions and delaying the process when required.

Despite all this "cordial conversation" taking place before the main meeting I will still be very surprised if anything is accomplished. They may agree to meet again later, which of course gives Iran more time to enrich more uranium, transport and hide specific machines and materials that the IAEA is being kind enough to spell out in advance what they will be looking for.

Negotiations only work when all parties have a sincere desire to come to an agreement. When one party is only using the talks to buy time as Iran has in the past, the outcome is not likely to be satisfactory.

This round of talks has the added incentive of the oil sanctions by the U.S. and the oil embargo by the EU, both of which are supposed to begin on July 1st. This has cost Iran sales of roughly 500,000 bpd in April according to the most recent estimates. That is costing Iran roughly $55 million a day in revenue or $1.65 billion a month. That could be a real incentive to play nice with others. If the sanctions and embargo actually ratchet up the heat on July 1st this could cost Iran another 500,000 bpd in sales so there is some real incentive on their part to come to an agreement.

The UN Security Council received a report this week showing that Iran was continuing to ship weapons to Syria for use against its citizens in violation of the Security Council sanctions. Clearly Iran is not yet ready to join the free world in a responsible manner. That suggests the eventual nuclear talks may prove less than fruitful.

Iran has turned off the transponders on its tanker fleet and has been renaming the vessels with names not related to Iran. Iran is also renaming its entire freighter fleet of more than 130 ships. In 2009 all the ships had a reference to Iran in the name and now there are less than 10. In an effort to avoid sanctions they have changed ownership of the IRISL vessels to show them owned by 75 different private companies in an effort to avoid the blacklisting of the parent Islamic Republic of Iran Shipping Lines (IRISL). These are not the actions of a country that wants to work with the UN to resolve its sanction problems.

It would be much easier to just let the IAEA into Iran to carry out inspections of all the places on their list and prove Iran was not trying to build a bomb. Since they are going to extremes to avoid inspections and circumvent the sanctions you have to believe they have something to hide.

Hopefully the current talks backed by a successful sanction program will finally bring Iran to its senses and all these smoke and mirrors delaying tactics will end. I am not holding my breath.