Inventory All Time High

Jim Brown
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The EIA reported crude oil inventories of 395.3 million barrels. That exceeds the prior high of 391.9 million in July 1990. We have been expecting this for a couple months but the market was shocked by the number and crude prices imploded.

WTI declined $2.12 to $91 and Brent lost -$2.42 to close a nickel under $100. The EIA began keeping records in 1982 and 1990 was the last time crude supplies rose to these levels. Despite all the anguish in the crude market the inventories are only +5.2% above year ago levels.

The decline in prices was aggravated by a sharp decline in the manufacturing ISM for April. The headline number declined from 51.3 to 50.7 and below expectations for a minor decline to 51.0. This is the second monthly decline since the cycle high at 54.2 in February. The last time the ISM fell for two consecutive months was May-June 2012. We seem to be repeating a pattern from the last three years where economic activity declined in Q2. The ISM was seen as confirmation and crude prices dropped.

The ADP Employment report showed there were only 118,934 new jobs created in April compared to estimates as high as 200,000. The consensus had declined from +170,000 last week to +145,000 ahead of the report. The prior month's gain of +158,000 was revised down to +131,000. February's gain of +238,000 was revised down to +198,000. Job growth has declined on 4 of the last five months. This puts a cloud over the Nonfarm Payrolls due out on Friday. After a gain of +88,000 jobs last month the consensus is for a gain of +150,000 for April. That would be a real surprise. The slowing employment also weighed on crude prices.

China's government PMI data for April fell unexpectedly to 50.6 from 50.9 in March. Expectations were for a slight gain to 51.0. The biggest drag was a sharp drop in exports and suggests the rest of the world is slowing and that is weighing on orders for Chinese goods. The export orders component declined from 50.9 to 48.6 and into contraction territory. Input prices fell to 40.1 and the lowest level in four years. That confirms an excess of material and lack of orders.

Crude demand in the USA is -2.7% below year-ago levels. The chronic unemployment and declining economic environment along with relatively high prices for fuel are forcing consumers to drive less. Added to that equation is the acceptance of more economical hybrid vehicles and better gas mileage conventional vehicles and overall demand is slowing.

The acceleration of production in the U.S. is fighting imports for storage space. Everyone expects demand to rise so the pace of imports remains relatively high at 8.0 mbpd. Unfortunately the combination of imports and production is more than we are consuming. Demand this spring has been lower than normal because of the week after week of late winter storms. The snow and ice keeps people off the street and thousands of airline flights are cancelled. This is a temporary situation.

Crude imports rose by 602,000 bpd last week compared to demand that rose only 222,000 bpd. Imports can be a volatile number because the arrival of one 2.0 million barrel VLCC on a weekly reporting boundary can spike imports one week and cause them to decline in the next week. Timing the arrival of the dozens of tankers each month is a wasted effort. Delays in loading overseas, storms in route, days of fog bound harbors in the U.S. can shift deliveries weeks from their expected arrivals.

I don't believe investors should be concerned about the high inventory levels. This is the peak season for inventory accumulation. Now that all the refiners are producing summer fuel blends they will be working to rebuild gasoline and distillate inventories in the distribution channel. Some refineries are still undergoing maintenance as evidenced by the 84.4% utilization rate. As we get closer to spring that will rise to the 90% range and crude levels will begin declining.

The inventory levels are outside the five year range but are still following the seasonal patterns.

Crude Inventory Chart

Crude imports will not end completely regardless of how much oil is produced domestically. Some of our refineries were built to refine heavy sour crudes not produced in the USA. These crude flavors produce some high-margin petroleum products. They produce larger amounts of diesel and yet the sour crudes sell for a steep discount. This produces wide profit margins for these refineries. They are not going to quit importing the cheap crude flavors. The crude from the Canadian oil sands is a heavy crude and refiners are gearing up to process more of it when the Keystone XL pipeline is completed.

The EIA claims the import of light sweet crude at ports along the Gulf Coast may only decline by 500,000 bpd as U.S. production of light crude increases. The majority of imported Gulf Coast crude is heavy sour crude. Imports of light sweet are more prevalent in the North East where refiners are not setup for heavy sour crude. They are used to importing Brent crude in the Northeast. Refiners there are accelerating their push for rail transport from the Bakken and plains states because of the steep discount from Brent. This will help to slow the import of light crude on the East Coast.

Gulf Oil Imports by Type

U.S. production and imports are very close to equal after production bottomed in 2007. The uptick to the current 7.31 mbpd is expected to continue to 8.2 mbpd by the end of 2014. There will be a corresponding decline in imports but as shown above we could have an excess of locally produced WTI in 2015 if demand does not increase. Analysts believe the U.S. will be back at a GDP rate of roughly 4% in 2015 so that should increase consumption by about 1.5 mbpd or more.

Imports versus Production

U.S. production was 7.33 mbpd the prior week. That is the highest since 1992. Since the EIA began keeping records in 1983 the highest production was 8.969 mbpd in April 1985. The lowest was 3.9 mbpd in Oct 2005. We are very close to doubling that 2005 number in less than ten years.

The EIA expects production to begin to decline again by 2020 and drop to 6.0 mbpd by 2035.

Inventory Snapshot

Gasoline inventories declined by -1.8 million barrels and the third weekly decline. We have not yet reached the seasonal turning point for inventories which occurs in late June. Expect the declines to continue unless the economy was to suddenly accelerate. I seriously doubt that is going to happen.

Gasoline Inventories

Distillate inventories rose by a meager +500,000 barrels. May is the turning point for distillate inventories and we should see inventories increase in the weeks ahead. The last two weeks have been marginally positive as new production and imports have matched demand.

Distillate Inventory Chart


May started out with a bang as a result of the ISM, ADP Employment and China PMI. Vehicle sales slowed from 15.3 million to 14.9 million. Construction spending fell -1.7% after rising +1.2% in the prior month. All the economic indicators are declining and the Fed suggested in their post meeting statement there were additional downside risks.

All these events combined to knock -138 points off the Dow, -30 on the Nasdaq and -15 on the S&P. That simply took us back to Friday's close on the S&P at 1582. The gains this week were erased but the loss was minimal.

The worry in the market now will be the Nonfarm Payrolls on Friday. There is a real risk for a sharply lower number and that could be the final straw that breaks the rally's back.

The S&P is in a double top formation if there is no rebound on Thursday. We are in May and a decline below 1575 on the S&P would setup a technical sell signal. The real level to watch for is 1540 and should we see a decline to that level I would expect a decent bounce. If we do rebound this week the 1600 level is critical. A move over 1600 would trigger massive amounts of short covering. Traders are setup for the "Sell in May" decline and should that not occur it could be a wild ride higher.

Jim Brown

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