Pretty Quiet Week

Jim Brown
 
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The energy sector failed to rebound with the market after the big decline on the 20-24th. There was a positive bias but it was slim. Events in Egypt provided support last week.

Mass demonstrations in Egypt against the Islamist Mohamed Mursi and the Muslim Brotherhood party. Nearly half of the population of 22 million have signed a petition calling for his ouster. Several protestors have been killed including an American student. Mursi calls the protestors bad losers backed by thugs left over from the rule of Hosni Mubarak. Mursi, who is celebrating his first year anniversary in office this weekend, believes the protests will eventually fade. He believes the population will weary of turmoil and things will return to normal. He angered the population when he forced through a new constitution heavily influenced by the Muslim Brotherhood.

Others believe we could see a revolution similar to Syria where the incumbent refuses to cede power and uses the army against the civilians. However, the Egyptian army is independent and does not necessarily owe allegiance to Mursi. The army has said it will step in to quell any serious violence but insists it will respect the "will of the people." This means Mursi is vulnerable.

The U.S. has evacuated all non essential personnel and put a contingent of U.S. Marines on alert for a quick reaction force if conditions surrounding the embassy and U.S. facilities gets out of control. The Egyptian army has deployed to protect key installations including oil facilities.

Analysts said the breakdown in Egypt was similar to what was seen in Turkey over the last month. An Islamist prime minister with a strong electoral mandate was opposed by the population, which had been stimulated by angry secularists.

Syria remains in heavy conflict although Assad's forces are starting to win back some key locations. Numerous countries including the U.S. have promised support for the rebels but it has not been forthcoming. President Obama promised arms for the rebels but was immediately criticized for taking sides with forces aligned with Al Qaeda. The administration immediately went quiet on the subject and it remains to be seen if any support will be forthcoming.

With much of the Arab world in turmoil it seems very likely there will be some interruptions in production or distribution. Currently all the demonstrations are being held in the cities and the oil fields in Egypt are operating normally. Critical oil pipelines in Turkey are still in operation.

The camel with its nose under the tent is Iran. U.N. nations are calling for prompt talks with the new president and a quick resolution to the nuclear problem. Unfortunately he has little control over the effort and while he has been talking a good game there is not likely to be any progress. This means Israel and the U.S. will have to decide if they are going to follow through on the red line warning at the end of the summer.

Iran has secretly taken control of Iraq. They are an active player in Syria having sent 4,000 troops and tons of military equipment to help Assad. They are also exerting influence in Afghanistan with support for the Taliban. Add in underlying support for dissidents in Lebanon and Turkey and they are promoting unrest all over the Middle East. This is another factor that will be pressing on the Iranian negotiations. Many countries in the Middle East like Saudi Arabia and Qatar are afraid of Iran and believe they would eventually try to take over the entire Persian Gulf area if they had nuclear weapons as a threat. With Iran already a critical influence in the conflicts I mentioned above the negotiations are going to have an underlying gulf security context.

The late summer period could see some serious volatility in crude prices as a result of Middle East events.

Even with all the sanctions on Iran our ally Japan doubled imports from Iran in May. They increased shipments to about 225,000 bpd and twice May of 2012 and April of this year. In March the U.S. extended Japan's exemption from the sanctions for another six months because they had cut imports by about -17% in the prior six months. Apparently they are taking advantage of the exemption.

I have questioned many times in these pages why we even bother with sanctions if 22 nations are exempt. The U.S. and U.K. have no backbone. They want everyone to like them more than they want to really force Iran to give up on the nuclear program.

The U.S. rig count fell by -11 rigs to 1,748 and a two month low. Oil rigs declined by -15 to 1,390 and a nine-week low. Gas rigs rose by +3 to 353 and only 4 rigs above the 18 year low set the prior week. You may remember in the Q1 earnings reports by Schlumberger and Baker Hughes they said exploration companies had given them advance notice of a sharp increase in rigs activity this summer. Well, summer is in full swing and no rig activity has appeared. Baker Hughes expected an increase of 30-50 rigs from the 1,750 active rigs back in April. There was a minor bounce to 1,770 for about 4 weeks but the decline resumed.

Natural gas prices dipped to $3.52 last week after gas injections into storage rose to 95 Bcf and higher than expected. Total gas in storage is 2.533 TCF and that is -17.1% below year ago levels but injections have been above average for the last four weeks. However, we could be at or near the lows for gas prices since summer cooling season has arrived.

The EIA still expects record production in 2013 even with the low rig counts because of the thousands of wells that were shut in and hundreds of others waiting on pipeline connections. Dry gas drilling is at a minimum to hold leases but associated gas is still being produced in large amounts with oil and NGLs.

Natural Gas Chart

The attack on coal by the White House is going to push more electrical generation plants to move to gas. The president wants to shutdown coal plants that cannot be converted to "clean coal" technology (an oxymoron if there ever was one). Plants are going to be required to capture the carbon dioxide for disposal rather than let it escape up the chimney. This is going to be a long fight and it goes against the industry, which is actually adding a lot of coal fired plants this year.

NOAA is showing no storms and no signs of future storms on their weather map for this week. The holiday weekend should be hot and dry except for the occasional thunder storm.

Hurricane Outlook Map

Market

Historically the first week in July is typically bullish. After that the historical trends tend to fade until August when the dog days of summer see the indexes begin to decline after the Q2 earnings reports. S&P future started Sunday night with a -6 point decline but recovered later in the evening.

The HSBC Manufacturing PMI for China was announced Sunday evening and fell to 48.2 and the lowest level since September. That was down from the May reading of 49.2. Anything under 50 represents contraction. New orders declined from 48.7 to 47.6 and the lowest level since October. When China releases its GDP for Q2 on July 15th it is expected to have fallen below the official 7.7% target.

China's accelerating decline is going to weigh on our market and on commodities like oil. I believe this is going to push oil prices back to the $92 level later this summer even with the security issues in the Middle East.

The S&P rebounded to stall at its 50-day average which is now resistance after being support for the last six months. This will be a crucial test for the historically bullish first week of July. A failure here this early in July would suggest a rough summer.

Oil - Daily

S&P-500 Chart

The energy sector is declining as I expected and we should see further declines in the July-August period. Be patient and we will use any weakness this summer as a buying opportunity.

There will NOT be a regular OilSlick newsletter this Wednesday due to the holiday.

Jim Brown

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