Egypt Still the Key

Jim Brown
 
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Oil prices held at a three-month high of $106 for the sixth consecutive day as violence continues in Egypt. On Tuesday seven people were killed and more than 260 injured in the fighting that also saw 40 policemen hurt.

The new leadership swore in a new cabinet including women and Christians but no Islamists. The Muslim Brotherhood has been eliminated from the government and from high ranking civil service positions installed by Morsi. The Brotherhood has vowed a fight to the death and refuses to recognize the "illegal" government.

The Brotherhood is vastly outnumbered and outgunned and that normally causes the underdogs to increase their efforts to cause damage by secretive means. Rather than direct confrontations they tend to turn to guerilla warfare with bombings and clandestine hit squads.

The urge for the Brotherhood to do something large in scale is the current worry for the army and police. Blowing up pipelines, oil facilities, airports or even an attack on the Suez Canal are things the army is trying to protect against.

While the Suez Canal is said to be off limits to rebels because of the heightened military presence there will continue to be worries about the safety of the waterway. More than four-million barrels of oil per day go through the canal.

With Egypt's tourist trade completely shutdown they have to keep the oil revenue flowing. The mobs on the street are looking for any Syrian, Palestinian, Israeli, Iraqi and Americans as they have all been labeled as "provocateurs." One prominent television stations warned they should all be turned over to the police for deportation. Previously all that was needed to enter Egypt was a passport. Now all foreigners must have a visa to enter. This is even tougher than it sounds because the Egyptian embassies in those Middle Eastern countries are not issuing visas and that effectively prevents anyone from entering the country.

This will not last indefinitely. With the Muslim Brotherhood vastly outnumbered and the new government moving on to putting the country back together the riots will eventually wither away. It could take weeks but the army is actively seeking out instigators and putting them in jail and freezing their assets. It is going to be a long slow process but once the demonstrations fade so will oil prices.

Inventory

Crude inventories have experienced some huge volatility recently. The EIA said today that inventories declined -6.9 million barrels after declining more than 20 million over the prior two weeks. These are huge declines and losing -27 million barrels over three weeks is unheard of.

Crude imports rose +180,000 bpd and domestic production rose +89,000 bpd or the inventory decline would have been a lot worse. That is nearly two-million barrels of increased input for the week and we still declined -7 million.

Refinery demand only increased +119,000 barrels despite refinery utilization rising another+0.4% to 92.8% and the high for the year.

The increased refinery utilization coupled with a decline in demand caused a +3.1 million barrel jump in gasoline inventories. Distillates spiked +3.9 million barrels after a +3.0 mb hike the prior week. Distillate inventories are now at a four-month high at 127.7 million barrels.

The EIA said the crude runs at refineries have increased to the point where some are the highest on record. At 16.24 million barrels last week that is the highest for any week since 2007. This is 2.1 million barrels over the rate in early March. Some of this increase is related to the new capacity recently started at the Motiva refinery in Port Arthur. They added +325,000 bpd of capacity. Refineries on the Gulf Coast are operating at nearly 94% of capacity. Additionally BP ramped up operating levels at the Whiting refinery to nearly 405,000 bpd after two years of sharply reduced volume as the plant was upgraded.

The sudden excess in gasoline and distillates is keeping the price at the pump relatively subdued. The national average for gasoline on July 15th was $3.64 per gallon and +21 cents over year ago levels and a +15 cent gain over the prior week. That is the largest weekly increase since February when WTI peaked at $98.50. Gasoline on the West Coast averaged $3.93 per gallon.

(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. The number of active gas rigs at 350 is an 18 year low. Oil rigs at 1,412 is an eight-month high. Crude oil at 397.6 mb is the highest since 1931.)

Inventory Snapshot

Crude Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

Chevron (CVX) must be hard up for new development prospects. Chevron announced they had signed a deal with Argentina's YPF SA to develop the country's shale oil and gas resources. This is the first time a major company has made a significant investment in Argentina since the country nationalized YPF SA. The company was state run until it was privatized in 1999. Over the years Repsol acquired a 57% stake in YPF SA. Argentina expropriated a 51% interest from Repsol in April 2012. This led to avoidance of Argentina by the major oil companies because nobody wanted to see their investment disappear. Since the nationalism Argentina underinvested in the energy exploration and development sector and subsequently became a net energy importer. Governments normally nationalize to gain access to the corporate funds for government use and they are notorious for not continuing development.

Chevron said it will invest $1.24 billion in the first phase of development in the Loma La Lata Norte and Loma Campana areas. Chevron will drill 100 wells in a 5,000 acre tract in a pilot program as part of a 96,000 acre concession.

Apache (APA) announced the discovery of another gas find off the coast of Australia. The Bianchi-1 wildcat in 240 meters of water found 112 meters of net gas pay. This discovery improves the chances of further discoveries in the adjoining leases where Apache is the majority holder and operator. Apache has 30.25% interest in this lease and the adjoining area. Apache has already discovered enough gas offshore Australia to participate in the two giant LNG facilities, Wheatstone and Gorgon, being built by Chevron. This area is going to produce massive amounts of gas for both companies over the next decade. Reserves are in the 50-70 Tcf range.

Energy XXI (EXXI) shares rallied +14% on Wednesday after the company said proved reserves jumped +50%. EXXI said proved reserves rose to 179 million Boe as of the end of June. About 75% of those reserves are liquids of which 95% of that is crude oil and condensate. The company has drilled 11 horizontal wells in the last year and nine of them have been successful. EXXI has leases in six of the 11 largest oil fields in the Gulf.

Natural gas prices continue to hover in the $3.60 range as we await inventory information on Thursday. The record heat in the Northeast and Midwest should produce significant demand by electric generation plants. However, production has increased with the advent of the higher prices in Q2. It will be interesting to see if there is enough demand to offset that increased production.

CSX reported on Tuesday that coal demand by domestic utilities rose +9% in Q2 thanks to fuel switching as a result of higher gas prices. The $4 level is where it becomes cost effective to switch to coal. For some utilities it is closer to $3.75 but you get the idea. As long as coal is plentiful it will be difficult for gas prices to rise much more than $4. Once the LNG export plants are completed starting in 2015 as much as 5 Bcf per day will eventually be taken out of the system. With weekly storage injections running between 75-90 Bcf the removal of 35 Bcf a week will be significant. Only two locations have been licensed for export but there are more than 20 applications pending.

Market

Fed Chairman Ben Bernanke testified before the House today and the markets initially rallied on his prepared comments. He again stressed that QE was data dependent and could still see purchases increase if the economic data warranted it. He is trying desperately to walk back his comments from several weeks ago that suggested there was a timetable beginning in September and ending in July to taper and end QE.

As the Q&A session continued the markets faded from their early morning highs but they managed to close with a minor gain.

The Fed Beige Book was released this afternoon and the report said "economic activity continued to increase at a moderate to modest pace across all Fed districts." The "moderate to modest" description was the same as the prior report. The Fed said the strength remained in housing and automobile manufacturing. However, mortgage applications had declined significantly due to the higher rates. The report blamed weather for some of the weakness in several districts. The report also said there was weakness in full time hiring but the data was collected before the announcement Obamacare was being delayed one year. Overall there was nothing to get excited about. There was not enough growth to cause the FOMC to change its current posture and it was not weak enough to cause them to add to QE. This was just one more month where nothing happened and the economy barely grew if at all.

The Q2 GDP to be announced on July 31st is shrinking by the day if you can believe the various analysts. Sub 1% growth is expected but some analysts believe we could actually see a contraction in the subsequent revisions. The Fed is not likely to cut QE with the GDP growth under 1%. Growth in Q1 was +1.78%. In 2012 Q2 was the low point at +1.25% growth.

The dollar sank to a four-week low this morning before the Bernanke comments. We have already heard from multiple corporations that dollar strength hurt their earnings. Coca-Cola (KO) said it reduced their earnings by -2%. IBM said currency fluctuation accounted for 2.3% of its revenue decline. The dollar decline on weaker economic reports is helping corporations and supporting oil prices.

After the close Intel posted disappointing earnings and IBM missed on revenue. Intel was down hard in afterhours and IBM rallied +5 on raised guidance. Ebay disappointed and crashed -4 while SanDisk beat and rallied +4. S&P futures were up slightly at the start but have begun to fade and are now down slightly.

Crude prices typically decline in August-September and then rebound in the fall as winter heating oil demand increases. Investors should wait for the normal end of summer weakness to add long positions.

Jim Brown

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