Oil Falls with Equities

Jim Brown
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WTI Crude declined -1.27 to close under $104 but Brent crude remained firm at $110 because of the various production disruptions in the Middle East and Northern Africa.

The EIA said this week they expect the price of Brent to drop slightly in the normal end of summer decline but still remain around $104 because of the disruptions. As I have been reporting over the last several weeks there are numerous production declined from overseas fields. The EIA said there was a -2.7 mbpd drop in production in July as a result of outages for various reasons. That is a lot of oil when OPEC is only overproducing their quotas by 1.0 mbpd. When those outages are cured the price of Brent should drop like a rock but that is not expected for a long time. The EIA is projecting a 4.0 mbpd surplus of OPEC production capacity by the end of 2014. Of course that assumes all the rebels and terrorists take a year long vacation and civil wars end in several countries. Neither is likely to happen.

Reporters claim several ports in Libya could reopen over the next few days. They have been shut down due to worker strikes and Libya's 1.2 mbpd in exports had shrunk to 400,000 bpd. Restarting the flows from Libya would pressure Brent prices.

Refinery runs in Europe and Asia hit their seasonal peak this week and it is all downhill from here as demand for motor fuels slows and refiners begin their seasonal fall maintenance. The IEA said global refinery runs in July averaged 78.3 mbpd compared to the Q2 average of 74.8 mbpd. They expect late August runs to decline slightly to 77.4 mbpd but then drop in September to 76.2 mbpd and then 75.9 mbpd in October. This will push global inventories higher until the winter heating oil season begins.

I write a lot about the disruptions overseas but floods in Canada accounted for nearly 25% of the non-OPEC disruptions in July. Much of Canada is covered in bogs and excessively wet weather turns them into an impassable swamp. That changes in the winter when the ground freezes and transportation becomes routine again.

EIA Production Disruption Chart

The EIA said crude inventories declined by -1.4 million barrels to the lowest level since August 2012 at 359.1 million barrels. Refiners are not importing as much oil and Cushing supplies are continuing to decline. Cushing inventories fell -1.1 million barrels to 37.4 million and the lowest level since March 2012. The Seaway pipeline is running full speed at 400,000 bpd after the initial hiccups that kept it at 150,000 for several months. There was a report early Wednesday the Seaway was halted but the operators responded saying it was operating normally.

Genscape reported the 90,000 bpd Hawthorn pipeline from a rail terminal in Stroud Oklahoma to Cushing was preparing to restart for the first time since August 2012. The decline of oil at Cushing has made it profitable to reopen that pipe to allow oil shipped by rail to flow towards Cushing once again.

Gasoline inventory declined by -4.0 million barrels as retailers stocked up for the Labor Day demand spike. After next week we should see gasoline inventories begin their typical decline as refiners begin to switch from summer blends to winter blends. This forces all storage tanks to be emptied of summer blends by November 1st. Refiners will let the inventory sell off before they begin producing the winter blends. Gasoline inventories are nearly 8% over year ago levels.

Distillates rose by +900,000 barrels and will soon begin to fluctuate as the winter heating oil season begins in October. Distillate inventories are already at their highest level since March 2013 and 3.3% over year ago levels.

(Inventory Snapshot guide: Green squares are multiyear highs. Yellow is multiyear low. Orange is multi month high. Pink is multi-week highs. Blue is multi-week low. 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

Oil Inventory Chart

Gasoline Inventory Chart

Distillate Inventory Chart

The weekly inventory report had little to do with the movement in oil prices. They have been supported by the geopolitical events and traders are growing bored of the daily headlines and they are starting to fear the normal August-September decline cycle. Critical support for WTI is $102 and a decline below that level could see prices go into freefall to the mid $90s.

WTI Chart

The FOMC minutes were a big drag on oil prices and equities. The minutes showed broad support among members for tapering QE with an end to QE by mid 2014. While everyone continues to use the "data dependent" qualification they have to start soon in order to end in June/July 2014 as Bernanke has suggested. The minutes said "almost all participants" confirmed they were reasonably comfortable with the contingent plan to taper. This was the most support we have seen in the Fedspeak for early tapering.

The Fed had originally said they would maintain stimulus until unemployment reached 6.5%, currently 7.4%, or inflation rose unexpectedly to 2.5%, currently 1.2%. It appears from the minutes they may be changing to something in the 7% range for unemployment. Inflation is nowhere near their targets so that calls into question the need to taper.

It appears they are slowly coming around to the need to taper before Bernanke leaves at the end of January and they are going to do it regardless of the economic numbers. Everyone is afraid of the ramifications of unwinding the stimulus and they want the blame to be shouldered by Bernanke as the outgoing scapegoat.

In a strange twist the committee considered adding more information to the statement concerning the contingent outlook for QE purchases. They decided not to do it because "it might prompt an unwanted shift in market expectations regarding QE" and that needed to be avoided.

Think about that for a minute. If they put more information into the statement that cleared up some of the uncertainty they felt it could produce an "unwarranted shift" in expectations. Enquiring minds want to know if that shift would have been positive or negative. Had they given us more information suggesting QE tapering would begin next month the market would have tanked even more than it did today. If they gave information suggesting QE really was data dependent and the data had failed to satisfy their goals then QE would continue and the market would have blasted off. The Fed is perfectly content to keep investors in an uncertain frame of mind because that prevents severe market swings. Unfortunately those swings will eventually appear when they are forced to reveal their cards.

A market that lives by QE, dies by QE. The market is anticipating that death and investors are taking their chips off the table.


The Dow fell to -122 after the FOMC minutes then rebounded briefly into positive territory before crashing again at the close to lose -105 points and closing at a new 6-week low of 14,897. The S&P moved in lock step to lose -9 points at 1,642. Both indexes closed well under strong support and the outlook is negative. August and September are the two worst months of the year for market performance and once support levels begin to break the declines can be dramatic.

I have been warning of this decline for the last two months and this is why we exited so many positions in early August.

Dow Chart

Energy equities are declining as expected and should accelerate to the downside once the decline in oil prices moves below $102. Investors should wait for mid to late September before adding long positions.

We need to get past the September debt ceiling battle and the FOMC meeting on the 18th before we start adding positions for the expected end of year rally.

Jim Brown

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