Inventory Overload

Jim Brown
 
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The EIA inventory report shocked traders once again with a major rise in crude inventories.

Crude inventories rose by +5.8 million barrels after an equally strong +6.2 million barrel build the prior week. This is the season where inventories do build but not at the present rate. Expectations were for a build of only +2.4 million barrels, which is more in line with seasonal norms.

The various factors that impact inventories were mostly unchanged. Production rose by +33,000 bpd, refinery demand declined by -36,000 bpd and imports were only slightly lower a -2,000 bpd. There was nothing to send inventory levels this much higher. This suggests that the existing refinery demand for crude is not strong enough to consume the crude going into storage.

If you look at the graphic below the refiner inputs for last week fell to 14.95 mbpd. That is down significantly from the 15.42 mbpd back in January and the lowest level in more than two months. Refinery utilization has fallen from 88.2% to 85.6% over the same period. Back in January refiners were supplying more than 20 mbpd of refined products to the market. That has declined to 18.78 mbpd.

This is why inventories build this time of year. Refiners are shutting down plants for maintenance and the switch over to summer blend fuels. Utilization is slowing and product output is slowing.

Distillate inventories fell -3.1 million barrels and gasoline declined for the fourth consecutive week with a -1.5 million barrel drop. Distillate inventories dropped because of a sharp increase in demand of +462,000 bpd. That is a huge spike and could have been due to the resumption of a full calendar of air traffic. So many flights have been cancelled in the prior weeks the demand had fallen into the 3.6 mbpd range. The surge this week pushed demand up to 4.16 mbpd and the most demand since January 24th.

Distillate inventories at 110.8 million barrels are at the lowest level since May 2008. Clearly there is plenty of room for more production. Inventories were as high as 175 million barrels as recently as August 2010. The decline has been steady and slipping to multiple year lows should prompt refiners to begin adding production.

Gasoline demand went the other direction with a -437,000 bpd drop and a decline in production of -126,000 bpd. Gasoline inventories should continue to decline as winter fuel blends are allowed to deplete.

U.S. crude production rose by 33,000 bpd as the impact of harsh winter weather begins to fade. That 8.22 mbpd of production is the most since March 1989.

Cushing inventories again declined with a -1.0 million barrel drop to 29.8 million. That is the lowest level since February 2012 and a -29% decline in the last 7 weeks. Inventories are now -19 million barrels below year ago levels. Roughly 1.0 mbpd of crude is now moving by rail and bypassing Cushing to go directly to refiners. That was less than 70,000 bpd just five years ago. The Enbridge/Enterprise Seaway pipeline is now fully functional at 250,000 bpd flowing from Cushing to Gulf refiners. The Marketlink pipeline began filling in December with an estimated 3.0 million barrels and began initial deliveries in January. That pipeline is expected to build to output of 525,000 bpd in 2014. These new pipelines south from Cushing have offset the 815,000 bpd of new pipelines into Cushing in 2010-2012.

Thanks to the ability to send more oil from Cushing south to the Gulf of Mexico refinery complex and the growing number of barrels moving by rail to coastal refineries the spread between WTI and Brent has declined to less than $6. WTI closed at $100.42 and Brent at $105.84 making the spread $5.42. The easing of tensions in the Ukraine is removing support from Brent prices and WTI is rising.





Iran and the P5+1 nations began meeting again this week on a longer term agreement regarding their nuclear program. Iran has already said they don't expect any new agreement to be reached. Iran got what they wanted out of the temporary agreement and that was the release of $6 billion in frozen funds and the ability to import various equipment and supplies. They also received permission to sell up to 1.0 mbpd of oil. That ceiling has been broken every month since November.

Crude loadings by just the top four buyers, China, India, Japan and South Korea rose to 1.16 mbpd in January and there were smaller amounts by random buyers. Also, Iran sold 105,824 bpd of oil by contract with Turkey. I suspect we are looking at something closer to 1.4 mbpd in total sales. The official numbers including condensates were 1.37 mbpd in February.

The Obama administration is pressuring India to cut back shipments to December 2013 levels and the Indian government has told refiners to cut Iranian imports by nearly two-thirds by the end of Q1.

I expect Iran to continue the delaying tactic of holding regular meetings without any agreement for as long as possible. When the agreement does not appear by July the sanctions will kick back in but Iran will have received $6 billion in frozen funds plus sold roughly $2.3 billion in oil over the six month period. That is a major boost for the ailing Iranian budget. Uranium enrichment will continue and the verbal battle will begin again.

Market

Welcome to the hot seat Ms Yellen. Janet Yellen held her first post FOMC press conference today and everything was going fine until she gave an unscripted answer. After repeatedly saying the Fed would not raise interest rates for a "considerable period" after QE ended a reporter asked her for the definition of considerable period. After a little rambling doublespeak she said it would be something around six months. All of a sudden the expectations for late 2015 to early 2016 evaporated. Treasury interest rates shot up and the equity market imploded. The Dow fell from -44 to -235 in the space of a very few minutes but eventually recovered to close down -114.

Yellen quickly found out that it is not good to adlib in the press conferences and you can bet she will be more cautious in the future.

While the sharp market drop may have triggered a bunch of sell stops it also attracted some buyers. The challenge for Thursday is direction. Will investors decide to sell just because the Fed "may" consider raising interest rates in July 2015 or will they buy the dip? I am betting they buy the dip. Worrying about rates 15 months in the future is not relative to today's stock market.

Jim Brown

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