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CRUDE OIL MARKET FUNDAMENTALS: The crude oil market has given back a portion of yesterday’s gains in the overnight trade under pressure from a sharp rally in the dollar while the market may be rethinking yesterday’s bullish reaction to the inventory data. Crude oil fell back as the Dollar gained diminishing the appeal of oil as an alternative investment and inflation hedge. Year end positioning and safe haven buying tied to a credit downgrade for Greece seems to be behind the dollar’s rally and crude oil is under pressure as investors scale back risk. But we also suspect the oil market may be undermined by expectations for the Fed to start tightening rates sooner than expected since the FOMC statement acknowledged that economic conditions show signs of improving while reiterating the Fed’s plan to withdraw its special lending programs early next year which suggests tightening liquidity conditions. But it’s also likely that the oil market is under pressure since taking a second look at the inventory report reveals several bearish indicators. While the market rallied yesterday off the headline that oil stocks fell 3.6 million barrels, a portion of the decline is likely due to refiners making inventory adjustments for year end tax reasons. In fact, with the refinery operating rate dipping below 80% and oil imports down sharply, this setup clearly shows oil demand remains weak which is confirmed by the EIA reporting total product demand over the past four weeks was down 1.7% compared to year ago. The low US refinery operating rate also suggests oil stocks could start building again in the New Year. News that Japan’s second largest refinery may close and idle facilities may be further undermining the global demand outlook for oil. While the fundamental setup for oil still isn’t particularly strong, the market still shows signs of being technically oversold after breaking sharply from the early December high. Therefore, we suspect more intense pressure from outside markets may be necessary to pressure February crude oil back below chart support at $73.07. Seeing good readings on jobless claims and leading indicators today is more likely to pressure oil than be supportive if the Dollar strengthens off the news. On the other hand, if the dollar starts to give up its early gains, there may still be enough short covering potential for February crude oil to make another run at the $75 resistance level. Escalating geopolitical tensions with Iran is another wild card that could potentially add risk premium support to oil prices. The bears have the early edge, but follow selling will likely key off the Dollar’s direction.

GASOLINE: February gasoline is also under pressure from the dollar rally and given yesterday’s inventory readings, the fundamental setup for gasoline still favors the bear camp. Yesterday’s rally may have been a bit overdone considering gasoline stock rose by 900,000 barrels despite a 1.1% decline in refinery operation which suggests fuel demand remains weak. But on the other hand, the market has become quite oversold on the sell off seen earlier this month and so more dollar strength may be needed to push February gasoline back below support at $1.86. A forecast by AAA auto club for holiday travel to be up 3.8% this year may also help to help to limit losses. While the market has an early selling bias in place, trading may be confined to the $1.9124 to $1.86 price range today with bearish fundamental and the Dollar influences working against an oversold technical condition.

HEATING OIL: It certainly must be disappointing to the bull camp to see February heating oil give back a good portion of yesterday’s gains overnight. The market appears to be a bit skeptical that the cold weather will be enough to significantly reduce distillate supplies, especially since fuel demand was still down 6.6% compared to year ago. It also looks as if the market ran into tough resistance at the $2.00 price level. The dollar seems to be having the most influence on heating oil in the overnight trade. But we suspect additional outside market pressure will likely be needed to push February heating oil back below support at $1.9779 considering the market still appears to be very oversold. Also, the cold temperature forecast and low refinery operating rate should provide a measure of support to heating oil since higher heating demand will help trim the supply glut in coming weeks. Therefore, given the mix of factors we suspect February heating oil may be confined to a $2.00 to $1.9780 trading range this session.

TODAY’S ENERGY MARKET GUIDANCE: A sharp rally in the dollar gives the bear camp in oil the edge this morning. But with energy markets still very oversold there may not be a lot of downside follow through unless the Dollar builds on overnight gains or a more extensive break in equities is seen.

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CRUDE OIL MARKET FUNDAMENTALS: Crude oil has pulled back from overnight highs after making an initial push above $80. Some of the profit taking in oil is likely tied to a steady Dollar/weaker equity trade overnight while lingering demand doubts could also be holding the market back. To a certain extent, the 3.5% gain in 3rd quarter GDP with the economy growing at the fastest pace in two years has helped to revive macro economic optimism that had been undermined earlier in the week by the soft readings in consumer sentiment and new home sales. Seeing US jobless claims fall has also helped to ease macro economic doubts and improve oil market sentiment a bit. But this week’s EIA report did show builds in gasoline and crude oil stocks and continuing evidence of weak fuel demand seems to have left the bull camp’s confidence a bit shaky. In fact, the global oil demand outlook may have been undermined by news that Japan’s oil product sales fell 5.9% last month due to weak industrial fuel use and low gas sales raising doubts that the strength in China’s oil demand can lead to global oil growth. Major oil companies have also reported poor corporate results due to weak fuel demand and that has also been creating some doubt among oil traders. Since pulling back from the high reached earlier in the month, December crude oil has had a hard time recapturing price levels above $80. But in order for the oil market to completely push aside internal supply/demand concerns and further raise macro economic expectations for a recovery in oil demand will likely require seeing good readings in today’s reports on consumer sentiment and Chicago PMI. A good portion of yesterday’s gains were also tied to the sell off in the Dollar which creates a bullish environment for commodities and raises the investment appeal of oil as an inflation hedge. After failing at a key chart level in yesterday’s trade, we suspect the Dollar could soon start a new leg down. But given the weak early price action in crude oil, the Dollar will need to build on yesterday’s losses in order for the oil market to regain its footing. Yesterday’s rally in crude oil was impressive, but technical indicators still show the market to be overbought and that could be another factor weighing on prices this morning. Therefore, in order for the oil market to completely shake off oil demand doubts and overcome its technical condition we suspect a very bullish outcome will need to be seen in today’s economic reports that triggers a strong positive reaction in equities and a break in the Dollar. End of the month position adjustments and the expiration of the November product contracts could also play a role in today’s trade that adds volatility in the session.

GASOLINE: December gasoline has started to pull back in the early overnight action as apparently the trade may want to see more evidence of a macro economic recovery before pushing the market to higher price levels. The rise in gasoline stocks and generally weak oil demand data have pulled the rug from under the bull camp this week. Yesterday’s strong GDP reading helped to restore some of the macro economic optimism that has faded this week, but we suspect stronger than expected readings in today’s scheduled reports will be necessary to further convince the trade that the economic momentum seen in the 3rd quarter is continuing in this quarter. Despite the sell off this week, December gasoline still looks a bit short-term overbought and for the market to overcome its technical condition will also likely require price support from bullish outside market influences. The technical action in the Dollar yesterday looked as if the recent corrective bounce in the currency had been completed and Dollar ready to resume its downtrend. But the Dollar has held fairly steady overnight and unless the currency starts to back peddle, we suspect gasoline could give back a portion of yesterday’s gains. Support for December gasoline comes in between $2.01 and $2.00 and below there at $1.9690, with resistance at $2.0441 then $2.085. A volatile trade could be seen due to end of the month profit taking and the expiration of the November gasoline contract.

HEATING OIL: December heating oil has backed away from yesterday’s highs in the overnight trade as a lack of follow through weakness in the Dollar and a soft equity market trade seems to have inspired some traders to book profits following yesterday’s price gains. While the GDP reading seemed to restore some macro economic optimism that had been lost earlier in the week, apparently the trade needs more economic convincing before lifting December heating oil back over the $2.10 resistance level. Certainly the fundamentals for this market remain bearish with distillate stocks high, a mild temperature outlook keeping heating demand low and industrial fuel use still weak. Technical indicators still show heating oil to be overbought and that condition is likely another factor weighing on the market. Therefore, the trade will need to see a combination of strong economic news and a sell off in the Dollar in order for the bull camp to reclaim control and make a run at yesterday’s highs. Otherwise, December heating oil could end up giving back a good portion of yesterday’s gains.

TODAY’S ENERGY MARKET GUIDANCE: Bearish outside market influences and some lingering fuel demand doubts are giving the bear camp the early edge. Therefore, in order to shift control back to the bull camp today’s economic reports will need to trigger a sharp sell off in the Dollar.

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In many ways the natural gas market sits in classically bearish fundamental position. US storage levels are nearly at capacity, industrial demand is expected to remain soft, and the threat against supply from the current hurricane season has so far been the lowest in over five years. However, we would suggest that the natural gas market is fully aware of its bearish fundamentals and that they were already priced into the market when prices fell to the September low of $3.49.

While a number of physical commodities like crude oil, copper, sugar and cocoa have already begun to factor in some form of economic recovery, one could suggest that natural gas prices have no such improvement priced into their equation. And while we still haven’t seen the “seminal” development that would indicate that a change is underway, we do think that the economic process is set to prompt a bottoming in prices. In addition to prices reaching the lowest level in seven years, the differential between natural gas and crude oil is trending back toward the extreme again, and that in conjunction with increased lobbying efforts from the gas industry might result in some governmental favor ahead.

In looking back at the speculator activity over the last year, one sees that a massive net short position was built into natural gas as petroleum prices were making historic highs. That might suggest that players were simply hedging long crude oil plays with short natural gas positions. In fact, in the wake of the major energy top in 2008, open interest in natural gas fell from a peak of 976,609 contracts just after the top to only 619,499 this past March. It should also be noted that the low point in natural gas open interest was seen in relative proximity to the major low in crude oil prices. This all seems to suggest that the trade has consistently used the natural gas market as a hedge against the desire to be long crude oil.

On the other hand, it would appear that a large portion of the sellers in natural gas during the sub-prime crisis were picking natural gas as the market most likely to suffer demand losses due to a sustained recession. As can been seen in a COT positioning chart, speculators built a historic short position in natural gas into the peak of the sub-prime disaster, apparently off of ideas that industrial demand for natural gas was set to decline. Given that demand did decline and storage levels exploded, the march to new lows over the last nine months was clearly justified.

While the jury remains out on the prospect of a recovery in the manufacturing sector, we would suggest that demand shouldn’t be as bad as was assumed into the summer of 2008. Certainly the natural gas market saw the net spec short position eradicated after a depression was avoided. Last March the market was even able to build a net spec long of 27,641 contracts.

In short, we think the market has moved back into a more normal economic and technical posture, with the speculative interest thought to the under scrutiny in the crude oil market, the prospect of gradually improving demand and the potential for political change on the rise. With their net position returning to at net short in excess of 40,000, the specs are leaning heavily to the bear side, but the case lower prices seems to be dissipating. However, because the fundamentals remain questionable, traders need to use strategies that compensate for lingering weakness in prices in the coming weeks. For instance, they could consider credit call spreads or long calendar call plays.

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CRUDE OIL MARKET FUNDAMENTALS: Crude oil has seen a two-sided trade overnight with the market running into some profit taking on an early attempt to follow through higher after yesterday’s strong gains. But stronger global equity markets and a generally weaker Dollar are starting to provide a lift to oil prices ahead of the US session. But with crude oil back near the price levels reached earlier this month, the market is also looking a bit fundamentally overvalued considering the high level of oil stocks on hand and since a low refinery operating rate is likely to cause a further build in oil stocks in the weeks ahead, especially if imports remain high. A report showing weak oil demand in Japan, the world’s number three oil consumer, may also have some traders questioning the prospects for a recovery in global oil demand. On the other hand, the price direction in crude oil has been mostly influenced by the macro economic outlook being thrown off by the action in equities and the Dollar. Since these outside market influences have been positive in the overnight trade, it has certainly limited the profit taking interest in crude oil. In fact, the revival in macro economic optimism this week tied to better global corporate earnings, growth prospects in China, rising sentiment in Europe and lower US jobless claims has certainly stirred up expectations for a strong recovery in fuel demand. But in reality, overall oil demand remaining weak and the market may need further economic evidence that conditions are improving in order to push oil prices significantly higher. So we suspect today’s reports on 2nd quarter GDP and regional purchasing managers reports from Chicago and NY will be a critical influence on today’s trade. Given the bearish fundamental backdrop for oil, September crude oil could encounter more significant end of the month profit taking unless today’s economic news triggers a strong bullish reaction in equities and raises investor risk appetite enough to inspire fresh buying in oil up at these price levels. Unless a steady flow of news continues to validate the macro economic optimism that has been building this week that also propels equity markets higher, we have doubts that crude oil will be able to hold up at these price levels.

GASOLINE: After an early attempt to follow through higher from yesterday’s sharp move the gasoline market has encountered some light profit taking in the early overnight action. Although gasoline supplies remain ample and fuel demand anemic, ideas that macro economic conditions are set to improve and revive gasoline consumption has been a key factor sweeping the market higher. Optimism for a recovery in fuel demand has also raised speculation that refinery outages and closures could start to tighten gasoline supplies and this outlook has also provided a lift to gasoline prices. But with the current fundamental setup for gasoline not particularly supportive since fuel demand this summer has remained anemic, we suspect it will be critical that macro economic optimism continues to grow in order to support a higher trade in gasoline. Outside market action overnight has remained bullish and so far that has limited the selling interest in gasoline. But in order to prevent more extensive end of the month profit taking and clear the way for September gasoline to retest the June highs, today’s economic news will likely need to support the bullish macro economic view.

HEATING OIL: Heating oil has also seen a choppy trade overnight with the market under a light pressure from profit taking. The heating oil market has been able to recuperate the majority of losses suffered earlier in the week as a revival in macro economic optimism has raised hopes for a quicker recovery in fuel demand. Gains in equity markets overnight along with the weak action in the Dollar could provide heating oil with additional upside capacity even though this market has one of the weakest fundamentals of the energy complex with distillate stocks at 25 year highs and demand readings continuing to slump. But if a bullish fuel demand outlook holds up, speculation that lower refinery operations will help ease the supply glut has also been a supportive factor. Therefore, today’s economic news could be critical in influencing sentiment towards fuel demand and that along with the direction in equities will likely determine in direction in heating oil this session. We suspect this market will need a steady flow of bullish demand side news to support a move back to highs seen earlier in the month. Otherwise, a breakdown in macro economic sentiment could trigger extensive profit taking.

TODAY’S ENERGY MARKET GUIDANCE: With the overnight action indicating energy market maybe a bit vulnerable to month end profit taking, today’s economic reports will be a key influence on market direction as bullish surprises may be necessary for the bull camp to retain control. But if equities manage another upside thrust, oil prices are likely to follow.

With the dramatic decline from the July 2008 highs, it appears the natural gas market has fully priced in its negative
fundamentals. The technical chart action also gives us confidence that market might have already set a major low in
the month of April. Furthermore, this price decline to a 6 ½ year low could set the stage for a strong recovery in the
second half of the year, as structural changes in the industry should help to re-balance the oversupply situation quickly,
while any sign of economic improvement may portend a recovery in industrial demand.

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While January natural gas continues to trade in a relatively narrow range the price action has been weak which leaves the market still vulnerable to an eventual break below support at the $5.45 price level. While it is certainly too risky to be short natural gas at this time of year and down at these price levels, the market has shown little ability to react to bullish news or positive outside market influences. In fact, the market’s failure to rally off the bullish weather outlook has to be disappointing to the bull camp recently and that is certainly a reflection of the market’s bearish fundamental setup. So far concerns over weakening industrial fuel demand, fuel switching by power utility companies and comfortable winter storage levels has kept a lid on Jan natural gas prices. As a result, traders have so far remained relatively unconcerned over supplies, despite the weather forecast calling for frigid conditions in the Midwest through Dec 28th and cooler temperatures in the Northeast next week.

Since crude oil did manage to hold onto overnight gains, that could provide a temporary measure of support to natural gas. But weak readings in today’s economic reports also have the potential of adding to the negative sentiment in this market. Plans for declines in investment and production by major natural gas producers will eventually set the stage for a strong price recovery in natural gas, but this will take some time to unfold. In the mean time, as long as economic conditions continue to worsen natural gas is likely to remain vulnerable to more downside than upside price risk.

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Ultimately we see a slide to the vicinity of $40 crude oil as removing a series of alternative energy sources from the world equation. In fact, seeing crude prices fall below $38 would mostly leave classic oil fields as the only viable source of supply.

Hydrocarbon Cost of Production

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