Oil Stuck in a Range

10/23/2012 8:45 am EST

Focus: MARKETS

Dominick Chirichella

Partner, Energy Management Institute

Don't expect wide price swings in crude or related commodities, at least until after the US elections, notes Dominick Chirichella of Energy Market Analysis.

Not much has changed over the last week or so, insofar as the overall oil complex price direction is concerned. The oil price battle continues, with negativity coming from the slowing of the global economy on one side compared to regional supply-demand issues, geopolitical risk, and the risk of inflation from the aggressive monetary policies by major central banks on the other side.

On the macroeconomic front, the latest round of data out of China was somewhat constructive in that GDP came in as expected and all of the other indicators (investments, industrial production, and retail sales) beat expectations as well as increasing versus the previous month's data.

This suggests that there is a possibility that the Chinese economy may be in the early stages of forming a bottom. Certainly, one month does not make a trend, but it is a minor bright spot in a world with mostly bearish macroeconomic data.
 
On the other side of the equation, the regional issues with gasoline supply in California have subsided, as total gasoline inventories built in the US this week more than expected. An excerpt from the EIA's Weekly Petroleum Report this week indicated that unlike other disruptions on the West Coast this year, which affected prices in Washington, Oregon, and California, the impact of last week's disruption was generally limited to California.

News that the Exxon Torrance refinery had returned to normal operations on Friday, October 5, calmed wholesale prices. More importantly, on October 7, the California Air Resources Board allowed for an early switch from summer- to winter-grade gasoline.

Typically, summer-grade gasoline must be supplied through the end of October. The waiver allowed more components that are produced at West Coast refineries to be blended into finished gasoline, immediately alleviating supply tightness. In addition, winter-grade gasoline that meets California specifications is more available globally than the summer-grade equivalent.

Summer-grade California gasoline is only produced at a limited number of refineries outside of California, and those refineries are significantly distant, including facilities in Asia and Canada's East Coast. By October 16, wholesale CARBOB prices in Los Angeles had fallen to $2.92 per gallon, a one-cent-per-gallon discount to New York Harbor RBOB.

The maintenance is about over and expectations are for North Sea production to return to normal levels by November. The prospects of this happening has already been pressuring the December Brent/WTI spread, which is now trading around the $20/bbl level after rising to over $24/bbl just a few weeks ago.

The spread may have peaked for the time being, as more supply is coming, and oil demand in Europe continues to be weak. In addition, more oil is flowing from places like Angola, Sudan, and elsewhere. As has been the case for a long time, there is no shortage of crude oil any place in the world.

On the geopolitical front, the war of words continues between Iran and the West. No real movement toward any lasting resolution on Iran's nuclear program, even after the EU announced this past Monday that they had tightened up their sanctions on Iran.

I do not expect any change in the standoff...especially ahead of the US election on November 6. The earliest I would expect to see any movement from either side is sometime during the first half of next year. That said the geopolitical risk premium—although small by historical standards—will remain in the price at least through the end of the year.

The net result from all of the above has been a crude oil market that has been in a modestly wide trading range since the middle of September, with the spot WTI price trading between about $94/bbl on the upper end of the range to about $88/bbl on the lower end.

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The spot Brent contract has been range bound for even longer, going back to the middle of August of this year, with the upper end of the range around the $116/bbl level and the lower level around the $107.50/bbl range. At the moment—or at least until after the US election—I do not see the oil complex moving significantly outside of the aforementioned trading ranges.

Global equities have lost some of the early gains from earlier in the week, but as it stands at the moment, it looks like the EMI Global Equity Index is heading for a weekly gain. The index is higher by 1.9% for the week heading into the US trading session with the year-to-date gain sitting at 8.6%.

China continues to remain in negative territory for the year, with a loss of 3.3%. If in fact the latest round of macroeconomic data out of China is truly suggesting a bottoming pattern starting to form in the Chinese economy, we could see the China bourse pulling itself out of negative territory before the end of the year.

This week, the global equity market has been a positive price driver for the oil complex as well as the broader commodity complex. Even with mixed corporate earnings so far, the performance of the global equity markets this week suggests that investors and traders may be starting to take a view that the global economy may in fact be starting to balance out and approaching a turning point.

Again, one week's trading activity does not make a trend, but the Index is still slowly trending to the upside since hitting a low at the end of August.

That all said the single biggest negative for all risk asset market is the high level of uncertainly that has been permeating around the globe for the last year with no clear sign that much of the uncertainty is going to dissipate anytime soon. For example after the US elections are decided and that sector of uncertainty is removed from the market attention will quickly be turned to the impending fiscal cliff in the US.

Even if that is solved (which I think a comprise will emerge) in some form prior to January 1, attention will revert quickly back to Europe, along with the evolving geopolitical risk in the Middle East—especially around Iran's nuclear program.

So uncertainty is here to stay, and as a result I expect the oil markets will continue to trade in a wide trading range, with an above-normal level of volatility, as many traders and investors continue to trade with a short term time horizon and maintain their trading books accordingly.

I am maintaining my overall view as neutral, as I expect the oil complex to continue to trade in a wide trading range, as uncertainty continues to cloud the entire complex. The battle continues between the negativity from the slowing of the global economy compared to what global stimulus programs might do to the economy going forward, while geopolitics have continued to remain an issue for market participants.

I am keeping my Natural Gas price view at neutral with bias to the bullish side, as the fundamentals and technicals are once again keeping the overall market well bid. As I have previously mentioned, the market appears to still be in a buy-the-dip mode.

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