Saudi Investment Fireworks

In my most recent blog entry I focused on the pressure being exerted on the Kingdom of Saudi Arabia by credit default swap (CDS) investors.  No surprise that the Saudi CDS rates continue to rise, as the probability of Saudi Arabia not meeting sovereign debt obligations continues to rise.

As the screws turn tighter on Saudi leaders to come up with solutions in the midst of soft petroleum markets, the Kingdom is tapping into old fashioned Western style financial instruments and manipulative strategies to help maximize Saudi crude assets.

In the past Saudi Arabia was able and was comfortable controlling crude market pricing by either increasing or decreasing production.  The US shale producers are making that simple tool much more difficult to administer as futures markets over react driving price points well beyond Saudi targets.

Meanwhile civilian strife or potential thereof is adding flames to the budget heat.

As reported by CNBC reporter, David Johnson:

"Saudi Arabia is somewhere in between: a stable nation with a sizable backup of reserve assets, somewhere around $624 billion as of December.  But much of that stability is bought with government jobs and generous public spending and with falling oil prices, the country has had to dip into its reserve assets to make up the difference.

Of course, the analysis depends on no major economic changes or events affecting Saudi Arabia. It also assumes oil prices remain low, which experts consider likely for the time being.

Looking at the country's finances in August, when oil swung between $48 and $41 a barrel. It had fallen a long way from its highs of $65 a barrel a few months before, but our lower estimate for its direction was way off. At the time, CNBC estimated the Saudis would be broke in August 2018, yet that was based on oil at $40 a barrel and before the Saudis cut public spending. 

The 2016 Saudi budget includes a spending cut of 13.8 percent from 2015 levels, though projections from Barclays puts that cut closer to 5 percent. Even so, the country is expected to reach a budget deficit of 12.9 percent of GDP in 2016, according to the investment bank."

That’s why the Kingdom may be considering to use an unconventional weapon in the oil war, which is to break the riyal ‘s peg against the US dollar. In other words, let the riyal fall.
That will make Saudi oil less expensive in global markets, help the country regain its market share in the US, and finish up the war against American frackers.

A weaker riyal will further help Saudi Arabia execute on its new strategy of producing and exporting refined products.
The problem is that this weapon may backfire and hurt Saudi Arabia’s economy. The prospect of a lower riyal, for instance, could cause a capital flight. And it could fuel inflation soon after it takes place, widening the Kingdom’s social budget deficit.

Saudi Arabia will be pulling out all the stops with its newly announced emphasis on sovereign equity fund investments, going public with a 5% equity of Saudi Aramco and currency manipulation tactics. 

Risky stuff.   Keep on your toes as the Saudi financial fireworks begin lighting up the volatile energy markets.

Will Saudi Arabian CDS Spreads Pressure the Kingdom to Cry Uncle Again

   
November 28, 2014 was the day that rocked the energy complex off its moorings. Tremors and aftershocks continue into 2016 as energy market participants struggle to understand the future of an unhinged market.

The hinge came off when Saudi Arabia announced it was no longer willing to be the price stabilizer for crude, rejecting cries from OPEC member countries to lower crude oil production.

Saudi Arabia blocked calls from poorer members of the OPEC oil exporter group for production cuts to arrest a slide in global prices, sending benchmark crude plunging to  four-year lows.

Brent oil fell more than $6 to $71.25 a barrel after OPEC ministers meeting in Vienna left the group's output ceiling unchanged despite huge global oversupply, marking a major shift away from its long-standing policy of defending prices.

This outcome set the stage for a battle for market share between OPEC and non-OPEC countries, as a boom in U.S. shale oil production and weaker economic growth in China and Europe have sent crude prices tumbling.

"It was a great decision," Saudi Oil Minister Ali al-Naimi said as he emerged smiling after around five hours of talks.  

The jury is still out on whether this was a great decision for Saudi Arabia.  They are rapidly losing desperately needed oil revenues. Increased domestic expenses along with the war with neighboring Yemen is posing increased budgeting stress. “This war is draining the Saudis militarily, politically, strategically,” said Farea al-Muslimi, a Yemen analyst at the Beirut-based Carnegie Middle East Center.
“The problem is, they’re stuck there.” 

Saudis have been busy cutting domestic spending and raising taxes to cope with the lower oil revenues. Not a good recipe for a country whose people have never been good at 
accepting austerity measures.

The ratings agencies are starting to take notice. Standard Poor's Ratings Services in October lowered Saudi Arabia's long-term foreign currency sovereign credit rating to A+ from AA-, citing a widening budget deficit resulting from weaker oil prices. The ratings agency projected the country's fiscal shortfall will jump to 16% of gross domestic product in 2015  from 1.5% in 2014. S&P said it expects Saudi Arabia to draw down its fiscal assets and issue debt to finance its deficit, though the country does not have much monetary-policy flexibility given the riyal's peg to the U.S. dollar. "The outlook remains negative, reflecting the challenge of reversing the marked deterioration in Saudi Arabia's fiscal balance," said S&P.

Deja vu may soon be coming for the kingdom of Saudi Arabia. In January of 1999 Saudi Arabia could no longer idly watch the continued descent of crude prices causing the kingdom's five year credit default swap (CDS) spreads to skyrocket. They cut crude production resulting in a prolific fifteen year crude bull market. 

There is nothing like good old fashioned market pressure that will soon be applied by Saudi CDS spreads that may lead to a repeat of 1999 crude production reductions.

How Petroleum Barrels Got the Blues

We often go about our daily tasks in the petroleum business working with strange measurements and symbols without giving a thought as to how they originated. For instance, how did 42 gallons become the standard for a barrel? And to go a strange step further, how did BBL become the symbol for a barrel of crude oil when a simple BL should have sufficed?

Many years ago after the first oil discovery in 1859, America's earliest oil and gas producers in Pennsylvania decided that a barrel of oil should be set at 42 gallons. Forty-two gallons seemed like the most reasonable size for transportation and for floating down the Allegheny
river. Titusville, Pennsylvania led the entire world in oil production at the time.

A 42-gallon barrel weighed 300 pounds when filled with oil. At that time, men, wagons, horses and boats and barrels moved the area’s oil. Pipelines wouldn’t come into play until later. Three-hundred pounds was about as much weight as a man would handle. Twenty would fit on a typical barge or railroad flatcar. Anything bigger was unmanageable, anything smaller was less profitable.

In that day, watertight tierce was a standard container for shipping fish, soap, butter, molasses, wine and whale oil. The 42-gallon barrels were quite familiar for commodity traders before the oil guys claimed it.

Just as a side note, a normal wine cask back in the day held 84 gallons. Today, wine cask capacity depends on the varietal.

Before the oil guys deemed a 42-gallon barrel their vessel of standard choice, they used wooden tierces, whiskey barrels, casks and barrels of all sizes.

In 1872, the 42-gallon standard was officially adopted by the Petroleum Producers Association, and by the U.S. Geological Survey and the U.S. Bureau of Mines in 1882.

The industry soon struggled with finding 42 gallon barrels after the decision was made, so Standard Oil Company began making the 42 gallon oil barrels, which they painted blue. 

It wasn’t long before people in the oil and gas industry started referring to the barrels as blue barrels, and thus the abbreviation BBLS came into play.

Today, the oil and gas industry refers to a 42-gallon barrel of any color as a “BBL.”

So now when you are crunching your spreadsheet analytic modeling metrics converting gallons to BBLs, BBLs to metric tons and so on, you will have a greater appreciation for our industry's arcane symbols and measurements.

QE Infinity Coming to an End

Seven years ago, Wall Street came closer to imploding than at any other time since the Great Depression.

That was when the venerable investment bank Lehman Brothers filed for bankruptcy on Sept. 15, 2008, amid the global mortgage meltdown, triggering a cascade effect across Wall Street. Within days, the insurer AIG had to be bailed out by the federal government while other investment banks, including Morgan Stanley and Merrill Lynch, were pushed to the brink. Merrill, in fact, was eventually sold amid panic to Bank of America.

Seven years later, the nation’s financial system seems to have largely healed. Banks are back to posting record profits. Over the past several years, financial stocks have been among the hottest areas of the market.

The recovery came mostly on quantative easing policies initiated by the US Federal Open Market Committee.

The US Federal Reserve held between $700 billion and $800 billion of Treasury notes on its balance sheet before the recession. In late November 2008, the Federal Reserve started buying $600 billion in mortgage-backed securities.  By March 2009, it held $1.75 trillion of bank debt, mortgage-backed securities, and Treasury notes; this amount reached a peak of $2.1 trillion in June 2010. Further purchases were halted as the economy started to improve, but resumed in August 2010 when the Fed decided the economy was not growing robustly. After the halt in June, holdings started falling naturally as debt matured and were projected to fall to $1.7 trillion by 2012. The Fed's revised goal became to keep holdings at $2.054 trillion. To maintain that level, the Fed bought $30 billion in two- to ten-year Treasury notes every month.

In November 2010, the Fed announced a second round of quantitative easing, buying $600 billion of Treasury securities by the end of the second quarter of 2011. The expression "QE2" became a ubiquitous nickname in 2010, used to refer to this second round of quantitative easing by US central banks. Retrospectively, the round of quantitative easing preceding QE2 was called "QE1".

A third round of quantitative easing, "QE3", was announced on 13 September 2012. In an 11–1 vote, the Federal Reserve decided to launch a new $40 billion per month, open-ended bond purchasing program of agency mortgage-backed securities. Additionally, the Federal Open Market Committee (FOMC) announced that it would likely maintain the federal funds rate near zero "at least through 2015." According to NASDAQ.com, this is effectively a stimulus program that allows the Federal Reserve to relieve $40 billion per month of commercial housing market debt risk. Because of its open-ended nature, QE3 has earned the popular nickname of "QE-Infinity." On 12 December 2012, the FOMC announced an increase in the amount of open-ended purchases from $40 billion to $85 billion per month.

On 19 June 2013, Ben Bernanke announced a "tapering" of some of the Fed's QE policies contingent upon continued positive economic data. Specifically, he said that the Fed could scale back its bond purchases from $85 billion to $65 billion a month during the upcoming September 2013 policy meeting. He also suggested that the bond-buying program could wrap up by mid-2014.While Bernanke did not announce an interest rate hike, he suggested that if inflation followed a 2% target rate and unemployment decreased to 6.5%, the Fed would likely start raising rates. The stock markets dropped by approximately 4.3% over the three trading days following Bernanke's announcement, with the Dow Jones dropping 659 points between 19 and 24 June, closing at 14,660 at the end of the day on 24 June. On 18 September 2013, the Fed decided to hold off on scaling back its bond-buying program,] and later began tapering purchases the next year—February 2014. Purchases were halted on 29 October 2014 after accumulating $4.5 trillion in assets.

The interest rate raising baton is now in the hands of Federal Reserve Chief, Janet Yellen, She likes the unemployment rate of 5.1%, she hates the inflation rate of only .2%. With all of the effort thrown at the economy Janet Yellen  is well aware that a rate hike may send the economy into a deflationary spiral.

 QE infinity will eventually come to an end.  We likely will not see a rate hike until December or sometime in Q1 2016. The energy complex will likely feed  off this support as traders rely on the Yellen put as a hedge.

"Don't Fight the Fed"

     The old adage used by Wall Streeters from time immemorial, "Don't fight the Fed", proved itself quite succinctly today with RBOB October futures finishing up .0625.  The highly anticipated speech by Fed Chairman Bernanke appeared to leave the door open for another round of quantitative easing to help counter higher US unemployment. This added more support to risk-appetites and fueled more gains in the crude oil market.

     Ben Bernanke has been on a mission to keep asset prices from falling since the fall of Lehman Brothers in September of 2008.  Being a life long student of the cause and persistence of asset depreciation during the "Great Depression", Mr Bernanke is willing, more than willing, to pump up commodity prices through quantative easing policies, to keep the US economy from sliding back into a deep recession.  Traders will do well to not fight the power that the Federal Reserve wields.

    Speaking at the Fed’s annual gathering in Jackson Hole, Wyoming, Mr Bernanke offered no direct promise of further intervention. But by spelling out the feeble state of the economy, the Fed’s intention to be forceful and its range of policy tools, he raised expectations of action in September.
“Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions,” said the Fed chairman on Friday.

     The clearest hint that Mr Bernanke is ready to do more came from his disappointment with the economy’s progress. He noted some recovery over the past few years but said that improvement in the labour market has been “painfully slow”. He said “unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time”.

     By midday, the S&P had rebounded from a drop after Mr Bernanke's comments, and closed up 0.5 per cent. The 10-year Treasury note rose, pushing its yield 5 basis points lower to 1.58 per cent, as markets decided Mr Bernanke’s comments did signal further easing. Mr Bernanke argued that the Fed’s forecasts of future interest rates – it anticipates rates staying low at least until late 2014 – illustrated its resolve in supporting a recovery.

     In one possible hint of future policy, he said that the current late-2014 date “is broadly consistent with prescriptions coming from a range of standard benchmarks”, but that “a number of considerations also argue for planning to keep rates low for a longer time than implied by policy rules developed during more normal periods”. That could imply a Fed policy of extending the forecast date into 2015 while making clear that it reflects a change in the central bank’s intentions rather than any downgrade to the economic outlook.

     The old adage is to be ignored at the risk of your own trading profitability, "Don't fight the Fed".

Drought Driving Ethanol and Gas Prices Higher

The worst U.S. drought in half a century has fueled a 50 percent surge in corn prices to a record of more than $8 a bushel, heightening fears of a food crisis. Even as the crop wilts, the farm economy has rarely looked healthier thanks to high property prices, widespread accessibility to insurance and a four-year commodity boom.


And a renaissance in domestic oil output in North Dakota and Texas is eating into dependence on foreign crude. Supporters of motor fuel made from U.S. grain have long used the foreign oil addiction as an argument for the Bush-era mandate, known as the Renewable Fuels Standard, or RFS.


Poultry, beef and pork producers complain the RFS, which requires petroleum blenders to use 13.2 billion gallons of corn ethanol this year or face fines, is also behind the rise in corn prices.

The higher corn prices go the more it boosts prices for one of their top expesnses: animal feed. So the industries are pushing the Environmental Protection Agency to waive the mandate this year.


But even with growing numbers of Midwestern counties declared disaster areas by the government, no ethanol opponent can yet make the case the EPA has said is necessary to grant a waiver: that implementing the mandate itself is causing "severe harm" to the economy of a state, region, or the country.


"Severe economic damage is a very high bar," said Mark McMinimy, a senior policy analyst at Guggenheim Washington Research Group, part of a financial services company.


Texas Governor Rick Perry discovered that for himself in 2008 when drought boosted grain prices and the meat industries pushed him to petition the EPA to waive the mandate. The agency turned him down, emphasizing that future petitions would have to demonstrate implementation of the mandate itself was causing the economic harm, not just contributing to it.


"I really don't see at this point what basis the administration would use to issue a waiver," McMinimy said.


U.S. Agriculture Secretary Tom Vilsack told a press conference at the White House on Wednesday the drought will spike crop prices. He also said beef and pork prices might rise late this year after rising in the short-term as ranchers and poultry farmers shrink herds and cull flocks.


But he also reiterated his agency's prediction last week that the corn crop could still be the third largest on record due to wider than normal plantings across the country this year.


In 2007 George W. Bush signed the RFS into law. It required 9 billion gallons of ethanol from corn in 2008, when Perry asked for the waiver. In 2015, the mandate peaks at 15 billion gallons requiring that level through 2022.


The mandate -- run by the EPA under the Clean Air Act -- was also embraced by President Barack Obama even before he hit the campaign trail for re-election and pushed an "all of the above" strategy on energy. Obama's blueprint lays out a future for oil, natural gas and wind and solar, but also for biofuels including ethanol made from corn.


Three of the swing states in the election, Ohio, Michigan, and Iowa, are top corn growing states, where voters might be dismayed by a move to take an important market for the grain off the table.


It is highly unlikely the mandate will be removed with these crucial swing states in play.


There is no doubt the severity of the drought has driven corn prices higher. This in turn lifts ethanol producers cost higher, resulting in higher ethanol prices and ulitmately higher ethanol blended gas prices higher.

The right thing to do is to relax the ethanol mandate immediately. However, it is doubtful any reduction in the mandate will come before the November Presidential elections.

Congratulations to all ethanol blenders who locked in large negative ethanol differentials to RBOB on their contracts earlier in the year!

German Chancellor Angela Merkel to the Rescue

What a day in the energy markets! RBOB rocketed up .15. HO even higher at .1577.  Brent crude and West Texas Intermediate bettered them all rising 7.5%. The catalyst for today's momentum was German Chancellor Angela Merkel reversing her stance on euro rescue funds being used to funnel  monies directly into euro zone banks.

So have all the world's problems been solved?  Are we to expect global growth to kick into high gear?

In my opinion, there are four glaring holes in the Summit’s announcements. First, it’s clear that given the language contained within the statement, any bank recapitalization plan by the European Stability Mechanism (ESM, which replaces the EFSF, the European Financial Stability Facility) is not a guarantee; it is a possibility if strict conditions are met. Secondly, and staying on the ESM, these changes now must be ratified by all 17 Euro-zone members; and Germany still needs to ratify the first agreement. So the ESM is far from being activated. Third, the idea of direct bank recapitalization will not sit well with tax payers in the European core. And finally, fourth, the bailout mechanisms, in my opinion, are doomed to fail once Italy and Spain tap them. Once these countries tap the funds, the burden falls onto the healthier countries, and we’ve already seen that Germany will be hard to convince to contribute more funds.

If there’s a positive to this Summit, it would be that seniority was removed from the ESM. This means that private bondholders, who were forced to take a haircut on Greek loans, won’t experience the same pain; this should help Spanish yields recover. They have thus far, with the Spanish 2-year note yield falling to 4.267% and the 10-year note yield falling to 6.393%.

All that being said, with peak hurricane season just one month away, I believe the bottom is in and hedgers are now able to ease up a little on seeking down side protection on crude and refined products.

The Rain in Spain Will Fall Mainly on Energy Futures

In these perilous economic times, Greece, Portugal and Spain are likely to be left to take the Doctor's advice given in Shakespeare's "MacBeth".
Macbeth:
Canst thou not minister to a mind diseas'd,
Pluck from the memory a rooted sorrow,
Raze out the written troubles of the brain,
And with some sweet oblivious antidote
Cleanse the stuff'd bosom of that perilous stuff
Which weighs upon the heart?
Doctor:
Therein the patient
Must minister to himself.

The irritation of the eurozone with Greece is at extreme levels. After all, 80 per cent of Greeks say they are in favour of staying in the euro, but then they fail to elect politicians prepared to implement the agreed programme. This drives creditors crazy. Increasingly, the latter are inclined to accept Greek exit, even welcome it. But they should be careful what they wish for.

A departure would create severe dangers. The danger of contagion is obvious. The long-run danger is more subtle. But the euro zone either is an irrevocable currency union or it is not. If countries in difficulty leave, it is not. It is then an exceptionally rigid fixed-currency system. That would have two dire results: people would not trust in its survival and the economic benefits of the single currency would largely disappear.
These perils are not of concern to the euro zone alone. Taken as a whole, this is the world’s second-largest economy, with the largest banking system. The risk that a bigger euro zone upheaval would cause a global crisis is real. As frightening is the likelihood that euro zone crises would become permanent features of the world economy.
If Greece leaves, the euro zone will have to change fundamentally to make survival less painful and therefore more credible. If that is impossible, as many suppose, irrevocability must be seen as a mirage, which would in turn guarantee the repetition of large crises. It also destroys the economic arguments for the currency union by undermining financial integration and rendering long-term investments dependent on access to the entire euro zone economy far riskier. It is a nightmare.
Greek exit then would create a choice between big moves to a stronger union and a future of endless crises. It is a choice the dominant creditor nation, Germany, must make – among big steps to integration that horrify many of its people, a future of horrible crises or a horrible break up right now. No good choices exist. But the euro zone must become a stronger union or it will disappear.

Greece is cooked. In four weeks Grecians will wake up to find themselves without a currency. The drachma will be revived. Until the transition from the euro to the drachma completes, Grecians will find themselves in a barter economy.

Portugal is the next bowling pin to tumble. Unfortunately for Spanish banks that hold $65 billion in Portuguese debt, Spanish banks will find themselves in a severe liquidity crisis having to absorb this enormous loss.

Forward thinking Europeans are already preparing for the worst. Runs are being made on Euro bank assets. Not the type of bank runs we remember from the depression with bank customers lining up demanding cash. Modern bank runs are performed online with a mouse and a click, removing cash via withdrawals or purchases of bonds.

This week European Union leaders will meet on Wednesday May 23rd to strategize short term stop gaps for the banking contagion that will spread with the fall of the Grecian economy. Failure to back stop Spanish banks will accelerate downward momentum in crude, gas and heating oil futures.

Where Have All the Onion Futures Gone?

One of the few vegetables that I have always detested is the lowly bulbous root better known as the onion. I am not sure why, but since as early as I can remember, I have fought hand and tooth resisting having to eat any dishes with onions as an ingredient. Little did I realize there was also a group of onion growers in Michigan that had an even stronger dislike for onion futures speculators.

Back in 1958, onion growers convinced themselves that futures traders (and not the new farms sprouting up in Wisconsin) were responsible for falling onion prices, so they lobbied an up-and-coming Michigan Congressman named Gerald Ford to push through a law banning all futures trading in onions. The law still stands.

And yet even with no traders to blame, the volatility in onion prices makes the swings in oil and corn look tame, reinforcing academics' belief that futures trading diminishes extreme price swings. Since 2006, oil prices have risen 100%, and corn is up 300%. But onion prices soared 400% between October 2006 and April 2007, when weather reduced crops, according to the U.S. Department of Agriculture, only to crash 96% by March 2008 on overproduction and then rebound 300% by this past April.

The volatility has been so extreme that the son of one of the original onion growers who lobbied Congress for the trading ban now thinks the onion market would operate more smoothly if a futures contract were in place.

"There probably has been more volatility since the ban," says Bob Debruyn of Debruyn Produce, a Michigan-based grower and wholesaler. "I would think that a futures market for onions would make some sense today, even though my father was very much involved in getting rid of it."

Commodities futures speculators provide the liquidity that make futures markets viable hedging vehicles.  Speculators bid up commodities futures prices or bid them down depending upon underlying fundamentals of supply and demand. Efforts to control commodities prices should be focused on underlying supply and demand driving commodities prices. Speculators will ensure that commodities prices neither rise to high or fall too low.

Central Banks and Higher Energy Prices

Higher energy prices continue to dominate news coverage.  Republicans are blaming Democrats for unfriendly domestic and offshore drilling regulations. Democrats are blaming Republicans for failure to support alternative energy funding. Missing in most of the conversation is the fact that central banks throughout the world are pumping trillions of dollars into markets in an effort to prevent deflationary pressures from taking hold.

There are lots of reasons for oil prices to be going up, of course. Demand is rising in the emerging markets, where growth is still strong. There has been a cold snap across Europe, increasing demand for heating oil. There is tension with Iran, and a revolt in Syria that may soon turn into a civil war. Russia has a tense presidential election this weekend: turmoil there might hit what is now the world’s largest producer of oil, if not yet the largest exporter.

But the main reason is one that is rarely mentioned. The world is being flooded with printed money. In reality, oil is not expensive. It is money that is cheap.

Central banks are fast getting locked into a destructive cycle. They print money to try and pump up demand. Commodity prices rise, which then takes demand out of the economy again.

Worse, it constantly distorts the global economy, draining money from manufacturing nations like Italy or France, and pumping it into resource-rich countries like Russia or Saudi Arabia. Since the manufacturing countries are usually more productive, and more democratic, that hardly makes much sense.

Crude oil futures generally will be on the bid whenever daily excess supply slips below 5,000,000 barrels per day. We are currently at an estimated excess supply of 2,500,000 barrels per day. Reports that Iran oil production is falling helped to drive NYMEX reformulated gas futures up .05 in 5 minutes on Friday.

When fear of tighter supplies meets continued central bank money printing, traders will be reluctant to short energy futures. However, should central bankers turn off the money spigot, fear of the market going down will return and WTI crude futures should be able to find a comfortable home under the three figure handle.   

The Developing Crude Bubble

Well folks it is that time of year again when gas prices are making headlines. Turn on the TV and you are sure to find a story on rising gas prices and what should be done to combat this phenomenon. Even President Obama has been addressing the issue to deflect any implications that his administration is to blame for the pain at the pump. The underlying fundamentals of supply and demand combined with speculative trading have driven prices higher. These same fundamentals and speculative trading will also cap the price rise and eventually bring prices crashing lower.

The main seasonal drivers for increased gas prices January through April are: shifts by refiners in their product mix percentage to an increase in distillates production with a decrease in mogas production and a shift in refiners production of higher winter RVP gas to lower summer RVP gas. Hedge funds are well aware of these supply issues with gas production and pile into RBOB futures and options pushing gas futures higher, which ultimately pushes spot cash gas markets higher.

These seasonal supply fundamentals have been exasperated this year by additional price drivers.  Israeli/Iranian tensions, the closing of several refineries in the US, Caribbean and Europe and Nigerian crude production decreases, have created current and potential future supply crimps.    

All of these forces coming together at the same time are creating a higher level of long speculation.  At the same time sellers have become more fearful to sell positions.  This has caused the futures and options markets to go into runaway mode, where normally patient traders who only buy on pull backs, are forced to buy whenever they get an inside trading day and are even buying on up days to make sure they get their long orders filled.

Traders have to keep in mind that the underlying demand for petroleum products are falling due to the worldwide economic slow down. Year-to-date, the first 40 or so days of 2012 have seen gasoline demand that is about 7% below last year, if you look at Energy Information Administration (EIA) reports. If you look at MasterCard data, you witness a year-on-year decline of about 5%. These are huge numbers for demand destruction. And, within this calendar quarter, crude oil output in North Dakota will surpass crude oil production in Alaska.

As world prices for light sweet crude advance above $120 bbl, the fear begins to shift to the buyers. They may perceive that this rally is getting long in the tooth, recognizing that global demand destruction takes place when crude prices are in a $120-$130 bbl range. When the fear of falling prices finally takes hold, crude futures are likely to take a quick elevator ride down $20 to $30.

2012 Energy Outlook

Not so long ago a predicted 2% GDP growth rate for the United States would guarantee liquid energy prices are heading lower.  There was a time when an economic slow down of the world's largest energy consuming country would assure lower energy prices are swiftly on the way.  The world has changed, and is continuing to change rapidly due to the emerging market energy demand led by China, Brazil, India and Russia.

For 2012 and into the foreseeable future, these emerging market leaders should more accurately be called growth market leaders.  China, despite a pull back in double digit growth, likely will lead the pack with 8% growth expected. And although these countries will not be immune to a financial melt down in Europe, with lower debts, much higher reserves, relatively stable banking systems, and trading ever more between themselves, the emerging markets will outpace the "advanced industrialised nations".

Europe's sovereign debt will once again take center stage in the first quarter of 2012. Italy, Spain and France all may receive credit downgrades in January. Italy has massive amounts of debt and is likely to have to pay above 7% on their long dated bonds. The weight of the sovereign debt may cause several European banks to fold, sending the euro and energy prices lower.

Despite this initial set back for energy, demand for crude, motorgas and diesel will likely continue  growing in 2012. During 2011, global oil consumption averaged 89m barrels per day, according to the International Energy Agency, the Western world's oil think tank, up from 88.3m in 2010. The global economy was relatively subdued, but oil use still rose to an all-time high. Back in 2001, global oil consumption was just 76.6m barrels daily. So during the decade to 2011, worldwide oil demand rose 16%. We now face another sharp rise, with global usage set to reach 95m barrels daily by 2016. That would amount to a 25% consumption increase in just 16 years.

On the supply side, global crude production expanded to 90m barrels daily in November, up from 89.1m the month before. In addition, OPEC crude output rose to 30.7m barrels per day, a three-year high, with Saudi Arabia and Libya accounting for most of the 620,000 barrel increase.

Last month, in addition, OPEC raised its production ceiling to 30m barrels, the first change in three years, moving the target nearer current output as the exporters' cartel struggles to absorb rising exports from post-war Libya. But, still, despite these favourable supply-side developments, Brent crude has remained stubbornly above $100 per barrel.

One reason oil markets are tight is that inventories are very thin. Oil stocks held by the OECD group of advanced industrialised nations have lately fallen to 2,630m barrels. That's around 57 days of forward cover, several days below the five-year inventory average. In fact, US crude inventories are ending 2011 at their lowest level since late 2008, while European inventories are now at an 11-year low.

This inventory dip reflects two important aspects of global oil production. Several of the world's leading oil fields are losing pressure – not least Ghawar in Saudi Arabia and Mexico's Cantarell. Two of the very biggest fields on earth, both are now producing at levels significantly below their medium-term production forecasts.

At the same time, oil-well exploration and development were hit badly by the credit crunch. Crude production is a seriously capital-intensive business with long "lead times". In recent years, a lack of available finance has hit the oil industry hard.

2012 US gas prices will also need to weather the closing of several Northeastern US refineries and increased exports of US refined products.

The opportunity for energy traders will likely emerge early in the year with a pull back in futures. By the 3rd quarter of 2012 energy futures will have a high probability of breaking out of its year long trading ranges and begin a steady upward trending market.

Navigating Macro Economic Influences on Energy Futures

Energy prices, along with all commodities, will look back at 2011 as the year of intense correlation to the macro economic environment.  Successful energy traders not only had to have a firm grip on traditional supply and demand fundamentals; a strong understanding of macro events and their consequences were essential to be on the right side of price movements.  Unfortunately for energy market participants, 2012 will require the same nimbleness to accurately navigate the major tidal movements of the macro economic waves.

2011 began the year with a strong upward trending pricing structure for crude, mogas and distillates. Crude reached a high in April of $115 on the hopes of a strong world wide economic recovery. Then came the less than stellar US economic data in May, combined with fears of European sovereign debt, creating a sell off in crude down to $75 in October.  Crude has since rallied back to the three figure level with one week left of trading for the year on hopes that the United States and emerging market economies will carry world economic energy demand.

Forecasting 2012 energy futures will not be an easy task as these macro economic forces will continue to mystify the best of traders. Until clear trends manifest themselves again, successful market participants will incorporate hedging strategies to compensate for influences well beyond the traditionally relied upon fundamental tells of supply and demand; contango and backwardation.

Analyzing the WTI/Brent Price Spread

The price of WTI vaulted 3.3% this week. The catalyst being that on Wednesday, Enbridge said it would buy a 50% stake in a pipeline that brings oil from the Gulf of Mexico to Cushing, Okla., and reverse the direction that the oil is pumped, so that oil would be leaving Oklahoma instead of arriving. That will ease the glut of crude oil, known as West Texas Intermediate crude, or WTI, stored at Cushing—a glut that has been keeping the price of WTI far below that of Brent, the European standard.

What was even more noticeable was that the price of other world oil benchmarks did not budge. Brent crude actually retreated on price. The "correlation" between the two crudes—their tendency to move in the same direction—has averaged 0.96 over the past two decades, just slightly below a perfect correlation of 1.0. On Nov. 15, it had fallen to 0.71, the lowest in at least 20 years.

Refiners in the US Midwest had been benefiting from the price of lower WTI Cushing prices and enjoying large crack spread margins.  On Wednesday Midwest refiners faced a new world of a tightening spread between WTI and Brent. Marathon was one of several refiners whose stock sold off 5% on this new dynamic. 

The global event pricing pressures that have been lifting Brent higher, have begun to retreat. Libyan crude production is coming back on line faster than forecasted, European GDP growth is slowing more than expected and Israeli/Iranian discord seems to playing itself out in rhetoric rather than rockets. 

This might not be the best time to bet that the "spread" between WTI and Brent will widen, however. The difference between the two has dropped already to about $9 a barrel on Nov. 15 from about $25 in mid-October. While some strategists see the spread narrowing even further—Goldman Sachs, for one, expects it to shrink to $6.50 during the next six months—the move likely won't be in a straight line. The best bet: Wait for the spread to widen before placing such a trade, or avoid it entirely.

The Euro Zone Financial Crisis and Liquid Energy Futures

Crude, along with heating oil and mogas bounced dramatically off yearly lows, rising 10% last week.
Could the bottom be in on liquid energy and the endless bid on petroleum futures resume its relentless upward march?  The answer will mostly depend on the collateral damage that will ensue to euro zone banks on the eventual default of Greek sovereign debt.

The European Central Bank, International Monetary Fund and European leader's are desperately trying to calm market fears by buying up bonds of floundering euro members, notably Greece. The actions appeared to have calmed investors last week as the euro gained versus the US dollar and other currencies. 

Will they be able to continue with the bond buying? Juergen Stark voiced his opinion by resigning his executive board position on the European Central Bank.  Mr. Stark was furious that the ECB has drifted from its original mandate of fighting inflation to bailing out weak euro countries.

Juergen Stark is not alone in is dissension to fighting the European sovereign debt crisis by running the monetary printing presses. The hard working people of Germany have had enough of seeing their tax burdens increase well into the future in order to fund bailouts for less hard working Southern euro countries. The turmoil among Germans is likely to increase should it become necessary to include Italy, Portugal and possibly even Spain into the bond buying program.

The end result of the European debt crisis is largely unknown. Europe may be able to delay the Greek debt default just long enough to allow Euro zone banks to build enough equity to mitigate collateral damage. Hopefully, this will contain the fallout from spreading into the worldwide banking system.
On the other hand, if euro banks are already too leveraged to build equity quickly over the coming months, there is the possibility that the contagion will spread resulting in a possibly worse banking crisis than was experienced in 2008.

Traders will be best served by tuning in closely to the developments that ensue from European leaders over the coming weeks. When the crisis has finally passed, normal seasonal trends will resume, with the most tradeable and reliable seasonal trend, rising gas futures from early January into April. 

The Red Metal Dr. of Economics and Liquid Energy Futures

The science of economics tends lean heavily on the art of forecasting future growth trends. Economists have a slew of carefully crafted computer models that are relied upon to forecast the general direction of worldwide economic growth. A more real life predictor of economic trends with a good track record of reliability lies not in computer models, but in the pricing trend of the world's third most widely used metal, copper.

Dr. Copper has consistently forecasted economic slow downs for many years. The reason is due to its primary use in cyclical applications, such as housing and industrial machinery manufacturing. Quite simply, when we are coming out of a cyclical worldwide growth phase, copper prices will begin peaking and then reverse trend.

Technically, copper has formed a double top. This formation generally, but not always, indicates a reverse in trend is about to occur. Fundamentally, copper supplies have fallen due to strikes and production difficulties in key mines throughout the world. Despite the copper supply shortages copper has had difficulty carving out new highs.

If the slow, but growing worldwide economic models that most economists are relying upon are truly accurate, the price of copper will need to confirm by breaking through the double top and resuming its longer term upward trend. Failure to break resistance will be one of the first real life indicators that the entire world economy is likely headed for a recession.

Liquid energy traders will be monitoring Dr. Copper, adjusting long or short positions to stay ahead of economic growth trends.

Japan's Recovery and Fuel Demand

Asian country economies have been, with the recent exception of Japan, steady and consistent growth and fuel consuming machines. Japan may reveal that it is back on it feet when this coming Monday they release gross domestic production numbers for Q2.

Japan's GDP data will be an important measure future fuel demand. While economists are expecting a contraction anywhere from 1.4% to 4.7%, any surprise data better than these contraction percentages, will put a bid on liquid energy futures.

Follow up strength or weakness indication from Japan will be given Thursday when they release trade data. Japan grew trade surplus to $900 million in June. If the July numbers continue showing this trade growth, energy futures, particularly heating oil futures, will receive additional support.

Technically energy charts are bearish. $88 provides solid short term resistance for crude. Should this level hold, bears have the opportunity to try to push down to the $70 handle. Should prices continue to fall, end users of gas and diesel will do well to lock in the lower prices, anticipating prices steadily moving higher in 2012.

Clubbing Oil Futures With the Strategic Oil Reserve

Frustrated with stubbornly high retail gasoline prices, President Barack Obama announced 60 million barrels of crude supply will be made available through a coordinated release of strategic reserve supply in the United States and Europe. The US contribution is set at 30 million barrels. With daily worldwide crude consumption at 83 million barrels, will this release of additional crude supply affect crude spot or futures pricing?

The immediate knee jerk reaction of the market to this announcement was to sell, pressuring the market down from $94 to $89. At the close of floor trading Friday, crude was back up to $95. Has the market shrugged the increase supply? Yes. However, traders need to be cautious discounting government intervention in the energy markets.

Government interventions in markets be it in currency or energy are normally futile efforts. Short term markets will react to the intervention, but longer term fundamentals eventually return. In and of itself the 60 million barrels of additional crude is a small amount. 23 million less than daily consumption. It was the surpise factor that caused the sell off. The buyers returned when better than expected economic data was released later in the week.

It is doubtful Mr. Obama will go away quietly should crude rise above $100. Expect for more intraventions with more strategic reserve crude gallons released until Libya crude production comes back online. Longer term demand for petroleum products will eventually drive the market. In the short term, longs need to be aware that a club is over their head ready to beat down upward price movements.

OPEC (Oil's Perpetual Enmity Coalition)

Well that was a big waste of time. I am referring to this week's quarterly OPEC (Oil's Perpetual Enmity Coalition) no decision meeting . None the less, a pivotal meeting in several ways.

This meeting used to be a very easy read simply by knowing the OPEC committee meeting's proposal recommendation held the day before, a crude trader would be reasonably sure of the following day full member OPEC meeting concenses results. Unfortunately with the strong rift between Sunni and Shiite sects within OPEC, committee recommendations are no longer guaranteed of receiving approval. This was the reason OPEC was not able to agree on increasing crude production quotas.

Saudi Arabia, (Sunnis), rightly argued that current crude oil production needs to increase 2 million bbls per day to meet projected demand. Iran, (Shiite), realizing that Saudi's crude is of a higher sulfur and more expensive to refine quality, understands that the world does need more crude but not the kind coming out of Saudi Arabia. They along with other Shiite dominated OPEC countries decided not to agree to the production increase.

Several television business commentators were arguing that this infighting ultimately means OPEC is no longer relevant and has lost its power to control crude production and ultimately crude pricing. On the contrary, OPEC is more relevant than ever and will continue to be so until alternative energy sources begin to compete with crude as a transportation fuel.

Saudi Arabia understands that even if they produce more crude, it is of the quality that refiners do not want. What refiners need is more production of lighter sulfur crude produced by Libya and Nigeria. As long as Libyan production remains off line, there is no country having excess capacity that can fill the demand gap.

Barring the entire global economy sinking deeply into a deep recession, CL futures will remain on its endless bid and higher crude prices should be anticipated.

Where Is the Floor on Crude?

Having come just short of targeted $117 crude price goal with a $114.95 high print, is it time to follow short term swing momentum with the bears? It all depends on where the selling on crude will stop and longer term players deem crude a value buy again.

With the US dollar seeming to put in a floor on strong euro selling due to Greece announcing it is considering leaving the 17 nation European Currency bloc, US unemployment climbing to 9% and June oil futures down nearly 15% for the week, it might seem wise to run with the heard and get heavily shorted energy.

Despite the massive sell off this week, Fund managers remain net long on NYMEX crude futures and options. Whatever, the bottom may be on crude; analyst vary between $92 and $94, the one great fundamental supply issue remains with Libya. With worldwide global recovery continuing, demand for crude will continue to rise. Going into early next year, should Libya's crude remain out of the market, tighter supplies will keep the longer term crude bull market securely in place.

It is possible this year's high in crude has been achieved. However, should Libya's supply remain off the market crude prices will easily surpass this year's current high.