Oil Drawdown Takes Traders by Surprise

By Brad Zigler

Real-time Monetary Inflation (per annum): 8.3%

Crude oil backpedaled from a cycle high above $60 Tuesday after being bolstered by data showing strong Chinese demand. Oil imports to China are up nearly 14% year-over-year. By the time the New York Mercantile Exchange [NYMEX] day session closed, June crude oil had eased back to $58.85, up 35 cents on the day.

Everyone Surprised

Overnight trading started relatively flat, then turned decidedly bearish as the opening of a new day session approached. The pattern suggested traders were putting more faith in oil analysts' inventory forecasts than in the survey data compiled by the American Petroleum Institute [API].

API figured this morning's report from the U.S. Energy Information Administration [EIA] would show a 3.1-million-barrel drawdown in domestic crude oil stocks for the week. Meanwhile, a Reuters poll of oil analysts pegged a 1.2-million-barrel inventory increase as more likely. Insiders queried by Bloomberg News took a more conservative tack, forecasting a 1-million-barrel build.

EIA's numbers came as a surprise to everyone. Crude oil stocks, in fact, were drawn down by 4.7 million barrels.

Calls on gasoline inventories, ranging from a 500,000-barrel build in the Reuters survey to Bloomberg's dead flat consensus, were as far off base as their crude oil guesses. EIA said gasoline supplies decreased by 4.1 million barrels from the previous week.

Guesstimates for distillate fuels, including heating oil and diesel were, by and large, pretty accurate. EIA reported a 1-million-barrel build compared with analysts' calls for a 1.1-million- to 1.3-million-barrel increase.

Government figures show that gasoline demand, now averaging 9 million barrels a day, is down by 1.2% from year-ago levels. Daily demand for distillate fuels, at 3.5 million barrels, is off 14.1%. On the production side, refineries operated at only 80.4% of operable capacity last week, far below the calls for an upward tick to 85.4%. Gasoline production fell last week, averaging 8.9 million barrels a day, set against an increase in distillate fuel production to nearly 4 million barrels a day

Is It Supply Or Demand?

Some market observers see speculative demand from hedge funds and institutional accounts as an underlayment for crude oil's recent rally.

In fact, speculative interest in crude oil has been waning since late January, according to data compiled by the U.S. Commodity Futures Trading Commission.

Net Long Interest In Crude Oil Futures Of Large Speculators

A weakening U.S. dollar is also frequently cited as a contributor to oil's strength. Since oil trades in dollars, its price is bolstered when the U.S. currency weakens. The greenback recently notched fresh lows for the year against the euro.

This week, traders bid up NYMEX crude prices by nearly $5 a barrel, or 9%, while boosting gasoline prices about 5.5%. Heating oil inched up less than 3% for the week. Fast-rising crude input costs shellacked product crack spreads as gross refining margins were squeezed more than five percentage points to 15.6%.

NYMEX-Implied Gross Refining Margins

Measured by the oil market's contango, crude oil supplies seem to be tightening. The three-month spread in nearby NYMEX futures averaged $2.95 a barrel this week, 80 cents less than last week.

Contango represents a market's potential for carrying a commodity for later delivery. A fat contango implies more-than-adequate supplies. Earlier this year, spreads were as wide as $15 a barrel, fat enough to allow an active carry trade. A three-month carry contracted through futures which would have generated over $14 a barrel in profit is now worth just 76 cents.

NYMEX Contango

Support And Resistance

Over the past three weeks, bulls have pressed their advantage in the crude oil market. The next major objective for the NYMEX June delivery, if the January reaction high of $61.33 is taken out, is the $66 retracement level left by 2008's price dive. Immediate support is at $58 with a secondary bulwark around the $55.50 mark.

Comments

[The Aft Deck:]

The best buy on any market right now is OIL

May 14 09:29 AM

[Contangotrades:]

Go OIL ;-)

May 14 03:23 PM

[Henrique Si...:]

Good article.

I am short oil and I have been posting my real time trading decisions in my blog.

Underlying conditions will prevail, and oil will trade back down to the low fifities in a jifty.

Regards

May 14 06:26 PM

[yank:]

Don't hold your breath on that one Henrique. And of course all the oil bears want us to believe that oil demand is being destroyed. Missed in yesterday's release by the IEA was the fact that they believe oil demand will drop 3% in 2010. Sounds like a lot doesn't it? It isn't. Not when oil producers have removed almost 1/3 of production from the market. And one other little tidbit about supposed demand declines. You can't have lower demand when all refined products report draws across the board (yesterday's EIA report). Sorry, not mathematically possible.


On May 14 06:26 PM Henrique Simoes wrote:

> Good article.
>
> I am short oil and I have been posting my real time trading decisions
> in my blog.
>
> Underlying conditions will prevail, and oil will trade back down
> to the low fifities in a jifty.
>
> Regards

May 15 09:17 AM

[twinnkie:]

Oil should be around 100 by nov.

May 16 12:40 AM

[AlphaZedder:]

Go long on oil... if you don't trust that... invest in roofing shingles instead... I hear people still need rooves.

May 16 08:25 AM