Tuesday Morning March 15, 2011 Quote of the Day A soothsayer bids you beware the ides of March Brutus to Julius Caesar in Shakespeare Play All eyes are following the evolving problems in Japan and in particular the precarious situation at the Fukushima nuclear facility. Overnight there has been another explosion and a new fire at another reactor pool. Radiation levels around the plant have increased significantly since yesterday and are likely to spread. The government has told about 140,000 people living within about 19 miles (30 kilometers) to seal themselves indoors causing a growing panic to permeate throughout Japan. The stock market plunged once again in Japan causing another day of massive sell-offs in risk asset classes around the world. The EMI Global Equity Index (table shown below) has declined sharply over the last twenty four hours. The Index is now down by 3.7% on the week resulting in a year to date loss of 2.8%. The Index is now trading at the lowest level since October of 2010. There are now only three of the seven bourses in the Index still showing a gain for 2011...US Dow, Canada and China. Based on where US equity futures markets are currently trading there will be a major decline in the US equity markets when they open in a few hours. Japan has obviously been hit the hardest showing a 15.9% year to date loss so far. Back in 1995 after the Kobe earthquake Japanese equity markets were in decline for about six months. As such we may be seeing just the beginning of the downturn in Japanese equities. At the moment there is no place to hide as the Japanese contagion has quickly spread around the world and in a much more pronounced manner than any radiation leaks are likely to spread around the world. The way risk asset markets are currently trading quickly brings back memories to previous crashes like in 1987 and as recent as after Lehman declared bankruptcy on September 15, 2008. Needles to say the massive downturn in global equities is a negative for oil prices as well as the broader commodity complex. The so called risk off trade is in full swing as the level of uncertainty surrounding Japan is growing at an exponential rate. As such cash is exiting all risk asset markets and moving into the safe haven of the US dollar and US treasury bonds and that is about it. The US Dollar Index is now higher by about 0.9% while US bonds are also up by around 1% so far this morning. The US dollar is also a negative for oil prices as well as the broader commodity complex. Even gold and silver are being sold into very strongly. As of this writing WTI and Brent crude oil are down by a tad over $3/bbl and falling strongly. The Japanese disaster has now replaced just about everything else out there that was impacting risk asset values. The market focus has completely shifted away from the evolving situation in Libya and elsewhere in North Africa and the Middle East as well as the on the sovereign debt problems in the EU and is now solely focused on the 30 second news snippets coming out of Japan and in particular the issues surrounding the Fukushima nuclear plant. The tensions have continued to escalate in Libya with Gaddafi forces now taking control of another oil city...Brega while Saudi forces have moved into Bahrain to help stabilize the situation that has been becoming more chaotic by the week. At the moment the likely reduction in oil consumption by Japan coupled with a possible overall downturn in the global economic recovery as a result of Japan are more than offsetting the loss of crude oil supply from Libya which in fact has been mostly made up by Saudi Arabia anyway. Oil prices are well off of the highs and are now trading back down to where they were at the end of February/early March. As I have been indicating since late last week the top of the oil price surge is likely over for the time being. The International Energy Agency released its latest monthly oil assessment this morning. They lowered their global oil demand forecast versus last month's report as higher oil prices are beginning to have an impact on global consumption. They also reported that OPEC's oil production fell only slightly as some member countries increased production to offset the loss of Libyan crude oil. This has resulted in OPEC's surplus crude oil capacity falling to the lowest level since the end of 2008 reducing OPEC's ability to offset new production shut downs. The report is mostly neutral and having no major impact on the market as all eyes are fixed on the evolving situation in Japan. Following are the main highlights of the report. Political unrest in the Middle East and North Africa, currently focused on Libya, has injected volatility into futures markets, with prices gyrating by an average $3/bbl daily. By mid-March benchmark crudes were trading $10-15/bbl above average February levels, with Brent last seen just shy of $114/bbl and WTI around $100/bbl. Global oil product demand growth remains largely unchanged at 2.9 mb/d in 2010 and 1.4 mb/d in 2011, but high oil prices entail significant downside risks to this year's outlook. Baseline changes in non-OECD Asia and stronger Middle East levels lift absolute demand slightly to 87.9 mb/d and 89.4 mb/d, in 2010 and 2011 respectively. World oil supply rose to an all-time high of 89 mb/d in February, up 0.2 mb/d from January. Non-OPEC oil supply rose 0.3 mb/d to 53.2 mb/d on re-instated Alaskan output. 2010 non-OPEC estimates are left unchanged at 52.8 mb/d, while the 2011 forecast is raised by 0.1 mb/d, to 53.6 mb/d, on stronger-than-expected Canadian output. OPEC crude oil output in February fell by 95 kb/d to 30.05 mb/d. A near 200 kb/d average monthly loss of Libyan supply was partly offset by higher production from Gulf states. OPEC's 'effective' spare capacity, excluding Libya, is now near 4.08 mb/d, its lowest since end 2008. The 'call on OPEC crude and stock change', revised up for 1Q11, is cut going forward, averaging 29.9 mb/d for 2011 overall. Global refinery runs are expected to drop sharply through 1Q11 to reach a seasonal low of 73.5 mb/d in March, when refinery maintenance peaks, before rebounding to 75.3 mb/d in June. 1Q11 runs are forecast to average 74.6 mb/d (+2.0 mb/d y-o-y) rising to 74.8 mb/d (+1.0 mb/d y-o-y) in 2Q11. January OECD industry inventories rose by 32.0 mb to 2 695 mb and forward demand cover increased to 58.2 days. Preliminary February data point to a sharp 43.4 mb decline, while oil in short-term floating storage grew by 8 mb. Much like the last several weeks I am not sure it will matter to the direction of oil prices this week but the weekly inventory cycle will get underway today as the API data will be released at 4:30 PM EST followed by the more widely watched EIA data on Wednesday morning. My projections for this week's inventory reports are summarized in the following table. I am expecting a mixed report with a modest build in total commercial stocks of crude oil but a decline in refined products inventories as refinery runs likely declined marginally on the week. I am expecting crude oil stocks to build by about 1.5 million barrels. If the actual numbers are in sync with my projections the year over year surplus of crude oil would come in at 6.4 million barrels while the overhang versus the five year average for the same week will be about 15.5 million barrels. With runs expected to decrease by about 0.1% and with imports expected to hold steady I am expecting a modest decline in gasoline stocks. Gasoline stocks are expected to draw by about 1.3 million barrels which would result in the gasoline year over year surplus to narrow to around 0.6 million barrels while the surplus versus the five year average for the same week will narrow to about 5.2 million barrels. Distillate fuel is projected to decrease modestly by 6.0 million barrels on a combination of some weather demand as well as a decline in production. The latest NOAA weather forecasts are now showing a significant portion of the US expected to experience above normal temperatures for the rest of March. The forecasts area a negative for heating oil especially after the last several weeks of less than bullish inventory reports. With the vast majority of the winter heating season now in the history books heating oil stocks may also start to perform much like diesel stocks have been over the last several months and that is to start into a premature inventory building pattern as the latest weather forecast almost guarantees that the net withdrawals from inventory for the rest of the official winter heating season will likely come in at below normal levels. If so the inventory building season may get a bit of a jumpstart in starting to replace the volume consumed this year. If the actual EIA data is in sync with my distillate fuel projection inventories versus last year will likely now be about 6 million barrels above last year while the overhang versus the five year average will be around 23.1 million barrels. Net result the US continues to remain well oversupplied of just about everything in the oil complex with supply expected to remain robust for the foreseeable future. The major wild card for distillate fuel over the next three to six months will be how much additional diesel fuel is going to be required by Japan. It is likely that Japan's import requirements for diesel fuel will increase strongly once the nuclear situation is stabilized and the country enters into the rebuilding and reconstruction phase especially with a large percentage of the refining capacity in Japan shut in. As usual do not overreact to the API data which will be released late today as more often than not it is not in line with the more widely followed EIA data. If the EIA report is within the projection I would expect the market to view the results as modestly bearish as total commercial stocks of crude oil and refined products combined are likely to have increased for yet another week. However, whether or not the market reacts at all to the inventory report will be dependent on what is going on with the evolving situation in North Africa and the Middle East as well as in the financial markets and how much the macro issues will offset any of the individual micro drivers like supply & demand. My individual market view is detailed in the table at the beginning of the newsletter. I am maintaining my view at neutral and my short term bias at cautiously bearish as it is continuing to appear that the big run up in oil prices may be over for the short term especially now that the protests did not materialize into anything major in Saudi Arabia. Barring an uprising in Saudi Arabia oil prices may have peaked for the short term as the risk premium slowly declines. I am maintaining my Nat Gas view and bias at neutral as I still think the Nat Gas market is still range bound as the market navigates through the rest of the winter heating season.

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