Petroleum Challenges Upside of the Range Following Federal Rate Cut

Petroleum Challenges Upside of the Range Following Fed Rate Cut and Stock Recovery despite EIA Supply Increases and Recession, while Natural Gas remains firm on potential late Winter Threat Following New Record weekly Drawdown

Technical Outlook: Since our last report we said looking ahead the market was exhibiting a mixed technical outlook once again with longer-term indicators such as the linear oscillator, the MACD, and parabolic all declaring a negative divergence still exists suggesting intermediate to longer-term weakness ahead. Meanwhile shorter-term indicators such as stochastics, relative strength and momentum have recently entered oversold territory which initiated the recent reversal and subsequent rebound into positive pricing, however, we felt the recent upswing was likely to be limited in its duration as well as distance with the market expected to run out of upward propulsion somewhere between minor resistance at $7.92 and more critically if reached at $8.0 to $8.10. We anticipated the impending rejection from the resulting failure at the expected lower high would come with renewed selling strength that could rapidly return the market to test recent lows below $7.60. The latter part of our forecast has yet to transpire, however just as predicted the market did rebound and thus far has been held in check and under our highest resistance point of $8.10 on a closing basis. Now, in looking ahead to next week, technical signals remain mixed in our view with some upward momentum sustained as prices are pressing the upside of our range resistance point of $8.10 with the market seeming poised to break above this level soon. However, we feel signs of technical fatigue are beginning to seep into the market from its recent attempts and subsequent failure to break through and with stochastics and relative strength, as well as momentum and other oscillators beginning to yield over bought warnings, the market remains vulnerable to fulfill the dramatic sell-off we forecast in last week’s report. Only the parabolic, and the linear oscillator, as longer term indicators maintain a bullish divergence remains in our view. From this analysis, we anticipate if prices on follow through of the recent short term uptrend, fail to breach resistance above soon to close above $8.10 with a targeted challenge at $8.25 soon, values will quickly fall as traders will move to sideline profits and a retracement back to intermediate support at $7.80 would be fitting, with some minor support found at $7.92.

This week's EIA report revealed an unexpected supply withdrawal of 274 bcfs that was a new one week record in the industry’s history and much higher than both previous estimates by Bloomberg and DowJones that were forecasting closer to 243 bcfs respectively. Storage now stands at 2262 bcfs which is 336 bcfs below last year’s record and yet 85 or 3.9% above the five year average of 2177 bcfs. The market reacted after trading as low as $7.94 earlier in the session prior to the release of the EIA’s supply report and then promptly traded toward the highs of the session before settling back on a modest gain of 2.9 cents to close at $8.07 per million BTU basis spot March. Of course this time of year the degree of cold in winter as the scale begins to tip from the heart to the back end of winter becomes critical as to price direction, however after such a record drawdown which clearly illustrates how precarious the production culpability is whenever demand exceeds normalcy and thus leaves the market vulnerable to a sharp spike should the weather shift in February to any sustained below normal cold especially if it is dispersed into the primary duel-zone of consumption comprised of the Midwest and Northeast. Currently, according to the recent WS I 6 to 10 day outlook the weather is forecast to be somewhat changeable with arctic intrusions coming down from Canada intermittently between milder air with the more severe cold being felt first in the Midwest and then somewhat moderating prior to impacting the Northeast. Under this scenario if the colder temperatures do not materialize in a more sustained fashion prices are vulnerable to a short-term correction especially if they fail to make a new price range high on the close that at least exceeds $8.25 basis spot in our opinion over the near term and more precisely within next week. However we anticipate that should the market suffer a short-term correction we anticipate it will be just that as the severe cold that traditionally can arrive in February will make the risk of holding a short position too uncomfortable for traders to sustain in our opinion. Considering how quickly the surplus above the five-year average was reduced in one week from over 7% to now 3.9%, it is easy to see how quickly the shorts could find themselves scrambling to the sidelines as they are replaced by aggressive buyers as the specter of the surplus being vanquished by only one week of below normal cold producing another 200 plus bcf drawdown as the current gas well production rate remains precarious at best.

Concerning Crude Oil the market posted a loss of $.58 to settle at $91.75 a barrel basis spot March in the first drop in six sessions despite an impressive gain of over $2 from earlier losses in excess of $2.50 when in the morning session the price was flirting with $89.50 and then in dramatic fashion yet characteristic to the same behavior of enhanced volatility that the market has exhibited over the past six months also went positive in excess of $92.25 about a half-hour before the close of the open-outcry session. Currently the market is feeling the impact of contrasting influences whereby the same bullish fundamentals of aggressive overseas growth, supply line threats in the Middle East and Nigeria, and precarious refinery capacity as well as lower than normal inventories here in the US are colliding with an opposing tidal force of the major threat imposed by a US lead recession that would no doubt spread its contagion throughout Asia and Europe similar to the way the subprime mortgage meltdown also infected overseas economies. Some analysts are even forecasting as early as mid year the benchmark price of crude oil could find itself in what would be considered a minor freefall by today’s standards back to the level of $70 which has not been seen since early 2007. This scenario is predicated on the US lead recession becoming much more manifest accompanied by more disastrous consequences that have yet to surface but remain a real threat nonetheless when one considers the huge number of foreclosures currently threatening consumers along with elevated gasoline prices that have only serve to exacerbate the dismal plight of the homeowner as credit card debt and mortgage delinquencies reach record highs. Other contributing elements to this scenario are the moderation of more traditional bullish pillars of support to the uptrend such as the recent juggernaut in China’s economic growth. While China’s economy grew at 11.4% in 2007 and the fastest pace in 13 years it seems to be headed for a modest slowdown this year as global demand weekend’s and credit curbs to Inflation ripple through the country. The economic softening was evident figures issued recently showing annual growth in GDP the eased to 11.2% in the 4th-quarter down from 11.5% in the July to September quarter which followed 11.9% in the 2nd quarter. And while some try to bolster the argument that crude oil cannot fall far even in the face of a US recession claiming that China and India would take up the slack and continue their growth unabated, is not exactly realistic when you look deeper into the numbers as the global credit woes stemming from the US subprime mortgage crisis would drag down demand for China’s exports which contributed about a third of last year’s increase in their GDP. Even under the current perceived slowdown economists expect China’s growth this year to get back to around and even 10%. Don’t forget due to the size of China’s population and subsequent challenge in maintaining control, the government must remain cautious as to the threat of inflation which has touched off social unrest many times in the past. Although consumer price inflation slowed to 6.5% in December from 11 year high of 6.9% reached in November, the factory – gate inflation jumped to 5.4% from 4.6%. This leaves China in much the same position as the European Central Bank whereby they must remain aware of the potential need to ease policy to support the economy but remain vigilant against inflation should it escalate above target. These modest yet noticeable changes contributed to The International Energy Agency lowering its estimate for global oil demand in the first quarter of 2008 by 100,000 barrels a day. It is our opinion under the current elevation in volatility that any sudden incremental shifts in major economic numbers such as Chinese GDP when considered in conjunction with other major economic indicators here in the US such is our GDP which recently slowed to a crawl of a much less than expected .6%, and prices will react violently especially if the perception begins to shift from one of tight supplies in the face of economic expansion to the opposite scenario of global economic slowdown led by recession in the world’s top consumer resulting suddenly in adequate supplies. This morning’s price collapse of almost $3.0 per barrel was triggered by the higher than expected jump in first-time applications for jobless benefits which hit 375,000 in the most in 27 months, when the highest estimate was for 350,000 and the previous number had been 319,000, which of course points to another anemic non-farm payroll number due to be released tomorrow morning, which if worse than expected could increase anxiety and elevate recent fears that the looming recession could be much more severe than anticipated earlier despite the recent aggressive actions taken by the Federal Reserve which have reduced interest rates by 1.25% in less than two weeks and the most dramatic drop within seven business days in many years. Two other major contributing factors that are ongoing as far as influencing crude oil prices remains as the plight of the US dollar’s value and future actions by OPEC concerning whether to answer the request by Energy Secretary Bodman as well as other US officials to increase oil output to ease prices further and thus distanced the threat of inflation versus leaving production at current levels for fear that raising output while at the brink of a global economic slowdown led by a seeming eminent recession here in the US which could lead to a virtual price collapse and obviously the least desired scenario to the prominent Petroleum Cartel. It is expected that the 13 member group will leave the current output target unchanged at 29.6 7 million barrels after today’s meeting in Vienna according to the majority of analysts surveyed by Bloomberg News recently. They are also no doubt considering recent gasoline demand numbers that showed for the week ending January 25 as measured by fuel supplied by refiners that demand has declined to the lowest level since the week ending January 27th 2006 one year prior. The logical fear is that this slowing demand will next impact the industrial and manufacturing sectors of the economy.

Changeable conditions are still expected to characterize the weather over most of the continental U.S. next week as most of the country is forecast to see at a least brief period of warmer and colder than normal temperatures. The pattern looks too progressive to allow for any prolonged periods of unseasonably warm or cold weather. In response, anomalies are expected to average close to seasonable levels for balance of the 6-10 day forecast period. That may change later this week as notable differences develop between the models regarding how much Arctic overspreads the Midwest and central U.S. late next week. If anything, today's next week and 6-10 day forecasts are colder than previous forecast as all models have trended colder over the eastern two-thirds of country late next week. Above

normal temperatures are still forecast over eastern third of the country for the balance of the 6-10 day forecast period as the warm weather is expected to be briefly interrupted by a 1-2 day period of more seasonable readings. Highs generally in the 30s and 40s are generally expected to be the rule for the Northeast next week. Readings may reach as warm as low 50s in the Ohio Valley and lower Mid-Atlantic on the warmest days. Highs generally in the 50s and 60s are generally anticipated over the southeastern. Meanwhile, today's next week and 6-10 day forecast are warmer over the western U.S., mainly based on mild weather expected to arrive late next week into next weekend. Highs in the 50s and 60s are still forecast over the California and the southwestern U.S. most of next week though readings may reach into the 70s on the warmest days. Highs in the 30s and 40s and 20s and 30s are anticipated in the Northwest and interior western U.S., respectively.

Natural gas has as we forecast last week, after failing to even reach $8.25 basis spot much less challenge the previous important peak at $8.48, has gradually climbed all the way up to the top of our forecast price range at $8.10 per million BTU and even exceeded this level of resistance and yet consistently has fallen short thus far of closing above it. However, after today’s record-breaking drawdown of 274 bcfs in the largest one week reduction since record-keeping began it certainly illustrates how precarious current well production is especially whenever there is a sudden increase to above normal demand which it is a chronic instability within the industry that we have drawn attention to and warned about many times in past reports. And in conjunction with this fact while we are in the heart of winter, should February suddenly produce a sustained the low normal cold that exceeds at least a one-week timeframe especially if it is dual zone encompassing both the Midwest and Northeast, we could see natural gas prices break out to the upside in an explosive almost vertical advance breaking traditional resistance and $8.60 and quickly surpassing the $9.0’s benchmark for a price escalation of at least $1.0 as the result would be the current 3.9% supply cushion above the five-year average being simultaneously reduced to a deficit initiating fear based panic buying! But until this scenario transpires if at all we see the price range remaining above $7.60 as an extreme low, and more likely sustained about $7.80 with an upward bias pressing to new highs within the range between $8.25 in the last recent peak at $8.48 at least until the first week of February or the weather forecast is able to reveal more of what is to be expected for the first half of February.

Concerning the petroleum complex, this week’s price activity, has confirmed the outlook from last week’s report whereby the market is continuing to recover from a dramatic short-term correction that saw spot prices drop almost a full 15% from their record intraday peak posted January 3 at $100 .09 per barrel basis spot and then declined within days to lows just above the $85 benchmark. Since then the market has been gradually working its way higher with today being the first loss posted over the last seven sessions as the EIA update revealed an overall negative result as crude stocks rose for the third consecutive week by 3.6 million barrels to now total 293 million barrels and yet remain in the lower half of the average range for this time of year. Meanwhile the primary consumer concern of motor gasoline stocks also increased by the same amount 3.6 million barrels and are now above the upper limit of the average range, while distillate fuel stocks declined by a more than anticipated 1.5 million barrels and are now in the lower half of the average range for this time of year. The reduction in distillate fuel which includes the important winter product of heating oil utilized predominantly in the northeastern US continues to provide an inordinate amount of support as enough winter demand remains to potentially impact supply and still cause a price spike to consumers. That is why despite last week’s numbers that were similar in revealing an increase to both crude stocks and gasoline while distillates had declined by the same margin and a result we saw a continuation of the recent upward price recovery to the entire complex. So while the single largest potential deterrent to the Energy bull market remains the threat of recession here in the United States it still is a gradual process that involves the methodical release of economic data that is revealed over a period of time whereas in contrast immediate impacts of supply demand factors that directly pertain to Energy consumption materialize more rapidly and are more repetitive such as in the case of the weekly Department of Energy’s report. We still feel to reiterate last week’s conclusion that the technical pattern along with the current supply demand fundamentals suggests prices are still on track to test our upside target at the $95 benchmark, and unless tomorrow’s nonfarm payroll numbers are much worse than anticipated or actually show negative employment growth which would indicate the recession has closed its grip on the economy by a much larger measure than anticipated, we don’t see an immediate reversal or sudden correction is eminent until at least hitting or at least challenging within $.50 of this important psychological level. We continue to expect buying support to come in at earlier levels posted in this morning’s session at $90 per barrel and then $89.50 per barrel with a more critical level below this at $88. The expectancy of OPEC to keep output levels the same and the possibility of even suggesting cutting production should prices begin to weaken in the face of further economic slowdown in the US along with the eminent threat of more cold weather impacting the Northeast and supporting heating oil, could easily combine influences and propel petroleum values up to the $95 benchmark over the near term. Don’t forget the wildcard of threat to supply lines overseas can always return from unstable regions such as the Middle East and primarily in Iraq, Saudi Arabia, and within the strained relations between the US and Iran, and let us not forget the chronic situation in Nigeria, which as of late have for the most part remained outside the spotlight or the major headlines. This usually instead of providing a sense of security in expecting a continuation of the same, rather increases the anxiety in anticipating the temporary quiet to be shattered by some incident or terrorist act that impacts oil flow and returns the international scene to the headlines which has transpired so many times in the past returning to haunt the world in reminding us all how delicate the supply demand balance is globally and how quickly it can unravel!

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United Strategic Investors Group