Petroleum Rebounds Back over the $80 Benchmark Following Modest Product Reduction

Petroleum Rebounds Back over the $80 Benchmark Following Modest Product Reductions in the EIA Update, yet Storm Fears Diminishing, and Technically still Overbought, Leaving the Market in a Top Search short term, while Natural Gas Gains on Lower Injection and Firm Technicals.

Technical Outlook: Since our last report we said looking ahead technical signals suggest a more bearish composition. We also said most indicators such as the linear oscillator, stochastics, the MACD, relative strength, and others, suggested further weakness ahead whereby we anticipated a test of minor support at $6.80 with a possible challenge to more critical support at the previous key low of $6.70, which is essentially what happened as this past Monday prices went down and broke our support at $6.80 and yet held above the critical support at $6.70. We had also forecast that in order to stage a bullish reversal the market needed to rebound resulting in a close back above minor resistance at $7.10 to then stage a challenge to key resistance at $7.40 which is exactly what transpired with today’s rally of .13.5 cents to close at$7.412, just above key resistance setting up a potential challenge to $7.60 resistance. The market is in a more constructive configuration with some positive undertones, although looking somewhat overbought. Technical signals such as stochastics, momentum, Relative strength, and others have turned more positive after the recent short term rebound. However, we anticipate some value fatigue beginning to set in whereby if price cannot achieve and sustain $7.65 on a close within the next 2-3 sessions, the market will likely fall back rapidly to retest minor support at $7.25, and then more pivotal support at $7.10.

This week's EIA report revealed an injection into storage of 57 bcfs that was just lower than previous survey estimates by DowJones and Bloomberg that were running near 65 respectively. Storage now stands at 3263, which is 54 bcfs less than the supply last year at this time and yet 227 or 7.5% above the five-year average of 3036 bcfs. After the market experienced the noticeably lower than expected withdrawal from storage natural gas rallied and ended with a gain of 13.5 cents close at $7.412 per million British thermal units basis spot November. Despite the short term bullish report, we feel the impending demise of “Storm threat” as this year’s hurricane season will soon end without serious damage to energy facilities in the Gulf, will soon manifest itself with some fear premium deflation. This could become a more substantial weakness as weather over the time remaining within this shoulder period will likely result in softer demand over the next 2 weeks, unless a wildcard appears. The market still carries a noteworthy supply cushion above the 5 year average, and this could increase over the remaining weeks of injection season putting storage between 3.5 and 3.55 TCFs, and thus a record supply pre-winter. The only possible threat to supply that remains that could alter the course of near record storage and softer values is the unexpected weather anomaly such as a Late season Gulf storm resulting in shuttered production, or worse, along with higher competitive fuel costs as petroleum values are already abnormally elevated. Although there currently is a weather system in the Bahamas that stretches over to the North of Cuba, labeled 92L, that shows some signs of tropical development along with a westerly direction towards the Gulf, so far it is considered a low threat probability for either reaching Hurricane strength, with taking a sudden Northern Gulf track even less likely. With this system quite possibly representing the last possible legitimate storm threat for Gulf energy facilities this year, as after October 15 the chances of storms making it from the Coast of Africa is greatly diminished, and so we anticipate the artificial support from storm threat that currently exists in the market could quickly erode once this is realized. When this transpires the market could quickly fall back to test earlier support levels back near the $7 benchmark and lower.

Concerning crude oil, the market today closed on a firm note reversing several negative sessions since last Friday’s bearish turnaround from the existing contract highs of $83.76 basis spot, by making a strong gain from the intraday low at $78.91which has become a minor double bottom over the short term. Technically just below this level there exists a more critical support at$78.44 which now remains as a two week low. The market made a strong technical statement by closing decisively once again above the key $80 benchmark with a gain of $1.50 per barrel, making the past several forays below this key benchmark seem like acts of bearish futility. However, we foresee a market that may soon be running out of bullish fundamental justification for sustaining such a lofty level, especially if one of the key supports to the recent uptrend is certainly removed, that being this season’s well-publicized storm threat. Barring something sudden and unforeseen, the current system being monitored in the eastern Atlantic that is moving in a westerly course towards the upper northern tip of Cuba, may very well be the last possible legitimate storm threat to the Gulf this season as typically after October 15th the chance of an Atlantic born storm threatening the Gulf becomes greatly diminished. In our opinion the market has not yet come to this realization and is already becoming overbought as the ongoing fundamental factors of support such as the weakening US dollar along with the shortage in gasoline supplies as peak driving season has passed, seem well priced in for now as the market is exhibiting some technical price fatigue. The demise of this year’s hurricane season, which may become more evident next week, could be just the catalyst to trigger a more sustained sell-off as the removal of storm premium support could cause the market to become more sensitive to the weight that is gradually getting heavier of the slowing US economy that threatens to pull petroleum down with its promise for softer demand on energy. The same promise of a dismal shopping season this coming winter that economists are forecasting, does not bode well for petroleum demand. Today’s greater than expected drop in factory orders of 3.3% in August and the largest decline in factory orders in the past seven months contrasting an expected drop of only 2.6% by economists only further bolstered the weakening outlook. Tomorrow’s much-anticipated non-farm payroll numbers may only serve to further dampen recent bullish fires for petroleum if they echo in any way last month’s poor jobs turn out. And a bearish reaction in petroleum may very well contrast a bullish reaction by the stock market as it already has displayed a strong sense of denial and suspension of disbelief with its traditional ability to translate clear economic weakness as a sign of further substantiation for the fed continuing it’s newfound love in cutting interest rates which it will conveniently interpret as long-term bullish rather than accepting it realistically as a desperate attempt to prevent an impending recession. However, unfortunately, if the recession materializes it will be hard to deny the slowdown in demand for petroleum products that may have already begun as this past weeks EIA update revealed a rather anemic consumption rate as only the distillates showed a modest decline and that was in the wake of restrained refinery output and a declared reduction in the production of both gasoline and distillates for the previous week. Crude oil also showed a surprising increase of 1.2 million barrels for the week leaving a total of 321.8 million barrels as inventories remain above the upper end of the average range for this time of year, while gasoline supplies only inched down by 0.1 million barrels yet remain well below the lower end of the average range, while distillates dropped by a modest 1.2 million barrels and yet remain in the upper half of the average range for this time of year. Refinery output edged up to 87.5% over the previous week, yet motor gasoline demand has averaged 9.2 million barrels per day or only 0.1% above the same period the previous year while distillate fuel demand has averaged 4.1 million barrels per day and is actually down 0.4% compared to the same period last year. Based on these consumption rates, as the predicted promise of literally thousands of adjustable-rate mortgages will be ratcheting upward to a much more expensive rate between the final quarter of 2007 and the first quarter of 2008, forcing many more consumers into foreclosure, and in the near-term, the future of energy demand in the US looks precarious at best. While some consider the more aggressive consumption rates being exhibited in countries like India and China being able to take up the slack, the negative impact a slowdown in the world’s top consumer that typically digests about 3 times its nearest competitor will be hard to ignore, much less circumvent. As we have mentioned in the past, the slowing US economy, while representing possibly the largest threat to the long-term up-trend in energy prices, still takes time to reveal itself and often takes a back seat to shorter-term conditions such as storm season, however it quickly returns to the forefront of traders minds when some of these conditions and or disappear. However, when the evidence is bold and clear such as in the month of August when it materialized in the form of a stock market meltdown, and the perception of change on energy demand is much more obvious, the price reaction can be much more dramatic as the $10 drop in crude oil pricing graphically demonstrated. Should the end of hurricane season be suddenly accepted as a reality next week, with the market finding no equally weighted bullish replacement, then in the face of a weakening US economy and the base price for crude oil could find itself suddenly challenging minor support at $77.50 before many expect it!

The late summer warmth that has been present over the eastern third of the country for most of September and early October is expected to come to an end during 6-10 day period. While the La Nina pattern that has brought the late summer warmth is forecast to continue, it is expected to undergo significant modification near the middle of October as the strong and persistent eastern ridge is forecast to retrograde into the Mountain West and central U.S. In its place, at least weak troughing and more seasonable temperatures are forecast to overspread the eastern third of the country. In response to building western ridge, the interior western U.S. and most of the central U.S. are expected to be on the upside of warming trend during the 6-10 day period. Highs in the 80s and 90s to near 100 degrees are forecast to become more commonplace over the southwestern U.S. late next week. Daytime highs in the 60s and 70s are expected to overspread the Intermountain West and North-Central U.S. Meanwhile, most of the eastern third of nation is forecast to be on the downside of cooling trend in response to the deepening eastern trough. Highs in 70s and low 80s over the northeastern U.S. to start next week are forecast to fall back into the 60s and 70s during the 6-10 day period. Highs in the 70s and low 80s are expected to become more common place in the Southeast. The region least likely to be affected by the anticipated changes next week will be the West Coast. While readings may not be quite as cool as they have been recently, highs in the 50s and 60s are generally forecast in the Pacific Northwest most of next week. Highs ranging from the 60s along the coast to the low 80s inland are anticipated over California.

Natural gas has recently rebound from critical support at $6.70 basis spot earlier this week and is now approaching overbought levels in our opinion. Just as we mentioned the potential negative aspirations for crude oil that an abrupt departure of this season’s storm threat provides, it holds an even more negative short-term outlook for natural gas prices. The removal of this year’s storm threat, leaves little to the imagination to impact natural gas supplies as the next legitimate threat is winter. Until then the near-term weather picture depicts softening demand as mild temperatures permeate the upper central Midwest and Northeast over the next 6 to 10 days. While the technical outlook as mentioned earlier shows more bullish promise, the market still shows signs of becoming overbought, and if overhead resistance at $7.65 per million BTU contains the recent advance we can see values falling back to test the $7.0 benchmark very quickly. Only a close above near-term resistance at $7.60 keeps the short term advance alive, with a further advance up to the $7.80 level likely to reject over exuberant bulls during the remains of the shoulder period pre-winter.

Concerning the petroleum complex, this week’s price activity clearly confirmed our last report’s conclusion and headline as we stated the current price advance up to test $83.50 and higher, could not be sustained in our opinion by the fundamentals, and left the market vulnerable to a sharp correction which was confirmed by today’s intraday low as the market briefly fell below the $79 benchmark. Certainly, as we mentioned last week, supportive conditions to the uptrend such as the weakening dollar, storm season, supply reductions which were modest this week, are all either well priced in, precarious, or soon to expire. Meanwhile the opposing threat to the uptrend in contrast, becomes more ominous on a weekly basis as revelations of the slowing US economy continue flowing from a badly wounded housing market that is hemorrhaging promises of the deeper recession yet to unfold and a resulting slow down in demand for not only Energy, but consumption in general across-the-board. This week’s factory orders continue to reveal this condition as will probably tomorrow’s payroll report. When the market suddenly finds legitimate bullish impacts such a storm season rapidly fading or in the case of the weakening US dollar becoming old news or possibly about the correct, and then you add a bearish impact such as the slowing US economy gaining momentum, and suddenly you can find the Bulls heading for the exits or in the name of prudence, taking a profit. What ever label they decide to give it and it still may translate into aggressive selling, especially after last week’s noticeable rejection from all-time contract highs near $84. Tomorrow’s employment numbers may provide the catalyst for a strong negative reaction in both stocks and petroleum, especially if recent optimism is disappointed again such as in last month’s employment debacle, as this time it may be more revelation as to the reality of a serious approaching recession, rather than a reason to buy equities in a continuation of the recent blind euphoria celebrating any support for the feds new rate cutting program. And what better excuse could traders find to sell stocks than from recently achieving their commensurate all-time new high in the Dow Jones above 14,000. A sudden stock market sell-off would also provide just the right impetus to encourage petroleum selling from the current levels of technical price fatigue the market is presently exhibiting, in my opinion. Let us not forget the incremental increase to OPEC production of 500,000 barrels expected to commence November 1, with any further suspension of prices above the $80 benchmark only providing further influence upon the Cartel to increase production again near term. Outside of the arrival of something unforeseen, such as a weather wildcard materializing in the form of a late-season Gulf storm, or sudden interruption to a critical supply line overseas from either a military conflict or terrorist act, and we continue to find crude oil running out of valid justification for remaining above the $80 benchmark over the short term.

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United Strategic Investors Group