Feb crude oil initially tried to trade a bit firmer overnight but has since pulled back below the $40 price level as the price support from the Middle East violence seems to be fading. Although Israel appears to be massing forces at the Gaza border in preparation for a ground assault, oil markets appear less concerned that the conflict will draw in other Arab oil states and threaten oil supplies from the region. The market also seems to be garnering little support from news that OPEC cut supplies in December to below their target level according to an independent oil tracking company. It is also surprising to see that a weak Dollar and a firmer equity market are also having little positive outside market impact so far. While the uncertainty surrounding the Middle East situation as well as year end position squaring could still provide a short-term boost to oil prices, it is also clear that any oil price gains will likely be temporary as long as worsening economic conditions continue to weaken the outlook for energy demand. With some predictions that Japan’s economy contracted sharply over this past quarter and South Korean industrial output down over 14% in November compared to a year ago, it is clear that oil demand in Asia will remain weak despite China buying oil for their strategic reserves. Therefore, with the global outlook for oil demand still weak, we suspect Feb crude oil will eventually be pressured back towards the $30 price level. In fact, seeing weak readings in today’s US economic reports on consumer confidence and regional manufacturing could further undermine the demand outlook for oil. We also suspect traders are hesitant to push the market up too far since this week’s inventory report in expected to show another sizable gain in product stocks. The Dec 22nd COT report with options for crude oil showed the combined spec and fund position to be net long 127,457 contracts which suggest this market still has ample selling capacity left. We suggest traders continue to take defensive strategies in crude oil looking to sell into technical or geopolitical inspired rallies or be prepared to buy bear put spreads since we suspect oil prices won’t find a major bottom until economic conditions at least begin to stabilize which doesn’t appear to be happening yet.
GASOLINE: Feb gasoline also traded a bit weaker overnight and while some additional year end short covering may be possible, it is clear from yesterday’s price action the market will have trouble holding up at higher price levels in the current economic environment. So far sliding retail pump prices have yet to revive gasoline demand which is unlikely to recover as long as the economy continues to pinch consumer spending and that should leave gasoline prices trending lower. In fact, gasoline could come under additional price pressure this session since today’s economic reports are likely provide further evidence of a weakening economy leaving the prospects for gasoline demand bearish. Expectations for another sizable rise in gasoline stocks in this week’s inventory report could also give the bear camp some leverage this session. The Dec 22nd COT report with options for gasoline showed the combined spec and fund net long position at 54,040 contracts which leaves the market with ample selling capacity.
HEATING OIL: Feb heating oil has seen a choppy two sided trade overnight, but it is clear from yesterday’s action that short covering rally attempts in this market will have difficulty holding in the current bearish economic environment. With more evidence overnight showing worsening economic conditions in Asia, a bearish outlook for global fuel demand is likely keep downward price trend in this market in tact despite possible short-term gains. With traders expecting another sizable gain in distillate stocks in this week’s inventory report, there should be little concern over supplies even with colder weather expected in January. The Dec 22nd COT report for heating oil showed the combined fund and spec net long position at 14,355 contracts as of early last week. But we suspect the market won’t be sufficiently oversold until the combined spec position shifts to a net short reading. Therefore, the bearish fundamental outlook and the technical setup should limit the short covering capacity in heating oil and ultimately leave the path of least resistance down. Look for chart based selling to pick up if Feb heating oil fails to hold support at $1.25 support level.
TODAY’S GUIDANCE: A lack of upside follow through on geopolitical turmoil certainly reflects the bearish fundamental setup in the energy market and that will continue to keep the path of least resistance down for now.
