Petroleum Rebounds from Lows of the Range on Technical and Supply concerns

Following EIA Supply Increases and further signs of Recession, while Natural Gas Strengthens Following larger than expected Draw-down and Winter Fears.

Technical Outlook: Since our last report we said 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 also felt signs of technical fatigue were 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 remained 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 maintained a bullish divergence in our view. From this analysis, we anticipated if prices on follow through of the recent short term uptrend, failed to breach resistance above soon to close above $8.10 with a targeted challenge at $8.25 that values would quickly fall as traders move to sideline profits and a retracement back to intermediate support at $7.80 would be fitting. This is exactly what transpired as values failed to obtain a close about $8.10 basis spot March futures and since then collapsed all the way down through our intermediate support level at $7.80 and subsequently testing critical support at $7.60 before rebounding sharply into the close. Since then, and almost exactly in-line with last week’s conclusion prices then rebound from this new multi-week extreme low and have now managed to not only challenge but also penetrate on close key resistance above at $8.10. Looking ahead most technical indicators are confirmed as bullish with stochastics, the linear oscillator, the MACD, along with the parabolic and others displaying a clear bullish divergence suggesting further upside is to be expected. The next important resistance point is $8.40 basis spot and should this be surpassed within the next 3-5 sessions the market could easily challenge key historic resistance at $8.60 basis spot. Depending on the fundamentals of the weather, which will be discussed in more detail in the next section, a close above critical resistance and $8.60 would be extremely bullish and could then preempt a move to ultimately challenge $9.80 to the $10 benchmark!

This week's EIA report revealed an unexpected supply withdrawal of 200 bcfs that was much higher than both previous estimates by Bloomberg and DowJones that were forecasting closer to between 186 and 175 bcfs respectively. Storage now stands at 2062 bcfs which is 317 bcfs below last year’s record and yet 62 or 3.1% above the five year average of 2000 bcfs. The market reacted after trading as low as $7.99 earlier in the session prior to the release of the EIA’s supply report and then promptly traded sharply toward the highs of the session before settling back on a modest gain of 11.3 cents to close at $8.107 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 last week’s record drawdown of 274 and then combined with this week’s much larger than expected drawdown of 200 bcfs, and it is clear to see how quickly the market has taken on bullish sentiment and just driven prices higher. With below normal cold anticipated to arrive in the upper Midwest and Northeast this weekend, prices should be able to maintain their upward bias into early next week. Based on the Weather pattern and the last 2 weeks whereby both storage draw-downs have exceeded expectations clearly displaying this market’s history of a precarious production rate especially whenever demand elevates. Thus if the market soon experiences a supply deficit to the 5 year average, which is only 3.1% from reality, then the degree of below normal cold that impacts the Midwest and Northeast, now that we are entering the final third of winter, could dramatically influence price direction because of the market’s historic, acute sensitivity to fluctuations in demand as production is considered less than reliable. These two conditions of the supply reduction rate and winter cold, deserve keen observation in the weeks ahead, as even a below normal cold winter spell being sustained in the consuming Midwest and Northeast for only a week and a half could ignite enough panic buying to launch prices into a dramatic bullish acceleration that could bring the market to challenge the $10 benchmark rapidly as storage levels would then fall to an uncomfortable level below the five-year average.

Concerning Crude Oil the market today posted a gain of $.97 or 1.1% to settle at the $8.11 per barrel basis the spot March contract on the New York Mercantile exchange. The upward price movement was supported today by production interruptions in Nigeria in the North Sea. Royal Dutch Shell said Thursday it was halting 130,000 barrels per day of Nigerian output because of a pipeline leak, and this came one day after an announcement by French petroleum company Total that it had shut off about 280,000 barrels of oil output from its North Sea oil fields. These brief but inconsistent supply interruptions served as a temporary price supporting buffer against the recent and more dramatic decline in petroleum values that in only a matter of day’s saw prices fall from above the $92 benchmark to today’s intraday low at $86.24 as a reflection of recent economic data that has all but confirmed that the world’s top oil consumer has now fallen prey to a full-blown recession. This past weeks Department of Energy report seemed to complement the effect of the US recession and its weakening consumer demand for energy as supplies dramatically increased for both crude oil and gasoline as petroleum stocks vaulted by 7 million barrels for the week ending February 1 and much above the 2.6 million barrels expected and yet remain in the middle of the average range for this time of year. Gasoline stocks increased 3.6 million barrels and remain above the upper limit of the average range for this time of year, while distillate fuel stocks inched higher by only 100,000 barrels and yet remain in the middle of the average range. Refinery capacity dropped slightly for the week ending February 1 to 84.3% as gasoline production decreased over the previous week while distillate feel production increased. The combination of the dismal unemployment report, whereby the government showed the slumping economy lost 17,000 jobs in January quickly followed by the largest one-month drop in the services industry as the ISM index declined to 41.9% from December’s 54.4% in the second largest drop on record, all but confirming recession as plus 50 indicates economic expansion where as anything below 50 denotes contraction, seem to provide a 1-2 punch that was just enough to derail crude oil’s upward momentum. The next shoe to drop that traders will be looking to that still may provide a temporary support as well as countermeasure against recessionary fears is an expected reactionary cut in production by OPEC in their upcoming meeting in Vienna on March 5. This would be a concerted effort to suspend the benchmark price of oil above the newly rumored floor price targeted by the cartel of $80. If the benchmark prices have fallen down between $80 --$85per barrel before the next meeting oil Ministry officials from four of the group’s nations have already indicated a production cut may be in order. According to Bloomberg estimates the cartel pumped 32.1 2 million barrels a day last month in the efforts to keep pace with global demand in lieu of robust consumption in China and Asia despite slowing demand in the US. OPEC, which produces over 40% of the world’s oil, could certainly affect price direction as they have in the past through production output changes and are no doubt reflecting back on the year 2001 when oil fell 30% in reaction to the last US lead recession whereby the cartel was forced to reduce production three times.

Very changeable conditions expected across the East next week; mild in most of the West

Temperatures are expected to average above normal across much of the western U.S. next week and weekend while nearly seasonable readings are anticipated for the north-central part of the country and East. The Northeast is likely to begin the week on the cold side with highs in the upper 20s and 30s, but may warm to the 40s and lower 50s near the end of the week when the mildest days should occur. The Midwest should be even more changeable with below and much below normal temperatures on certain days interspersed with much warmer ones. Highs mostly in the 20s and lower 30s are expected on the coldest days but upper 30s and 40s will be possible briefly late next week. In the Deep South, changeable conditions will be the rule as well, but especially the Southeast. Highs should be mostly in the 50s and lower 60s here but 60s and lower 70s are forecast to dominate the south-central U.S. on a more consistent basis as the coolest weather remains east of this region. In the West, highs will be mostly in the upper 30s and 40s across the Central Great Basin ranging to the upper 60s and 70s in the Southwest deserts. Meanwhile, highs in the upper 50s and 60s are anticipated over much of California with 40s and lower 50s in the Pacific Northwest.

Natural gas just as we forecast last week, after failing to surpass our minor resistance at $8.10 per million BTU and then just as we predicted prices collapsed in dramatic fashion and yet failed to fall below our targeted extreme support at $7.60 and in fact hit that exact price as an extreme intraday low before rebounding sharply which is now resulted in today’s pivotal close and settlement just above $8.10. In looking ahead both the technical outlook as well as at least the temporary fundamental winter outlook seem to be bullish with below normal cold anticipated this weekend and into the first half of next week. Based on this convergence of both technicals and fundamentals we see the potential for the market to move higher over the immediate near-term and expect to see resistance between $8.40 and $8.60 tested within the next 3-5 sessions unless the weather picture dramatically shifts back to milder than expected conditions. In the meantime look for support from value buyers to come in just below current levels at $8.0 scaled back to $7.92 with a close below this level needed to temporarily negate bullish forces and possibly return the market to test pivotal support at $7.80. Also let me remind you the same warning from last week’s report in that should the colder than normal weather anticipated for the key consuming regions of the Midwest and Northeast next week intensify into a more sustained demand enhancing Arctic blast, then a bullish break out exceeding key historic resistance at $8.60 could result in a vertical acceleration initiated from panic buying that could bring the market to challenge the $10 benchmark very quickly!

Concerning the petroleum complex, this week’s price activity, has confirmed the threat of recession here in the world’s top consumer is legitimate and has now become a major concern amongst traders. Key contributing influences to look for in the weeks ahead will continue to be the gradual outflow of economic data that has recently taken on a rather bleak and dismal characteristic that seems to only further confirm the severity of the approaching recession and reveal the possibility that conditions may be much worse than analysts had previously indicated. However, as conditions in Nigeria and in the North Sea graphically reminded us, the tight supply demand balance is equally real as it is the international threat to supply which could immediately jeopardize oil flow availability despite the apparent slowdown in demand here in United States. Let us not quickly forget that the current rate of global consumption overall remains robust with China still experiencing double-digit GDP growth above 11% and even with this year’s potential slowing affect from its exposure to the US is still only expected to fall back to a growth rate of 10% along with India’s above average growth and thirst for energy, and thus the world balance of demand versus production can still not withstand a sudden supply disruption of serious magnitude such as from a Katrina or military conflict or terrorist act involving a major producer. Until then we see the market in a continuation of the ongoing tug-of-war between potential and real supply threats and the gradual revelation of the slowing US economy as the release of the financial data dictates. In between these two influences traders will continue to rely on the technical price pattern for price direction especially when the outlook from the other two seems cloudy. In our opinion crude oil will still maintain an upward bias over the near-term and remain above the $87 benchmark as prices have failed for various reasons to close below this pivotal mark over the past several weeks despite the weak economic data here in the United States along with several consecutive increases in crude stocks. It seems traders are reluctant to abandon their bullish trend and have not fully accepted the recessionary theory yet especially while the fed scrambles to cut interest rates and as Congress is about to disburse the funds executing the $160 plus billion dollars stimulus package designed to thwart the approaching recession. Traders may also feel that it was not long ago when prices were trading at the key $100 benchmark and have since corrected a full 13% already and yet there still remains enough winter to put a late season bite into heating oil supplies that could undermine an extension of the recent decline. And finally, knowing the intentions of OPEC in doing their best to keep prices elevated above at least the $80 benchmark and more likely above $85, in the past it has not proven wise to trade against the cartel’s desires. Looking ahead, we feel if prices remain suspended above $87 over the near term we anticipate a rather rapid return to test the recent upside resistance level at $92 with a break above this possibly bringing the market to challenge $95 once again. Even if the market should decline further and bring a close below the $87 benchmark, it is our view the market will have a hard time breaking below $85 with value buyers and bargain hunters jumping in knowing the support of OPEC will be close behind.

FUTURES AND OPTIONS TRADING INVOLVE RISK OF LOSS AND MAY NOT BE SUITABLE FOR EVERYONE.

United Strategic Investors Group