Seven Week High

Crude prices rose for their sixth straight day thanks to a small decline in crude supplies and the unexpected drop in gasoline inventories. Crude inventory levels declined by -800,000 barrels for the fourth weekly decline. Gasoline inventories declined by -1.8 million barrels for the first decline in five weeks.

Bernanke downplayed the risks of a double dip recession in his comments to the House during his second day of testimony. He said the Fed did expect the recovery to slow but not return to a recession.

The decline in gasoline inventories suggested demand may be increasing with the refiners still operating at a utilization rate of 92%. Gasoline inventories are now 6.5 million barrels below year ago levels. Part of that gasoline decline came from a -284,000 bpd drop in gasoline imports.

Inventory Snapshot

Crude oil inventories are still well above the normal five year range thanks to stockpiling by refiners ahead of the Iran embargo. Refiners wanted to make sure they had plenty of oil on hand in case Iran did try to block the Strait of Hormuz or supplies disappeared because of a successful embargo. Crude inventories are 7.3% over year ago levels.

Cushing inventories declined by another -500,000 barrels to 46.3 million. This could be a result of accelerated movement of oil through the Seaway pipeline but more than likely just a temporary fluctuation in oil being delivered to Cushing from other parts of the country.

EIA Crude Oil Inventory Chart

EIA Gasoline Inventory Chart

EIA Distillate Inventory Chart

U.S. housing starts rose +6.9% in June to 760,000 and the strongest month since October 2008. Mortgage applications soared +16.9% over the prior week suggesting home buyers were out in force as well as quite a few refinancing applications at 80.1% of the total. The 30-year fixed rate at 3.74% was down 5 basis points from the prior week. The rapidly improving sentiment in the housing sector carried over to the equity markets and commodities including oil and copper.

In Syria President Al-Assad's brother-in-law and a top general were killed in a suicide bomb attack to bring the battle into the heart of the Assad government. More than 15,000 citizens have been killed in the last 16 months. The rising violence in Syria and the worry over a spread to surrounding areas is supporting oil prices.

U.S. Defense Secretary Leon Panetta said the U.S. will hold Tehran directly responsible for any attempt to disrupt shipping in the Gulf region and will defeat any Iranian attempt to shutdown seaborne commerce. Panetta said any attempt by Iran or "any of its surrogates" would be dealt with severely.

The U.S. also announced a joint exercise consisting of 20 nations to practice detecting and removing sea mines in and around the Persian Gulf. The large minesweeping exercise is scheduled for Sept 16-27th and is a "defensive drill" and "not aimed to deliver a message to Iran" according to the Defense Dept. If you believe that I have a bridge you might want to buy.

The Defense Dept said the exercise will focus on "a hypothetical threat from an extremist organization to mine international strategic waterways in the Middle East" such as the Strait of Hormuz.

The Defense Dept said earlier this week the Navy was sending another aircraft carrier battle group, led by the carrier USS Stennis. The Stennis is going to arrive four months earlier than its previously scheduled rotation. The early arrival will mean the U.S. will have three carrier groups in the area but one is scheduled to rotate back to the states several weeks after the Stennis arrives. The buildup is a warning message for Iran and the rotating carrier can always be kept on station if tensions continue to build.

WTI Crude Oil Chart

Longer term about the only reason for oil prices to rise further is an increase in hostilities over Iran. With Europe, China and the USA all in slowdown mode the demand for crude oil is going to slow. Actually I should say demand growth will slow. I reported last week the major agencies (IEA, EIA, OPEC) were still expecting demand to increase in 2012 and 2013 but at a slower pace. That pace may not be enough to reduce global supplies by an appreciable amount until OPEC decides to slow production to support prices. Right now the supply-demand balance is about even depending on how much oil Iran is actually able to export. We won't know that for another couple of months.

Long term (fall and winter) I would expect WTI to hover in the $85-$95 range and Brent in the $100-$115 range. Eventually demand will catch up with excess supply and the entire cycle of higher prices and demand destruction will begin again. For today the low fuel prices are helping support the global economy. Prices are high enough to support capital investment into oil exploration and that should keep the drilling sector healthy.

If shots are fired in the Iranian conflict then all bets are off on oil prices.

Jim Brown

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