Morning Futures Roundup

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Was the IEA's Decision to Release Strategic Oil Supplies Short-sighted?


 Today's Idea

Given the increased supplies of high grade Crude that will be placed in the market in the next several weeks, the term structure of the Brent futures has moved from a backwardation to a contango. Some traders looking for the near-tem contract to lose ground vs. a more deferred contract may wish to explore bear spreads in Brent Crude Oil futures. For example, the October 2011 Brent Crude futures could be bought and the August Brent Crude Oil futures sold. Currently August is trading 40 cents below the October futures. Traders initiating a bear spread would want to see this spread differential widen even further.

 

  Fundamentals

Many oil traders were caught by surprise on Thursday, as the International Energy Agency (IEA) announced that member nations would release 60 million barrels of Crude Oil or Oil products into the market through August. The Oil or Oil products released will come from member countries' strategic reserves to help control rising Oil prices following the shut-down of Oil exports out of Libya, which is estimated to have taken 1.3 million barrels per day out of the market. Futures prices tumbled on the news, with the Brent Crude Oil futures leading the charge lower, as at least 30 million barrels of Oil to be released will be of a "light and sweet" grade of crude, which similar to that lost from Libya and is in demand, especially from European refiners. It was the loss of the high grade of Oil from Libya that helped contribute to the historic widening of the spread between the benchmark Brent and WTI Crude Oil futures contracts. In the short-term, the increase of supplies should weigh on Oil prices, especially Brent Crude Oil, which should help to narrow the spread differential with WTI Crude. Longer-term, the affects of this action remain unclear, but may actually turn out to be bullish for Oil. First, the supplies being drawn from the strategic reserves will eventually need to be replaced, which would then add another entity competing for supplies with refiners in the global market. Secondly, it appears that many OPEC members were very unhappy about the IEA's move, as they insist that the market is well supplied with Oil, and we may now have a glut of Oil which could push prices even lower. If true, we may actually see OPEC members begin to discuss cutting Oil production, which could cause inventories to tighten should global economic improvement gain some traction. Thirdly, there are some concerns that the move to release Oil was more of a "political" gesture, rather than action to address a real crisis in Oil supplies, which may have hurt the relationship between Oil consumers and more "dovish" Oil producers such as Saudi Arabia, who had pledged to raise Oil production despite OPEC's decision at their June meeting in Vienna to keep output unchanged. Although it does appear that the IEA's move did achieve its objective in the short-term, consumers should be aware that the IEA's action may ultimately lead to higher Oil prices -- especially if demand begins to recover.


 Technical Notes

Looking at the daily continuation chart for Brent Crude Oil futures we notice follow-through selling on Friday, after the sharp drop in prices on Thursday, on record volume, following the IEA's announcement. Oil prices were already starting to slump, and the IEA put pressure on the large speculative accounts to liquidate their net-long positions. Additional selling may have also come from the unwinding of long Brent and short WTI spreads. Though prices are now well below the 20-day moving average, we still are holding above the 200-day moving average, which should be the next support point for the front month futures. Support is seen at the 200-day moving average, currently near the 101.70 area. Resistance is found at the 20-day moving average near the 114.70 area.


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