The Energy Report for 1/28/2013

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By Phil Flynn | January 29, 2013 1:37 AM EST

Price Futures Group

By Phil Flynn

Sr. Market Analyst at The PRICE Futures Group
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RBOB is rocking and Russia is running out of palladium, two features that will grab attention as many traders pull in their horns ahead of the Federal Reserve meeting this week.  Refinery glitches and tight supply in the New York Harbor has sent RBOB on an earlier than normal rally. While the WTI and heating oil look toppy. RBOB on the other-hand looks poised to drive higher.  RBOB looks to target over $3.00 a gallon basis the March future.

On the retail Side CNN reported that U.S. gasoline prices crept up by about 2 cents per gallon over the past two weeks, but higher crude oil prices are likely to mean more small increases on the horizon, the latest Lundberg Survey concluded Sunday. Friday's national average price was $3.44 for a gallon of regular, survey publisher Trilby Lundberg said. That's up from $3.42 in the previous survey, conducted January 11, but down about a nickel from a year ago.

Mid-January's modest increase can be blamed on a rise in crude oil prices over the last two weeks, Lundberg said. The benchmark West Texas Intermediate crude rose $2.32 a barrel over that period, and that's going to push prices up again in the coming weeks, she said. "We can see wholesale price increases by refiners, who are now paying higher prices for crude, hitting the wholesale gasoline markets," Lundberg said. "I think we can expect another few more pennies at the pump within a few days' time."

The hostage crisis at a natural gas plant in Algeria likely contributed to the increase in crude prices, she said. Algerian oil is similar to the European benchmark Brent crude, and the seizure of Western hostages at the In Amenas facility "did make some kind of unquantifiable contribution in geopolitical concerns within the oil market," she said. The Lundberg Survey canvasses about 2,500 U.S. filling stations to calculate its national average. The latest survey found the highest average fuel prices in Los Angeles, at $3.71 per gallon; the cheapest were in Albuquerque, New Mexico, at $2.88.

 On Friday I wrote an article called from "Glut To Glut" about the importance of the Seaway Pipeline and its major impact that it will have on crude prices in the foreseeable future. Today the Wall Street Journal wrote that" oil-transit problems for an important pipeline to the Gulf Coast have forced traders to rethink bets on rising U.S. crude prices. The Seaway Pipeline, which runs from the transit hub of Cushing, Okla., to refineries on the Texas coast, was expanded on Jan. 11 in response to bulging stockpiles in Cushing that have depressed the price of U.S.-traded crude compared with oil imported from overseas. But last week Seaway's operators said they reduced capacity on the line to 175,000 barrels a day from 400,000 barrels a day. This prompted U.S. crude-oil futures to retreat from four-month highs.

Many investors had expected that the flow of oil through Seaway would quickly lower U.S. oil stockpiles as more refineries gained access to the oil at Cushing, the delivery point for the benchmark U.S. crude futures, allowing prices to rise. Initially, those investors were right. In early January, just before Seaway was expanded, stockpiles in Cushing rose to a record of 51.9 million barrels, according to weekly data from the U.S. Energy Information Administration. In the week following the expansion, stockpiles fell for the first time in seven weeks. Nymex crude futures have rallied 4.8% since the beginning of the year. This is due in part to anticipation of the Seaway expansion, which more than doubled the flow of oil through the pipeline. But those price gains came to a screeching halt on Wednesday, when Seaway's operators cut deliveries due to rising inventories at the end of line. Nymex crude settled 1% lower that day as investors unwound their bullish bets. Still, many investors expect that as Texas refineries emerge from seasonal maintenance over the next few months, oil demand will rise and prompt additional deliveries through the pipeline, raising U.S. prices."

Of Course this highlights the growing nuances in the US crude oil market. Today's Wall Street Journal writes when it comes to oil it is location, location, location. "What's the price of oil?" That question has taken on a whole new meaning, and thereby created a list of winners and losers for investors.  The average spot price for Brent crude oil in 2012 was about $112 a barrel. Meanwhile, West Texas Intermediate averaged only $94, a 16% discount. But that is nothing compared with some lesser-known benchmarks. Oil priced at Clearbrook, Minn., mainly barrels produced in the prolific Bakken basin, got just $88, a 22% gap. Western Canadian Select crude, meanwhile, sold for an average of about $74 a barrel, a one-third discount to Brent. Today, those Canadian barrels command less than $65 a barrel against Brent's $113.

The reason? Rising output from inland fields has overwhelmed the infrastructure that gets oil to market. In areas lacking easy access to refineries and consumers, which are largely on the East, West and Gulf coasts, supply gluts form, forcing discounts. Pipeline operators are obvious winners, and not just because of fees they charge for usage. Larger firms with a diverse set of pipes and storage tanks can use those to arbitrage disconnected prices. For example, profit per barrel in Plains All American Pipeline's PAA +1.00% supply and logistics division has almost doubled since 2009.Railroads also benefit. Rail is more expensive: It costs $8 a barrel to pipe Western Canadian oil to Houston, for example, but $14 by rail, according to Deutsche Bank DBK.XE +0.58% . Still, if you are a producer facing a $50-plus spread to Brent and rail is the only option, you'll take it. Moreover, as Darren Horowitz of Raymond James points out, railroads offer flexibility. While pipelines usually require multiyear contracts, railroads sell their services on much shorter schedules. They can also quickly link regions where pipelines are scarce, such as between Midwestern fields and East Coast refineries. The oil boom is helping some railroads cope with falling coal cargoes. Canadian Pacific RailwayCP.T -0.69%  and Kansas City Southern KSU +0.25% could see the biggest boost to earnings from shipping oil in the next few years, according to Credit Suisse CSGN.VX +0.47% .  Other winners are midcontinent refiners such as HollyFrontier  HFC +0.98% . They can process cheaper, relatively local oil and then sell the refined products. Because refined products can be freely exported from the U.S., they command higher global prices relative to domestic crude oil, which can't.  On the losing side are producers heavily exposed to more-discounted crudes. Firms such as Canadian Natural Resources CNQ.T +0.82% and Baytex Energy,BTE +0.24%  for which medium and heavy Canadian oil makes up most of their output, have seen their stocks lag well behind the exploration and production sector over the past year.

But even they may now spell opportunity. While the future of the Keystone XL pipeline, a major potential route south, remains questionable, help is coming from other quarters. One is BP's BP -0.41% Whiting refinery near Chicago, which is being retooled to absorb more heavy Canadian oil in the second half of 2013. And as new pipelines and rail links narrow the gap between WTI and Brent, that should also pull up the price of Canadian oil.

- Above all, cheap oil attracts buyers and logistics firms. The big discounts on Bakken crude led railroads to add almost one million barrels a day of transportation capacity last year, according to investment bank Tudor, Pickering, Holt. It estimates a combination of pipelines, rail trucks and barges could close the discounts on Canadian crude by $20 a barrel or more in the next couple of years. That could boost profits substantially. Every $10 a barrel extra that Baytex gets on its heavy crude oil would boost 2013 cash flow per share by 16%, according to RBC Capital Markets."

 

The Ukraine could be headed for another showdown with Russia. Dow Jones reports that    Russia has hit Ukraine with a $7 billion bill for gas deliveries just as Kiev took a step toward energy independence by signing a deal with Royal Dutch Shell PLC to explore for shale gas, an official at Ukraine's state energy firm said.  A dire warning from Johnson Matthey sent Palladium to the highest levels since 2011. Bloomberg New reported Palladium reserves in Russia, the world's largest producer of the metal, are "pretty much exhausted" and sales this year may be only 3 metric tons, according to Johnson Matthey Plc. Russian inventory sales dropped 68 percent to 250,000 ounces last year from 775,000 ounces in 2011, according to Johnson Matthey. Sales from state stockpiles are expected to range from "zero to several tons" in 2013, Anton Berlin, deputy chief of ZAO Normetimpex, OAO GMK Norilsk Nickel's sales arm, told RBC TV yesterday.  "Maybe 3 tons this year, and that will be it," Peter Duncan, general manager of market research at Johnson Matthey, told reporters in London today. Three tons is equivalent to 96,452 troy ounces. "Russian state stockpiles have been dwindling and are now pretty much exhausted." Shrinking Russian stockpiles at a time when output is falling helped send the metal into the biggest shortage in 12 years. Output in South Africa, the second-biggest producer, was disrupted by labor disputes and strikes, while lower grades contributed to a decline in Russia.

 

The Fed is meeting today and after the Fed Minutes I wrote that diamonds are forever and we thought that quantitative easing was as well. So much for Federal Reserve transparency, it is very clear after the release of the Fed minutes that the Federal Reserve either misled the market after the last Fed meeting or there is something more sinister going on. In the last Fed Statement, the Fed said quite clearly that that their intention is to keep the target range for the federal funds rate at 0 to 1/4 percent as long as the unemployment rate remains above 6-1/2 percent or inflation goes above 2 percent. Traders assumed that that included quantitative easing as the Fed talking about the woes of the fiscal cliff and the turmoil in the global economy would continue to support their dual mandate by continuing purchasing mortgage-backed securities at a pace of $40 billion per month and purchase longer-term Treasury securities at a pace of $45 billion per month.

  The assumption was until the Fed dual mandate of employment and inflation was breeched. Now in the Minutes in the same meeting it seems that behind the scenes that assumption may have been mistaken. According to page nine of the Fed Minutes they said that "several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013." 

Yes, they said there were concerns about the balance sheet but some might assume it is because they think inflation is going to soar or that unemployment is going to drop. That is assuming that the Fed's new targets for inflation and unemployment then would be meaningless. Or more sinisterly, perhaps they added that dissension to the minutes to thwart commodity bulls that would go to town driving prices higher. The hope may have been that putting a bit of doubt in the commodity traders' minds might thwart the commodity bull-run that we have seen in the aftermath of QE1 and QE2. 

Of course the Fed also has to worry about a bond bubble.

 

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Phil Flynn

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