At These Levels

This week's inventory data marked a subtle shift. Crude oil inventories had been expected to rise but remained basically flat with last week's data. As my chart at the end of today's post shows, inventories are about average for this time of year.

The big porblem remains gasoline where inventories are not only above average but also above the 5-year high for this time of year. Gasoline inventoeis were expected to fall this week but they actually fell even more than widely predicted. This is bullish for gasoline.

One of the most obvious victims of the high gasoline inventories has been the refiners. Sky-high gasoline inventories put downward pressure on gasoline prices relative to crude and that hits the refiners. This is unusual because typically the period between late January and May is bullish for the refiners with crack spreads--a measure of refiners' profit margins--tending to rise during the run-up to summer driving season.

Natural gas inventories released today were bullish. The EIA reported a drawdown of 85 billion cubic feet, above analyst expectations and the 5-year average drawdown for this week of about 50 billion cubic feet. Natural gas inventories are now in-line with the five-year average and I suspect we'll undercut that average before the end of March. Gas prices ticked higher intra-day on the news but gas remains lower overall today.

The weakness in gas short-term stems mainly from a spillover effect from the oil market. With the dollar at least temporarily stabilizing, crude is finally falling to reflect the increasingly bearish fundamentals of falling demand and more-than-sufficient supplies. I highlighted some of these factors in yesterday's post.

But gas and oil aren't perfectly correlated. For the past two years crude oil fundamentals have been broadly bullish while natural gas fundamentals remained bearish -- oil prices rose and gas fell. I suspect we'll see somewhat of a switch in that this year -- gas prices, supported by strong fundamentals, can rise in spite of oil.

Oil inventories rose less-than-expected this week. This breaks a long string of reports where inventories of crude have been building at a faster-than-forecast pace.

Oil inventories have been rising quickly since the end of 2007 and are back to an average level for this timne of year. Typically, when inventories rise more quickly than expected, crude oil falls in price. But that hasn't happened this year and there's one reason -- a weak US dollar. In euro and yen terms, crude is actually flat to lower so far in 2008.

Ironically, this week's report was mildly bullish from a supply perspective -- the first bullish report in weeks, yet crude oil fell. There are two main reasons for this in my view. First, oil has run up considerably despite the weak market of late, therefore, some traders likely decided to take profits. From a technical perspective, oil still looks to be seeing a simple correction within the broader uptrend.