Petroleum Report: Large Supply Gap, QE3 Keep Brent Near $120 (USO, DIG, DUG, SCO, OIH, ERY, ERX)

Sumit Roy:  Resilient demand, tight supplies push Brent toward high for 2011. The Department of Energy reported this morning that in the week ending July 8, 2011, U.S. crude oil inventories decreased by 3.1 million barrels, gasoline inventories decreased by 0.8 million barrels, distillate inventories increased by 3 million barrels and total petroleum inventories increased by 4.3 million barrels.

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Crude oil was able to hold its ground over the past week, despite intense fears regarding the European sovereign debt crisis. Brent was last trading just under $120 resistance, an area that corresponds to the high of last month. A break of that level would open up the opportunity for prices to advance toward this year’s highs near $127.

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Oil’s strength continues to stem from the 1.6 mmbbl/d of lost output due to the civil war in Libya, as well as robust, emerging market demand. High prices—while having an impact on consumption in the developed world—have done little to discourage consumption in the developing world.

China’s National Bureau of Statistics announced this morning that the country’s economy expanded at a faster-than-expected rate in the second quarter. Real GDP in the country grew 9.5 percent year-over-year in the period, above the consensus estimate of 9.3 percent, though that was down from the 9.7 percent seen in the first quarter.

Meanwhile, China’s industrial production for June grew by 15.1 percent year-over-year, besting the 13.1 percent estimate. Retail sales for the same month increased by 17.7 percent, better than the 17 percent that was anticipated. The latest economic figures suggest that growth in the world’s second-largest economy remains robust despite persistent monetary tightening by authorities.

In light of the strong outlook for emerging markets, the International Energy Agency increased its demand growth forecast for this year to 1.2 mmbbl/d from 1 mmbbl/d in its latest Oil Market Report. Meanwhile, the agency continues to see a big gap between supply and demand in the third quarter. If OPEC crude supply were to remain at June’s 30 mmbbl/d level, global demand would outstrip global supply by 1.3 mmbbl/d, according to the latest IEA estimates.

While these underlying fundamentals are supportive of oil specifically, there were also some bullish macro developments this week. In particular, speculation that the Federal Reserve may provide more stimulus to reignite the sluggish U.S. economy lit a fire under most commodities.

In his testimony to Congress today, Fed Chairman Ben Bernanke said that “… economic weakness may prove more persistent than expected … implying a need for additional policy support.” He went on to say the central bank had “a number of ways in which [it] could act to ease financial conditions further.” Among those options was the possibility of initiating more securities purchases; in other words, a third round of quantitative easing (QE3).

While QE3 may never come to fruition, the fact that the Fed has put the possibility out there is seen as supportive for risk assets in general, and commodities in particular.

Turning to this week’s EIA inventory figures, total petroleum inventories in the U.S. increased by 4.3 mmbbl against the five-year average of 4 mmbbl. In turn, the surplus over the five-year average was only up fractionally to 13.5 mmbbl, or 1.3 percent.

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Crude oil inventories fell by 3.1 mmbbl, much more than the five-year average of 1 mmbbl. Thus, the surplus over the five-year average declined to 19 mmbbl, or 5.7 percent. The entire drop in inventories took place outside of the Midwest, with crude inventories excluding the Midwest region still below both the five-year average and last year’s levels.

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Gasoline inventories fell counter-seasonally again, taking inventories in this category slightly below the five-year average. Meanwhile, distillate inventories rose by the most since August 2010, or almost 3 mmbbl, taking the surplus over the five-year average to 4.8 mmbbl, or 3.5 percent.

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Demand

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Imports

Crude oil imports reversed last week’s big spike, falling by 0.9 mmbbl/d. On a four-week rolling basis, crude oil imports have been 0.4 mmbbl/d below the year-ago level.

 

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Refinery Activity

Refinery utilization edged down to 88 percent from 88.4 percent, modestly below the year-ago level and the five-year average. Gasoline production plunged from 9.5 mmbbl/d to 8.9 mmbbl/d. Distillate production edged up to 4.5 mmbbl/d.

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Miscellaneous

U.S. crude oil production edged up to 5.6 mmbbl/d. Output remains near seven-year highs thanks to surging output in unconventional oil plays. Year-to-date production is up 2 percent year-over-year.

 

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Inventories at the NYMEX delivery point in Cushing, Okla., rose by 0.6 million barrels to 37.6 million barrels, or 65 percent of the EIA’s estimate of capacity. Overall Midwest inventories increased 0.5 million barrels to 99.4 million barrels, or 79 percent of estimated storage capacity.

Front-month WTI calendar spreads were little changed week-over-week at -0.42.

West Texas Intermediate’s discount to Brent increased to -$20.46 from -$16.97 last week, while WTI’s discount to Louisiana Light Sweet increased to -$17.85 from -$13.75 last week.

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Related Tickers: United States Oil (NYSE:USO),  ProShares Ultra Oil & Gas (NYSE:DIG), ProShares UltraShort Oil & Gas (NYSE:DUG),  ProShares UltraShort DJ-UBS (NYSE:SCO),  Oil Services HOLDRs (NYSE:OIH), Direxion Daily Energy Bear 3X Shares (NYSE:ERY), Direxion Daily Energy Bull 3X Shares (NYSE:ERX).

Written by Sumit Roy From Hard Assets Investor

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