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The energy complex saw an aggressive liquidation wave in the month of May, and that wasn’t surprising considering that at the May high crude oil was trading $18 per barrel above the February lows. In retrospect, the washout was justified from both fundamental and technical perspectives. In addition to a mountain of physical supply sitting inside the US, the market was picking up on the prospect of reduced global demand. With the COT reports at times this spring showing speculators holding a massive net long position in crude oil, even the technical condition of the market was screaming for a correction. Surprisingly, crude oil market seemed to get around news of a slight slowdown in the Chinese purchasing managers reading, even though the prospect of strong Asian demand was helping to discount the ultra-high level of crude oil supplies on hand in Cushing, Oklahoma. With gasoline stocks failing to continue a pattern of declines seen earlier in the year and demand not ramping up as expected in the wake of positive views on the economy, there were just too many negatives for the market to ignore as it went into the May debacle.
With the probe below $67.50 in July crude oil and in the face of periodic bouts of deflation, we suspect that many US refiners will begin to ratchet down their activity, which could ultimately bring about a very solid low in prices. In the meantime, to avoid a retest of the May lows, it would probably require evidence of rising weekly gasoline demand and a pattern of falling refinery operating rates. In other words, to see a bull market mentality return to the energy complex, we probably need to see some proof of tightening US gasoline stocks. Last year US gasoline stocks saw a decline of roughly 15 million barrels in the April through June time frame. It could take that size decline and perhaps even more to fully restart the bull market action in the energy complex.
It is possible that RBOB pricing will begin to garner some support from a seasonal pick-up in demand, and that demand pattern might also serve to cushion gasoline prices against the residual slowing fears that look to be propagated by the ongoing travails inside the Euro zone. Still, it might take a temporary return to the late May low of $1.8888 in July RBOB to put gasoline prices back into a deflated/cheap condition. Talk of stronger summer air travel this year and fairly active US trucking activity would seem to suggest that the product markets have a much better fundamental outlook than crude oil, which might see its physical supply condition worsen markedly in the face of scaled back US refinery activity. Therefore, we see RBOB pricing gaining on crude oil, and we see RBOB managing to gain on heating oil toward the end of June. For those that look at spread strategies, we think that RBOB will hold up better than crude oil on any near term weakness, and we expect RBOB to spring higher than crude in the event that the entire energy complex rebounds off of improving global psychology.
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