Oil Takes Stock Of Crude Realities

After back-to-back inventory drawdowns over the last three weeks that had slowly started to eat into oil’s multi-year inventory overhang, we got an unexpected inventory build today (Wednesday). Oil’s impressive recent gains - the commodity has roughly doubled from its Feb ‘09 lows - have been driven almost entirely by an improving economic outlook and favorable currency moves. But the inventory reports over the last few weeks have been helpful, nevertheless. Can today’s bearish report break that momentum?

The EIA reported a greater-than-expected 2.9 million barrels build in crude oil inventories. Current crude oil stocks are 19.3% above the year-earlier level and remain above the upper limit of the average for this time of the year, as is shown in the chart below from the EIA. The supply cover increased from the previous week to 25.2 days of supply, significantly above the year-earlier level of 20.1 days.

The demand picture also remains very weak. Total refined products supplied over the last four-week period, a proxy for overall petroleum demand, was down 7.7% from the year-earlier period, with gasoline down 0.4%, distillates (includes diesel) down 8.8%, and jet fuel down 11.7%.

So while the future may be better than the present, today’s inventory report is a crude reminder not to lose sight of the existing oil glut.

We continue to believe that there are good fundamental underpinnings for the ongoing oil rally. Having said that, it would be useful for the budding economic recovery as well as the sustainability of the rally if the commodity can pause for sometime to consolidate recent gains. Today’s inventory report and potentially weak payroll numbers on Friday will do just that, in our view.

We continue to favor early-cycle leverage through oilfield service names, such as Weatherford (WFT) and Ensco (ESV). Our long-term favorites remain Exxon (XOM), Schlumberger (SLB) and Diamond Offshore (DO).

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