Expectations for $75

Energy markets gained fresh legs last week from a number of positive economic indicators enabling both WTI and Brent to settle firmly above the $70 level. The end of the week saw Chinese retail sales and factory output increasing substantially while the EIA released surprisingly bullish inventory data. The IEA added to the bullish trend by issuing a forecast for a rise in crude demand on the back of an expected increase in energy consumption in the US and China. While these numbers can certainly be viewed as optimistic in the short-term, it remains to be seen whether there is significant underlying strength (post-stimulus) in this economic recovery, particularly in regard to China’s private sector demand.

Expectations for this week center on the push by WTI and Brent to break through near-term resistance around the $75.85 level. Otherwise, expect a slow and painful drift lower. The fact remains that funds and various speculators have been piling into the market as of late (last week crude longs increased 3.5% to 206,000 while speculative longs surged more than 7% to 118,000 contracts according to the CFTC) and thus there is enormous paper length invested in a further move higher. From a psychological perspective, the more we rise the more those who missed most of the “fun” will feel pressure to jump in now and not miss any more of it. Expect significant upward pressure to continue.

Monday morning begins with market participants digesting bullish news of incumbent Ahmadinejad’s re-election victory in Iran. Given the lack of a significant retracement since bouncing off $66, many consumer hedgers and traders are reluctant to simply purchase swaps to protect/profit from further moves higher. Instead, call spreads and call spreads partially financed by put sales are more in demand. For instance, the Brent APO August $80/90 call spread can be owned for only about $1.75 ($8,250 possible payout vs only $1,750 of risk). Similarly, the Brent APO December09 $85/110 call spread can be owned for only $1,500/1000bbls when the $61.50 put is shorted to provide financing.

Singapore