Oil Set For Better Flow

The sell-off in commodities continued this week after the Italian election outcome and with the U.S. sequester kicking in and associated worries over a soft patch in U.S. activity (see Global Macro Views: Beware of U.S. soft patch), we cannot rule out dollar buying in the near term, which could weigh on commodities. However, downside from here should be limited if physical buying starts to pick up in China after the Lunar New Year holiday.

Gold Shed By Investors -- Ripe For A Move Higher
Total known ETF holdings of gold plummeted in February as investors shed the yellow metal on worries the Fed may exit its QE programme earlier than previously anticipated. The shedding of gold is also evident in the latest IMM data on speculative positioning from the Commodity Futures Trading Commission (CFTC). We still expect the Fed to continue to expand its balance sheet until early 2014 and Ben Bernanke’s comments this week support our call: notably the Fed chairman emphasised that the benefits outweigh the costs of QE and stressed that the upcoming fiscal tightening due to the U.S. sequester along with the latest rise in gasoline prices are key worries for the central bank. This suggests to us that gold has upside potential from current levels.

Oil: Iranian Nuclear Talks And U.S. Crude Output At Turning Point
The tensions between Iran and the international community may have reached a turning point this week after the so-called “P5+1” talks led Iran’s negotiators to say that a “more realistic and logical” proposal has been made after talks with the International Atomic Energy Agency (IAEA) broke down in early February. This could lead to sanctions on the Islamic Republic’s petroleum exports being eased. Negotiations are set to resume in mid- March and early April but it increasingly seems that a turning point has been reached. This could eventually reduce the geopolitical risk premium significantly as well as lower the “fundamental” price of oil as Iranian oil would gradually return to the world market. Notably, as Iran has produced to inventories for extended periods of time when the sanctions prevailed and is in desperate need of oil revenue, we cannot rule out a temporary flooding of the global oil market if restrictions are alleviated. Needless to say, this could exert downward pressure on crude prices.

The U.S. Energy Information Administration (EIA) this week published figures showing that U.S. crude oil production reached 7m b/d for the first time since the 1990s. As a result, U.S. net imports of oil also dropped by more than 400,000 b/d in 2012 as a whole, a 15- year low. This underlines that energy markets are undergoing significant changes after the shale boom has gained pace. This has recently spurred calls for U.S. export restrictions – which imply that U.S. crude can go no further than Canada or Mexico – to be eased. Thus far, the heavy rise in production in, for example, North Dakota and Texas has led inland oil prices to drop with the price of West Texas Intermediate (WTI) light sweet crude depressed. However, with pipeline infrastructure now being expanded (notably in the form of the Seaway pipeline) to allow crude to go into Gulf of Mexico refiners, the spread between Louisiana Light Sweet (LLS) crude (the price refiners pay for their crude intake) and WTI should start to narrow. This could have knock-on effects on U.S. gasoline prices.

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