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The energy complex is sharply higher (prices rising) trading well above Friday’s close as continued developments in Libya and the shut-in of roughly 100,000 bpd there continues to force fresh length into the market while flushing recent shorts as Brent hits a fresh 2 ½ year high above $108/bbl.  Unrest in the Mideast is approaching a one month anniversary now and while the IEA says OPEC can offset any production shortfalls that may emerge, it’s important to note that several of the key OPEC players are the very country’s that are at risk of political upheaval (Iran, Saudi Arabia, Libya, Algeria, etc…).  This isn’t over by a long shot.

The macros remain in support with a sharply weaker dollar (-905 basis points) and notably higher equities on the day.  European debt concerns have eased with good bond auctions this week, prompting a sharp rally in the euro.  Overall the energy complex continues to have an upward bias this week, no doubt in reaction to the pipeline closure, higher equities, and sharply weaker dollar which is down another 700 basis points this morning.

Overall the crude market remains extremely bullish as speculative money continues to fly into the nearby contract, flattening the curve which indicates increasing interest in oil today vs. the out-months (from the pipeline issues).  HO continues to lead the market however with the nearby breaching $2.62 this morning having risen over a dime in just the last two sessions alone.  Today we remain overbought and at risk of a substantial downside move, but now into our 4^th higher day with gains of better than a $1 in crude each session……….we’re not expecting that weakness to materialize anytime soon with all the aforementioned issues affecting the market.

Shouldn’t these investments have to stand on their own, without subsidies to compete in the marketplace?

http://online.wsj.com/article/SB10001424052702304772804575558400606672006.html

Bullish: Crude will move up due to quantitative easing (QE 2), which will depress the U.S. dollar and thereby increase the cost of commodities like oil.

Bearish: Inventory is comfortable, supply is ample relative to weak demand due to a weak economy.  Interesting though, is that one of the bearish cases for oil (shift away from heating oil to more natural gas), is a bullish pull for natural gas, as more natural gas is expected to replace petroleum based energy.

Here is a link to an article that expands on the bull and bear case for crude oil.

http://www.insidefutures.com/article/179618/Crude%20Oil:%20the%20Case%20for%20the%20Bulls,%20and%20the%20Bears.html

There has been a lot of talk in the news of Quantitative Easing (QE), which is is the unofficial description of the act of essentially printing money.  The Fed goes into the market place with “created money” and buys things like assets, treasuries, and say mortgages…….essentially acting as another buyer (think big investor) but usually the buyer of last resort.  They pay for that stuff with printed money or “hold it on their balance sheet” as a liability to be sold out again later.  They essential create demand where there isn’t in theory with money that isn’t there.  If what the Fed had on its balance sheet could never be sold back (currently roughly $2 Trillion), they would effectively have monetized it or “printed the money”.  They technically haven’t yet, but that’s only because there’s a belief they could one day sell these assets back to the open market or let their Treasuries mature and not buy more………it’s called sterilizing.  If they don’t sterilize they are directly monetizing debt which is highly inflationary…..more dollars in circulation chasing the same number of goods.  Ultimately it will take more dollars to own things and you have supply-side driven inflation.

We think it’s a mistake to do more QE and that our woes lie in the government policy sector, not the monetary policy sector.  We are at zero and deleveraging needs to happen.  I think inflation will do more harm than good because it won’t inflate growth and incomes (wages) just costs for things like oil and all our imports, further deteriorating buying power, reducing disposable income, and tightening consumer and business balance sheets even more.  We are a consumer nation………inflation is a net negative to us in our opinion.

Sentiment continues to improve with the better data out of China and less-bad data domestically from jobless claims to the trade balance.  NG continues to slowly rise, jumping above the $4 level in early trading this morning from the $4.62 low seen at the end of August.  Congesting now for a couple weeks near the lows from this spring, the market looks ready to move higher as it moves above the 18-day MA in its first 3-day rally since……well, the end of July (that’s how oversold we’ve become).  We are beginning to see more coal-to-gas switching which you would expect below $4/Dth, and that is likely to keep these values flat to higher heading into winter from here.  The first week of September marked the low last year, and we’ve probably already seen the low heading into the winter for this year…..we’ll see?  Overall I expect a weaker dollar and/or higher trade in equities today to continue to keep energies well supported heading into the DOE report tomorrow.

Another dose of reality, Morgan Stanley last week dropped a “bomb” on some by indicating that investors in U.S. Government bonds will face inevitable defaults due to an aging population and increased difficulty in securing tax revenues in their latest research paper.  While our government debt to GDP in only 53%, our debt to government revenues is 358%, one of the highest levels in the world.  For Morgan Stanley, the question is only which debts do they default on and which do they not, adding that the sovereign debts crisis is global and not over yet.  With defaults inevitable and the U.S. likely on that list, the risk remains that growing concerns over our ability to service debt will begin to force yields up as they have in Europe, adding more pressure to an already fragile economy and forcing a reduction in debt financing that will force us to balance our deficit at a minimum which is currently at 9% this year (government tax revenue below its spending) at over $1.3 Trillion.  The government is just an extension of our wallets at the end of the day, and if they run up a bill that can’t be refinanced and otherwise “comes due” in the next few years, the economy and the consumer will be the one coming up with those funds and one can imagine what that will do the economy…”inevitable defaults.”       

We continue to see selling as investors move toward safe-havens or prepare to take profits for month/quarter-end.  Sentiment has shifted negative on the economy and we expect lower energy trade to prevail in the next week or so.  There appears to be a tri-fecta of bearish influences in fundamentals, technical, and macro-economic influences and that usually leads to, in this case decidedly lower prices.

It’s important to remember to view the longer term picture through the day-to-day market “noise.”  Short-term things look bearish due to poor economic recovery.  If/when the economy takes root, the energy markets will turn with it, thus the importance of long-term hedge thinking/program.

To what extent will energy prices be effected by the Chinese government’s move to let the yuan appreciate against the world’s currencies?  This move by the Chinese is giving that country more buying power which is helping equities there and abroad and raising the prospects for increased fuel demand implications.  It’s key to note that while the peg was floating, which ended two years ago, the energy complex put together its largest bull run in history as a “rising China” looked to increase fuel demand almost exponentially.  Given the 50% increase in car sales last year, the double-digit increase in oil demand YoY, and the idea of a China with more buying power down the road, the energy complex may once again be pricing in massive Asian demand growth that may overshadow weaker readings from the world’s mature economies….a painful combination for U.S. consumers.  This is a significant market impact as China remains one of the few legitimately bullish factors for energy prices today.