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Jim Hyerczyk

Jim Hyerczyk

Fundamental and technical analyst with 30 years experience.

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Strong Demand For Gasoline Shifts Momentum To Upside

April Unleaded Gasoline surged this week, indicating that prices may have reached an important low. The trend is still down, however, momentum has shifted to the upside.

“We are in mid-February , and 45 out of 50 states have a gas average below $2 per gallon, said Jeff Pelton, a GasBuddy.com petroleum analyst. “Sadly, these incredibly low gas prices won’t be here forever, as refineries talk of production cuts.”

The recent price action in the futures market seems to be suggesting the same.

A gasoline glut has pushed prices down, with inventories in the Midwest reaching their highest level in 23 years. Cheap crude and high output from refineries has helped create huge inventories in the region, but this may be coming to an end if the seasonal factors start to gain control.

With crude oil prices showing signs of forming a support base, gasoline prices may be ready to take off to the upside because of seasonal demand and expected reductions in refinery production.

This week, the U.S. Energy Information Administration reported a 3.5 million barrel increase in crude oil supplies for the week ended February 17. This was slightly above the estimate, but well below the American Petroleum Institute’s 7.1 million barrel increase reported for the same time period on February 23.

In the U.S. however, total production fell by 33,000 to 9.1 million barrels a day last week, the EIA report said. According to the data, output has fallen by more than 130,000 barrels a day over the last four weeks and at that rate, the annualized rate of reduction would be at over 1 million barrels a day.

The news about the drop in total production may have underpinned crude oil prices this week, but the size of the total supply may have put a lid on any rallies. Since crude oil is in a position to close higher for the week, we have to conclude that the main trend is down, however, momentum is pointing up. This is helping to produce the choppy two-sided trade.

Comments by Saudi Arabia and Iran also helped limit price gains. The Saudi’s said they would not cut production. Iran called the proposal to freeze output at January production levels a “joke”. In the meantime, Venezuela and Qatar along with Russia and the Saudi’s will continue to try to hammer out the details of some kind of agreement.

At this time, volatility traders are probably the biggest winners with crude prices seemingly swinging 2 percent to 5 percent in either direction on a daily basis. For those expecting the selling in crude oil to end in a whimper and with a “V” bottom, the price action may be a little overwhelming.

But major bottoms take time to form so investors are going to have to put up with the numerous stops and starts while the support base is being formed. According to recent data from the Commodity Futures Trading Commission, there are a lot of shorts in the market that need to be convinced that the low is in. Until they start to cover, we have to expect the sideways price action.

We are basically in the beginning of a transition period where traders and investors are trying to balance current record crude supply against signs that demand is rising and supply may soon be falling. Since everyone seems to be focusing on supply, let’s take a look at where demand could come from.

The EIA data showed that gasoline supplies fell 2.2 million barrels, while distillate stockpiles declined by 1.7 million barrels last week. Over the last four weeks, implied demand for gasoline was up 5.2 percent from the same time last year.

In order to build a bullish case for crude oil, we have to look beyond the headline numbers. The internals of the EIA report offer the best evidence that we may have reached a short-term bottom.

Firstly, U.S. production has fallen by more than 130,000 barrels a day over the last four weeks. Secondly, implied demand for gasoline was up 5.2 percent from the same time last year. These are two potentially bullish factors. In order to trigger a more pronounced move in the crude oil market then we are going to have to see a more dramatic shift in gasoline demand. If we can get a 7.5 percent to 10 percent increase in gasoline demand this year during the peak driving season then this would translate into a 500,000 to 750,000 barrel a day increase in gasoline demand.

(Click to enlarge)

echnically, the main trend is down on the weekly chart, however, momentum has shifted to the upside with the formation of a new main bottom at 1.1253 from the week-ending February 12.

The main range is 1.5695 to 1.253. Its retracement zone at 1.1374 to 1.3998 is the primary upside target. A downtrending angle at 1.3695 falls inside this zone, making it a valid target.

If the upside momentum continues next week then look for the rally to extend into at least 1.3474 and perhaps into the loose resistance cluster at 1.3695 to 1.3998.

Since the main trend is down, sellers are likely to show up on a test of this resistance zone. They are going to try to produce a potentially bearish secondary lower top. Bullish traders are going to try to drive prices through this zone. Traders should look for increased volatility and volume inside the retracement zone.

If U.S. production continues to weaken and gasoline demand continues to trend higher then eventually buyers will grind through this area and go after some major tops. At this time, the market is still going through the bottoming process so don’t be surprised by a choppy, two-sided trade over the near-term.

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