Morning Petrospective – November 22, 2010       

he oil complex was slightly lower on Friday, with traders and investors locking onto Chinese monetary tightening as the biggest single factor. Thursday’s activity had centered on Ireland and the likelihood of steps being taken (by the EU) to bring its debt back from the brink. The first steps seemed to address the urgency of the problems immediately confronting Dublin, and investors were buying the euro and selling the US dollar on Thursday, because of those first steps. The weaker US dollar, in its turn, had a bracing effect on oil prices, which were stronger, as a result. On Friday morning, the dollar rallied, and it kept going until a little after 11 AM. Prices sold off again from then through the afternoon.

The US dollar weakened through the last couple of days, selling off from around 11 PM on Thursday night, from 73.40 euro cents, until just before 7 AM EST Friday morning, at which point it had dropped to around 72.80. The dollar rallied against the euro, getting back to 73.30, until a little after 11 AM, but it sold back to around 73.00, giving back more than half of its late morning gains by 4 PM. The bottom line here was that the dollar had weakened enough on Thursday evening and into Friday’s early morning for oil prices to react.

Friday morning’s opening was determined by the weakness seen Friday morning in the dollar. But, the tone of the conversation shifted from Thursday, when Ireland was the central topic, to Friday, when investors were talking about China’s central bank and reserve requirements. On Friday, China increased banks’ reserve requirements by raising the ratio of reserves required to make loans by half a percentage point.

For every dollar held in a bank’s deposits, the institution is allowed to loan a certain multiple of those deposits. If a bank can lend 20 dollars for each one held, that is a reserve requirement of 5%. China effectively cut the amount that Chinese banks can lend by raising the reserve requirement. The intention is to cut down the amount of money in circulation, which should, theoretically, cut the amount chasing goods and services, thereby cutting inflation or weakening inflationary pressures … slightly.

Increasing the amount needed to be held in reserve against each loan is a less dramatic and less effective way of cutting inflation than raising interest rates. This move just cuts the amounts being loaned, without raising the cost of those loans, which would hurt businesses, especially those competing internationally.

For the week as a whole, crude oil prices dropped $3.37 a barrel, heating oil prices dropped 8.88 cents per gallon and gasoline prices dropped 1.31 cents a gallon. Natural gas was up 37.4 cents per million Btu. The losses would have been much larger if it had not been for Thursday’s steep rally.

The simple fact is this: Now that China has raised reserve requirements, that factor has been discounted. It is unlikely to raise that again for a month, at the soonest. But the reserve requirement “is the equivalent to withdrawal of RMB350 billion,” according to Capital Economics, and it says its impact is unclear and that “another interest rate move is only a matter of time now that the government has clearly made the taming of inflation its top priority.” So, more Chinese tightening is coming, just probably not this next week. In the meantime, investors will shift their attention to any resolution of the euro-zone debt situation, starting with Ireland.

And we still think that QE2 has plenty of mileage left in its tanks. It has gone through the pre-announcement buy-in period, which was made all that much easier by the Fed’s thoroughly transparent habit of telegraphing its every move, it then went through the “sell-the-fact” reaction, when investors reacted once it was made official. Now, we are likely to go through the long, slow period of reacting to the drawn-out process of actually implementing the program. That should be bullish.

     FMX Newswire       

FMX Newswire is an overnight news summary designed to meet the needs of professional energy traders. The content is to-the point, professional grade and not widely reported in the mainstream media. All sources are professional respected firms and newspapers.

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