Our last report suggested that crude at US60.00 then US70.00 would be on “borrowed time”. We went short the market at US67.00. So...

... far this predication has been holding with crude trading to a low of US56.00. However, in the wake of milder forecasts for the northern hemisphere winter we have seen a long market square up and investor’s and fund managers book profits for the year end bonus pool. Just prior to the commencement of the cooler months of the year it is a good opportunity to take stock of the current price drivers and then proceed with an outlook that sees us into the first quarter of next year.

As mentioned in our previous report it is accepted that the driving forces behind the recent surge have been as a consequence of supply concerns from the Gulf of Mexico, Chinese revaluation of their currency, Terrorism threats, and economic demand from the two largest consumers, China and the US. In this report we will touch on these aspects then focus on the weather as a major driver for the next two months. We culminate with the view that the fundamental picture for Crude remains conciliatory in a bull market. We see good support at current levels for a test back in to the mid US60.00s then see a final leg lower before the up trend resumes.

So what has changed?

Economic growth in China and a revaluation. On the revaluation front we continue to see support from the US for a strengthening in the Reminbi. The pressure will continue as long as China has a trade surplus with them. One interesting aspect to the revaluation is the potential pick up in purchasing power that China will have as a result of the strengthening currency. This only adds weight to the demand side of the equation for China especially when we see China maintaining their economic growth rates.

As witnessed over the last two years the Chinese economy has a lot to catch up on. Recent first hand experiences suggest that the economy can continue to steam on. Although, China is the “catch cry” for many economists concerning the commodity cycle we cannot see them letting up. China is on a mission. Expected growth rates remain higher than western and other developing economies at between 8 and 9% per annum. Averaging 9% requires an awful lot of energy and oil is a primary commodity for economic activity. Although, we can expect a limited slow down in economic activity during the colder months of the year, come the New Year a similar demand cycle to the one we experienced this year would be expected.

What about growth in US?

Economic conditions remain mixed in the US. Data continues to suggest that monetary policy has been set at a level that hopefully keeps inflation in check whilst keeping demand relatively solid. The FED only recently has become neutral concerning interest rates, which have been increased to stave off inflation. This begs the question that the higher prices of crude perhaps has not been all that inflationary for the economy. The Feds latest comments concerning monetary policy could be construed as igniting the possibilities of ebbing towards an economic slowdown or perhaps even a deflationary period. If economic demand remains steady then demand for oil should remain constant. Keep an eye on new housing starts in the US, as this will give us a signal to potential easing in economic growth. We view the demand cycle for crude in the US to be constant with economic growth, which we see as moderating into the first quarter.

So what about terrorism?

Acts of terrorism have been confined to western economies. Supply from regions in the Middle East remains supportive and we would expect this to continue. We have had at least twelve months worth of rebuilding in Iraq and we expect to see interruptions at a minium. Any major disruptions caused by acts of terrorism would be seen as outside the norm over the next quarter. So given we expect to see limited acts of terror from the middle east resulting in increased production and more moderate demand from major economies what potentially will be the wild card for a price increase?

Adverse weather conditions remain the wildcard.

Adverse weather conditions have primarily been responsible for the move through to US70.00. Weather conditions in the Gulf of Mexico have subsided with the Hurricane season ending, however market players are know tuned to any news concerning weather, in particularly news concerning potential cold snaps. Due to the unusually strong Hurricane season in the US the US Government has had to sell parts of its Strategic Petroleum Reserves (SPR) to local refiners (see chart). As a consequence we have seen a large draw down in US reserves as the market has come off. At the moment we are seeing the US SPR slowly pick up and if the previous trend remains intact then we should, not only see reserves replenished, put also prices firm. Any adverse weather conditions over winter in the US will only add to this need to top up reserves. Only recently we have had an early unseasonal cold blitz in Europe. We would have to be kidding ourselves if we thought weather conditions would be stable during this winter.





We believe the Oil market is fully focused on the weather aspect. As the market is nervous towards this issue we can expect to see prices gravitate to the higher end giving any prolonged periods of cold weather.

Does the technical picture add support to our view?

Technically, we have seen an impulsive move from the low US56.00 as long as this level holds then we can see prices retracing the move from US55.72 to US70.85. We need to see US59.00 cleared to confirm the move higher. Momentum indicators on both a daily and weekly basis also support this move. Once this is broken we can expect to see the market move back to US64.70 then US70.85. Until US70.85 is broken we can only assume that we have a confirmed range.



Overall we see Crude remaining firm during the winter period. Once spring hits we should see some consolidation as the market gears up for 2006. We are happy being long at current levels with stops in at US55.70



Jonathan Barratt BEc| Head of FX and Metals | Tricom FX & Metals
Ph +61 2 8274 6121
Ph 1300 732 288
Fax +61 2 9251 6331
jonathan.barratt@tricom.com.au
http://www.tricom.com.au/