Inventory Drop Supports Oil Rally

A bigger-than-expected drop in crude oil inventories and the seasonal uptick in gasoline demand is helping sustain the spectacular rally in crude oil prices that has pushed the commodity to a new high for the year.

While an improving economic outlook and favorable currency moves account for the bulk of the commodity's gains, recent moves on the inventory front have also been helpful. Crude oil stockpiles, still at multi-year highs, have been steadily coming down over the last few weeks. Including today's report from the Energy Information Administration (EIA), crude oil inventories have dropped in four of the last five weeks.

We continue to believe that there are good fundamental underpinnings for the ongoing oil rally. We continue to favor early-cycle leverage through oilfield service names, such as Weatherford (WFT - Analyst Report) and Ensco (ESV - Analyst Report). Our long-term favorites remain Exxon (XOM - Analyst Report), Schlumberger (SLB - Analyst Report) and Diamond Offshore (DO - Analyst Report).

The EIA reported a greater-than-expected 4.4 million barrels drop in crude oil inventories. Current crude oil stocks are 19.9% above the year-earlier level and remain above the upper limit of the average for this time of the year. Driving the drawdown was a drop in crude oil imports, partly offset by reduced refining utilization (85.9% vs. 86.3%).

Gasoline inventories dropped 1.6 million barrels from the previous week, bringing stockpiles roughly inline with year-earlier levels, but below the average range for this time of the year. Given the strong seasonal component of gasoline's consumption, the current tight inventory picture is expected to continue putting upward pressure on prices through the summer.

Notwithstanding the seasonal uptick in gasoline demand, the overall demand picture  remains very weak. Total refined products supplied over the last four-week period, a proxy for overall petroleum demand, was down 6.9% from the year-earlier period, with gasoline up 0.4%, distillates (includes diesel) down 8.4%, and jet fuel down 14.3%. Gasoline's improving demand picture is mostly due to easy comparisons -- demand last summer was hit hard by $4+ dollar gasoline.

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