For weeks we have been hearing that oil has been rallying on signs of economic recovery. If we got good economic news, then oil would rally. If the news was bad, well then oil would fall. Yet after one of the more surprising unemployment reports in recent memory, oil failed to join in the economic optimism.

On Friday the Labor Department reported a loss in non-farm payrolls jobs of 247,000 in July. The street had called for a loss of 320,000 job. At the same time the unemployment rate dropped to 9.4 percent from 9.5 percent in June while expectations were for an increase to 9.6 percent. Despite this good news and a strong stock-market rally oil traded lower. This disconnect between Friday's enthusiastic rally in stocks and the less than enthusiastic break in oil prices may signal a shift in what traders are going to focus on. Oil may now focus on the Fed and fears that they may start roll back some of the policies that drove oil to these levels in the first place.

You see oil has been a beneficiary of Fed policy. Oil's recent rally was manufactured in the backroom of the Federal Reserve. The Fed accommodative policies and its move to quantitative easing to save the economy from disaster created the oil price that we have today. Of course if the economy gets too good the Fed will have to start taking away some of the stimulus which will be very bearish for the price of oil. The Federal Reserve meets on Tuesday and Wednesday to discuss where we are in this economic crisis and whether or not they should send a signal to the marketplace that it's time to start cutting back on the punch before they take the entire bowl away. When they do then oil will become bearish, the dollar will firm and the market will focus on oil supply.

Kuwait News KUNA reports that core Gulf OPEC members are delivering over 90 percent of the oil supply curbs the cartel agreed last year according to a Kuwait oil official. 'Compliance is good, especially in Gulf countries where compliance exceeds 90 percent,' Nawal al-Fuzaia, Kuwait's national representative to OPEC, told KUNA. OPEC members Saudi Arabia, the United Arab Emirates, Kuwait and Qatar have been the most disciplined in the group in adhering to supply targets this year. Reuters says that OPEC agreed to cut supply by 4.2 million barrels per day, or around 5 percent of global demand, at the end of last year to match the impact of the recession on global demand. They said that top oil exporter Saudi Arabia went further than neighboring Gulf Arab states to pump below its target earlier this year in an effort to balance the crude market and prop up prices. The kingdom shouldered the biggest share of the group's cuts.

It was easier for the Saudis as their brand of heavy crude has not exactly been in high demand. Last week the Wall Street Journal reported that, 'U .S. refiners that turned to cheaper, dirtier crude oil in recent years in a bid to boost profits are seeing the strategy backfire as supplies of the oil dwindle. In past years, many of the nation's refiners invested in pricey equipment to process so-called heavy crude, a more viscous grade of oil that usually contains more contaminants such as sulfur and nickel. The heavy oil cost much less than more desirable, lighter crude, so refiners could boost profit margins by processing the cheaper oil. But in recent months, a barrel of heavy crude has been selling for nearly as much as a barrel of light crude.' 'That cost advantage has all but disappeared,' said Bill Day, a spokesman for Valero Corp., the nation's largest refiner.

The change in the heavy crude market is adding to the woes of U.S. refiners already hurt by feeble demand for gasoline and diesel as consumers and industry cut back in the recession. As fuel inventories pile up, refiners are also facing increasing competition from new, more cost-efficient refineries in Asia. Why has it become so expensive? The root causes lie in a combination of OPEC output cuts and refineries limiting their oil processing runs in response to the first global recession since the Second World War. OPEC has reduced its output target by a record 4.2 million barrels of crude per day in a series of cuts pledged since last September. Its members predominantly scaled back production of their heavier crude, since those normally fetch the lowest prices and are the most expensive to pump.

In the mean time the Fed may be the most important factor facing oil this week. We should see crude supply rise by one million barrels, gas supplies down by one million, distillates down by one million and runs fall by 0.5%.

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We're short Sept crude from apprx 7150 - stop 7390.

Stopped on short September heating oil from apprx 19700 at apprx 20000.

We're short September RBOB from apprx 20750 - lower stop to 20500!

Sell September natural gas at 470 - stop 480.

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