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Expert Commentary: Oil Rallies For Now, But Can OPEC Keep Its Promise?

Oman well

• OPEC exceeded the market’s expectations this week by creating a plausible deal to reduce output to 32.5m bpd with broad participation (10 members will cut, Libya and Nigeria are exempt from cuts while Iran can grow output by 90k bpd to 3.8m bpd) within the group in addition to help from Russia. Whether or not the group sticks to their plan to reduce supply remains to be seen, but for now OPEC has succeeded in 1- increasing the floor for spot oil prices and avoiding another painful, FX reserve burning trip into the low $40s, 2- protecting their ability to talk prices higher and 3- bringing time spreads closer to backwardation with the market seeing an accelerated rebalance. Following WTI’s rally from $45.25 on Tuesday to just shy of $52 on Thursday we are maintaining our medium term oil outlook of $47-$55 WTI continuing to see major barriers of support and resistance in the market.

• As for resistance, the market will remain skeptical that OPEC members will stick to the 32.5m bpd plan until real evidence of supply cuts is produced and there will be no real evidence in 2016. The cuts for all ten countries making reductions represent serious revenue sacrifice at a time when budgets are highly strained and serious geopolitical tensions within the group remain. The second bearish factor guiding sentiment at current price levels will be more signs of life from high cost US producers in the form of hedging activity, increased rigs and of course higher US output which climbed to 8.699m bpd last week for its highest mark since June. High levels of existing supply evidenced by generous m1-m2 contango for WTI, Brent, RBOB, Heating Oil and Gasoil should also keep a lid on the current rally in coming weeks.

• In terms of market support we continue to believe that downside risk to flat price is limited by evidence of the market rebalance in 1- steady inventory draws on a global level in Gasoline, Heating Oil and Gasoil from June through October which brought product stocks from bloated to normal levels and in some cases y/y deficit 2- US crude inventories that are highly unlikely to match their May ’16 peak in their current seasonal climb (currently 24m bbls lower than May peak) 3- recoveries in global refining margins to normal seasonal levels after spending most of 2016 at massive y/y deficits and 4- adequate demand growth particularly in US gasoline. We also believe that bullish money flows could substantially increase in a market which is flipping into backwardation and rewarding passive length.

Spreads think OPEC is for real

OPEC’s agreement was met with a signficant amount of skepticism (deservedly) with traders now waiting to see if the cartel + non members actually perform on their agreement. Our base case at the moment is that the group will ultimately remove 500k - 1m bpd bpd from the market beginning in January therefore coming short of their stated goal but still accelerating the market rebalance. Time spreads are clearly of the mindset that OPEC’s deal will play a signficant role in bringing balance back to the market and pushing spreads into backwardation. The front of the WTI curve showed a relatively muted impact but the 1m-2m spread was still able to touch a weekly high of -84 cents after traded down to -1.01 late last week. The 2nd half of 2017 was where the real action was in spreads with WTI M17/Z17 trading up to flat on Thursday for the first time since 2014. Related: Russia To Cut From November’s 11.231 Million Bpd Output

Brent spreads had a similarly bullish reaction to the OPEC deal with the prompt m1-m2 spread rallying from a low of -95 cents on Nov 9th to over -60 on Thursday. Brent M17/Z17 traded up to -30 cents on Thursday for its highest print since June.

In diff markets the big mover of the week was obviously WTI-Brent which sank to new 2016 lows (-1.65 for the H7 contract) following OPEC’s cut announcement. Our assumption is the arb will find considerable support in the -2.00 area as it has throughout the era of US exports. In Texas the Midland diff rallied from +5 cents to +35 cents this week while Bakken – WTI was mostly flat near -2.90.

US producer data maintained its recent trends in the past week including 1- a relentless increase in the rig count 2- flat-to-higher production near the 8.6m bpd – 8.7m bpd mark and 3- high levels of producer shorts. The US crude oil rig count jumped by 3 rigs w/w to 474 and is higher by exactly 50% since its May low at 316. Production increased by 9k bpd w/w to 8.699m bpd (+271k bpd from July low) and producer/merchant shorts fell by about 36k contracts w/w to a still-elevated 588k contracts.

(Click to enlarge)

US producer data maintained its recent trends in the past week including 1- a relentless increase in the rig count 2- flat-to-higher production near the 8.6m bpd – 8.7m bpd mark and 3- high levels of producer shorts. The US crude oil rig count jumped by 3 rigs w/w to 474 and is higher by exactly 50% since its May low at 316. Production increased by 9k bpd w/w to 8.699m bpd (+271k bpd from July low) and producer/merchant shorts fell by about 36k contracts w/w to a still-elevated 588k contracts.  

Volatility plummets from 8-month high on OPEC rally

Crude oil options had their own Black Friday sale following OPEC’s deal that sent oil up more than $4 on the day. Front month volatility had jumped to nearly 55% on Tuesday heading into the announcement before falling back into the low 40% area on Wednesday as prompt brent jumped over the $51 mark. For WTI H17 50d volatility fell from 45% on Tuesday to 35% on Thursday while maintining a 7-vol premium to the put on 25 delta options. 

Funds held large short positions heading into rally

Recent COT data revealed that hedge funds had maintained significant bearish positions leading into Wednesday’s announcement which certainly lead to short covering and aided Wednesday’s +$4 rally. Net length in both NYMEX WTI and ICE Brent was unremarkable at 188k contracts and 292k contracts, respectively. This was largely due to a gross short in NYMEX WTI of 163k contracts (+107k contracts in the last four weeks) and a gross short in brent of 147k contracts (+95k in the last five weeks.) 

(Click to enlarge)

Refined product data was unremarkable among speculators with RBOB net length cut from 26k to 17k while heating oil went from a very small net short to a net long position of 3,300 contracts. Money flows into the USO were once again a harbinger of things to come in oil with four straight weeks of inflows totaling $636m for the period ending November 25th.

Weak DOE’s couldn’t slow the OPEC rally

• US crude stocks fell 884k bbls w/w but are higher y/y by 6.8%. Cushing stocks added 2.4m bbls jumping to 61.5m bbls.
• Refiner inputs failed to make their expected w/w jump and dropped to 16.28m bpd. Overall inputs are lower y/y by 1%. Gasoline demand also fell to from a market-leader to very average while distillate demand was extremely poor
• Distillate and gasoline data was also much more bearish than expected showing large overall builds alongside large builds in the PADD IB region.

US crude stocks gained nearly 1m bbls w/w and are now higher y/y by 6.8%. PADD I stocks drove this week’s decline with a 3.3m bbl draw on decreased imports while PADD II stocks added 3m bbls. PADD II stocks are now higher y/y by 4%. PADD III stocks are higher y/y by 11% following a 245k bbl draw and Cushing stocks reached their highest mark since mid September at 61.5m bbls following a 2.4m bbl build. An increase in imports into PADD III helped keep overall imports elevated at 7.55m bpd- higher by 5% y/y over the last four weeks. Related: Is This The Mastermind Behind The OPEC Deal?

US refiner demand took a disappointing turn this week falling 114k bpd to 16.28m bpd and defying their seasonally bullish trend. Overall inputs are currently lower y/y by 1% and it is important to note the sharp regional divergence with PADD I runs lower y/y by 4.5% while PADD II runs are higher y/y by 4.3% (PADD III runs are flat y/y.) Refining margins continue to grind towards seasonally normal levels with the WTI 321 crack near $14/bbl, gasoil/brent near $10/bbl, LLS 321 near $8/bbl and RBOB/Brent near $11.50/bbl.

(Click to enlarge)

Gasoline data was also disappointing this week and failed to continue recent trends of strong demand opposite tighter supplies. Overall stocks jumped 2m bbls and are now higher y/y by 4%. This included a 700k bbl jump in PADD IB stocks to their highest mark since September. PADD II stocks added 145k bbls (flat y/y) and PADD III stocks added 1.6m bbls (+8% y/y.) Domestic gasoline demand had a slight w/w decline to 9.1m bpd and is lower by 2.2% y/y over the last four weeks. Exports at 879k bpd are higher y/y by 43%. 

Gasoline futures jumped about 15-cents this week moving over $1.54/gl on Thursday morning for anearly 30-cent jump since mid November. Spread market also moved sharply higher with RBOB M17/Z17 printing +24 cents for the first time since June. 

We finish our roundup of weak EIA data with an overall w/w distillate build of nearly 5m bbls bringing overall stocks +7% y/y. PADD IB accounted for roughly 40% of the jump adding 2.1m bbls (+5.7% y/y) while PADD II added 300k bbls (+14% y/y) and PADD III added 2.7m bbls (+6.7% y/y.) Distillate exports + domestic demand dropped sharply to 4.68m bpd and is lower y/y by 2%. 

Prompt heating oil futures moved sharply higher this week despite the weak EIA data jumping over $1.63/gl on Thursday for the first time in 2016 and a 25-cent rally off of its November 14th low print. Spread markets also moved considerably higher with M17/Z17 heat moving above -5 cpg for the first time since June. 

Refined product data away from the US was also more bearish than expected- particularly for Singapore middle distillates. Gasoil stocks in the Amsterdam-Rotterdam-Antwerp hub jumped 89k mt but are still lower y/y by 21%. ARA fuel oil stocks decreased by 27k mt w/w and are lower y/y by 47%. In Singapore middle distillate inventories jumped by 1.2m bbls w/w and are now higher y/y by about 5% after trending steadily lower in the fall.

By SCS Commodities Corp.

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