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Can U.S. Shale Survive Below $40?

As oil prices fall back…

SCS OTC Corp

SCS OTC Corp

SCS Commodities has been providing energy and agricultural brokerage services to institutional traders since 1991. As commodity derivatives have evolved from open outcry to electronic…

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Why The Huge Inventory Build Didn’t Crash Oil Prices

Crude oil tanker

- WTI snapped out of a two week coma on Wednesday trading to a low of $51.22 following an API report revealing a 14m bbl crude oil build which was later confirmed by EIA data. Technicians feared that a break below recent support near $51.50 and a spike in US crude stocks to within 3m bbls of their all-time high meant that oil’s ‘5 handle’ could be in jeopardy. A closer look at the data, however, brought relief to the market and a bounce back to the $53 mark with traders realizing that the second largest weekly crude oil build on record may not have been the fundamental disaster that the algorithmic traders had pounced on.

- Rather than signaling a renewed supply/demand apocalypse, the inventory build appears to be driven by trading flows revealed in three different trends occurring in PADD III where 11m of the 14m bbl build occurred. Firstly, imports into PADD III spiked to 3.97m bpd and are higher y/y by 19%. This trend is not surprising following a long stretch of LLS-Brent strength late in 2016 which invited more brent barrels into Houston. However, a reversal in this diff to brent-premium in January and February should limit import opportunities in the coming months. Secondly, more than 6m bbls appeared to have moved out of floating storage in the Houston area into inland tanks. Over the last 4-5 weeks Bloomberg estimates that USGC floating storage has dropped from 10.9m bbls to 4.3m bbls and appears to be merely a relocation of barrels as opposed to a signal of new supply congestion. Thirdly, US crude exports have slowed sharply in recent weeks from a peak of 727k bpd to just 567k bpd. We also expect this trend to reverse as WTI-Brent arbs have widened and offer profitable opportunities to export WTI to Asia. We’re pointing to the combination of these three arb driven trends- in addition to the tailwind of seasonal inventory builds- as the culprit for the large inventory build and do not believe that we’ve entered a new phase of abnormally bearish data.

- Looking forward our view is unchanged that WTI will shift into a $56-$61 range as the effects of OPEC production cuts move west and the market’s trend towards supply/demand deficit creates sharp global inventory drawdowns in the spring. 

Prompt WTI strength catches traders off guard

The front WTI 1-month spreads performed extremely well in the second half of the week and by Thursday’s close the WTI m1-m4 spread had rallied about $1 since January 10th. In trying to make sense of the rally traders cited optimism that dissipating imports and OPEC production cuts will take pressure off of Cushing in coming weeks. Short covering was also a major factor in the spread’s strength with large positions caught wrong-footed as WTI m1-m2 managed an 11-cent rally to just 45 cents contango despite there being more than 65m bbls currently stored in Cushing. Further back in the curve WTI M17/Z17 was relatively tame moving in a -80 to -100 range before settling -92 on Thursday.

News flow from OPEC producers regarding production cuts (and production gains from Nigeria and Libya) was limited this week making way for sideways trading in brent spreads. In the front of the curve the Brent m1-m3 spread sold off from a weekly peak of -50 on Wednesday to a close of -69 on Thursday partially due to profit taking after an extended rally. In 2h17 the Brent M17/Z17 spread was basically flat for most of the week near -40 and Dated First Line vs. the 1-Month brent was steady near -84 cents.

(Click to enlarge)

US producers keep pedal on the metal

US producers were busy last week starting with a w/w increase in output of 63k bpd. US production at 8.98m bpd represents a 550k bpd improvement from its low mark last July. Meanwhile the US crude oil rig count jumped to 583 last week for an 84% jump since May. As for hedging, producers / merchants brought their gross short in NYMEX WTI to a new record high at 703k contracts. Given the combination of the rig count and hedging activity it seems the US output recovery is unlikely to wither in the near future.

Funds stay positive on oil

COT data for the week ended Jan 31 showed hedge funds as net buyers of NYMEX WTI for a fourth consecutive week and in ICE Brent for a third straight week. In NYMEX WTI funds added 8k contracts in net length w/w to bring their position to +380k for an all time high. In ICE Brent funds were net buyers of 25k contracts which brought their total to 473k contracts- within shouting distance of its all time high reached in December at 478k. A key contributor to the amount of length in the market is the lack enthusiasm from bearish speculators who continue to hold gross short positions of about 45k contracts in both NYMEX WTI and ICE Brent. Related: Nigeria Rescues Oil Tanker From High-Seas Pirates

Product flows, on the other hand, were bearish with funds selling a total of 5k contracts in gasoline w/w while also selling 2k Heating Oil contracts. In ETFs investors sold the USO to the tune of $15 million for the week ended February 3rd. The fund has experienced net outflows of $944 million since late November.

Options tic lower on range bound trading

WTI implied volatility moved slightly lower this week as range bound trading persisted and sent realized volatility down to just 24% for an 8-month low. By Thursday morning WTI J17 at-the-money vol priced near 27% while 25 delta puts implied 29% vol and 25 delta calls implied 26% vol. There was a slightly change in the skew compared to recent weeks as downside risk priced slightly cheaper and the heavy put-skew flattened out somewhat. FX was also a bearish influence on volatility with EUR/USD vol sinking below 8%.

(Click to enlarge)

PADD III leads second highest w/w crude build on record

• Crude oil inventories added 13.9m bbls w/w (surpassed only by a 14.4m bbl build in October of last year) due to a 10.9m bbl build in PADD III

• PADD III build was result of decreased exports, increased imports and barrels moving from floating storage to inland tanks

• Gasoline draw of more than 850k bbls was much more bullish than expected and took pressure off the market

US crude stocks jumped by 13.8m bbls w/w, are higher y/y by 8% and within just 3m bbls off their all-time peak reached last April. Inventories ballooned on a combination of 1- extremely high PADD III imports (which are higher y/y by 19% following an increase to 3.9m bpd last week,) 2- falling exports which were below 600k bpd for a second straight week and 3- movement of barrels from floating storage to inland tanks as USGC floating storage has decline from more than 10m bbls to less than 5m bbls over the last three weeks. Further north, stocks in the Cushing hub increased by 1.1m bbls and currently stand at 65.3m bbls.

US refiner inputs fell in line with seasonal expectations to (by 54k bpd w/w) to 15.9m bpd and are higher y/y by 2.2% over the last month. Regionally, PADD I remains as the major regional laggard with inputs on the east coast lower y/y by 6%. PADD III inputs are higher y/y by 5%. As for margins, the WTI 321 crack is roughly flat y/y trading near $14/bbl this week while gasoil/brent traded just over $11/bbl. On The east coast a rally in the 2q17 RBOB/Brent swamp to $18/bbl could improve PADD I demand in coming months. Related: Is $55 Oil Really Enough For Qatar?

US refiner inputs fell in line with seasonal expectations to (by 54k bpd w/w) to 15.9m bpd and are higher y/y by 2.2% over the last month. Regionally, PADD I remains as the major regional laggard with inputs on the east coast lower y/y by 6%. PADD III inputs are higher y/y by 5%. As for margins, the WTI 321 crack is roughly flat y/y trading near $14/bbl this week while gasoil/brent traded just over $11/bbl. On The east coast a rally in the 2q17 RBOB/Brent swamp to $18/bbl could improve PADD I demand in coming months.

US gasoline stats reported a surprise 869k bbl draw with help from a surge in domestic demand by 600k bpd to 8.94m bpd. PADD III stocks lead the decline with a w/w draw of 2m bbls and are now slightly lower y/y over the last four weeks. Overall inventories are flat y/y. Unfortunately PADD IB added 415k bbls to its already record-high pile of inventories bringing gasoline stocks in the mid Atlantic to a y/y surplus of 14% over the last month. Domestic demand improved sharply w/w but is still lower y/y by 2%. Exports at 900k bpd are higher y/y by 96%.

Gasoline futures were highly erratic this week moving to a 2.5 month low on Tuesday at $1.465/gl following the bearish API report before rallying back over $1.57/gl on Thursday. Spread markets were similarly volatile as M17/Z17 RBOB sank to +24 cpg on Wednesday before moving to +25.75 cpg on Thursday.

US distillate stocks were also more bullish than expected with a modest w/w build of just 30k bbls. Overall distillate inventories are higher y/y by 6% over the last four weeks. In the mid Atlantic PADD IB stocks fell by 665k bbls but remain bearishly +8.6% y/y. In the USGC distillate stocks are +3% y/y. As for demand, domestic consumption remained strong at 3.9m bpd (+24% y/y over last month) while exports at 1.1m bpd are lower y/y by 10%.

(Click to enlarge)

Heating oil futures followed crude oil and gasoline sharply lower through Wednesday morning bottoming at $1.6028/gl before rallying sharply to over $1.6600/gl on Thursday. In spread markets HO M17/Z17 was also somewhat dull this week trading between -5 cpg and -6 cpg.

Overseas product markets headed in different directions this week with ARA gasoil stocks enjoying a steep draw while Singapore distillate stocks jumped by more than 4.5m bbls. In Europe, gasoil stocks have averaged 3.2k mt over the last four weeks for a y/y decline of 8.6%. In Singapore distillate stocks are higher y/y by 3% after this week’s massive build. Gasoil spreads in 2h17 were basically unchanged for a second straight week with the M17/Z17 spread trading -9$/t.

By SCS Commodities Corp.

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Leave a comment
  • Brett Ingham on February 10 2017 said:
    This is really good information. I hope to see more of this on oilprice.com.
  • carlos Vinicius on February 15 2017 said:
    Bloomberg estimates that USGC floating storage has dropped from 10.9m bbls to 4.3m bbls and appears to be merely a relocation of barrels as opposed to a signal of new supply congestion.

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