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Expert Analysis: A Long Road Ahead For OPEC

OPEC

• WTI rallied to a weekly high of $48.32 mid-day Thursday following OPEC’s announcement that it will agree to limit production to between 32.5m bpd and 33m bpd at their November meeting. While the signal of cooperation between members with dire finances and opposing involvement in violent conflicts in the Middle East and North Africa was a rightful bullish jolt to oil, the real heavy lifting of devising a plan of shared sacrifice between ideological opponents at time of extreme fiscal stress still lies ahead. By Thursday afternoon WTI’s rally had cooled somewhat with futures trading near $47.70 and the market already had a signal that cooperative cuts would be difficult to achieve as Iraqi leadership very publicly questioned the use of secondary source output estimates in determining output quotas.

• Saudi Arabia’s willingness to consider pausing its market share strategy clearly adds upside risk to the market and could help accelerate the physical market rebalance in 2017. In the short term, however, we see challenges associated with an OPEC-driven rally and believe that the range bound price action in the oil market will persist.

• We continue to see a $42-$50 range for WTI despite this week’s unexpectedly bullish event and believe that market sentiment could sour as the upper limit of our forecast is tested due to the following-

1- We think the market will question the likelihood of the proposed deal being executed and also come to an understanding that a 32.5m bpd -33.0m bpd cap would do little to accelerate supply/demand balance for at least 3-4 months

2- Trading flows still reveal bearish sentiment with ‘wingy’ call options trading at an implied volume discount to 50 delta strikes while COT data for last week showed the largest addition to ICE Brent and NYMEX WTI fund shorts in more than two years

3- 1-month brent spreads still have at least 30 cents contango through June ’17 suggesting that increased output from Nigeria, Libya and Iran during refiner turnarounds could soften an already oversupplied market

4- Crude oil over the $50 mark will shift focus back to the resilient, above-forecast U.S. production story where rigs have increased in twelve of the last thirteen weeks and producers are aggressively hedging output

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OPEC flattens Cal ’17 curve, prompt spreads still see too much oil

U.S. fundamental data showed a continuation of familiar trends this week as Cushing stocks fell (to 10 month lows) the rig count increased for the 12th time in 13 weeks and U.S. output continued to moderate near 8.5m bpd. The WTI Calendar ’17 WTI swap traded near $51/bbl and Cal ’18 rallied to $53. Our expectation is 2H’17 and Cal ’18 levels will invite more hedging into the market. COT NYMEX WTI producer shorts fell by 19k w/w and are within 3 percent of their all-time high.

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WTI 1-2 moved lower this week and traded -0.59 Thursday afternoon after peaking near -0.52 last week. Further back in the curve WTI Z16/Z17 strengthened towards the -4.00 mark which was faded by trade groups and hedge funds via WTI CSO Cal ’17 -50 puts on Thursday.

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In brent the 1-2 spread continued to weaken due to export gains in Libya and Nigeria. Nigeria’s October loading program is expected to provide the market with 2m bpd of exports (an improvement of about 600k bpd in less than six months) and Libya’s port Zueitina is set to receive a tanker for loading on October 3rd after an extended force majeure. By Thursday afternoon Brent X16/Z16 traded at -0.59 for a 21-cent loss on the month. Further back in the curve Brent M17/Z17 strengthened to to -1.25 for a rally of about 40-cents from its September low. In our opinion the reaction of brent spreads to OPEC’s announcement implied a base case of a modest impact on supply/demand balances in the coming year. Calendar 2017 brent spreads were certainly tighter on Wednesday and Thursday but still well short of their June peak when unplanned outtages in Nigeria, Libya and Canada removed more than 1.5m bpd of supply from the market. Related: Is The EIA Wrong On Texas Oil Production?

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Volatility higher, but the skew remains the same

WTI Z16 at-the-money options traded above 40 percent this week for a w/w jump of about 2 percent. As of Wednesday afternoon WTI Z16 50 delta options priced at 40.6 percent, 25 delta puts implied 43 percent volatility and 25 delta call options implied 39 percent volume. In keeping with recent themes even 10 delta calls (39.5 percent) priced below 50 delta options revealing a continued lack of demand for upside risk despite the on goings at OPEC. Realized volatility (20 day basis) jumped to 47 percent on Monday for its highest level since July and made options implying ~40 percent volume seem inexpensive. The CBOE/NYMEX WTI volatility index also reached its highest point since July at 44 percent on Monday but sold off to 41 percent later in the week after the OPEC rally faded.

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Funds turned sharply bearish pre-OPEC

The week ending September 20th saw total speculative net length between ICE Brent and NYMEX WTI cut by 18 percent representing the largest w/w decline since at least January 2015. In WTI, net length fell by 54k contracts due to an addition of 50k cotnracts to the gross short position. In ICE Brent net length dropped 47k contracts with help from a 15k addition to gross shorts.

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In refined product markets managed money was a net buyer of RBOB by 1,500 contracts bringing net length to just under 22k contracts. In heating oil speculators flipped to a net short position of 2k contracts after holding a net long of 22k contracts just five weeks ago. As for real money the USO sawnet inflows for a fourth consecutive week and the $71m w/w addition has brought the total buying spree to $250m.

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DOEs show more rebalance progress

• Stats highlighted by overall crude oil draw, drop in Cushing stocks to their lowest level since December ’15 and a sharp decline in refiner demand

• Refiner demand still has a long way to drop if it is to fall in line with last year’s turnaround season

• U.S. crude production in the lower 48 states by 5k bpd

Crude oil inventories fell 1.9m bbls w/w and are higher y/y by 10 percent. PADDs I, II and III fell by 3.3m bbls, 366k bbls and 664k bbls, respectively. Inventories in the Cushing hub dropped by 631k bbls to 62m bbls, their lowest level since December ’15. Imports fell sharply- by 474k bpd- due to declines in PADD II and PADD V. Overall imports at 7.8m bpd are higher y/y by 7 percent. PADD II imports at 2.4m bpd are higher y/y by 5 percent and PADD III imports at 3m bpd are higher y/y by 6 percent. Crude oil production fell just below 8.5m bpd. Output in the lower 48 states is lower y/y by 7 percent.

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U.S. refiner demand fell sharply (in line with seasonal norms) w/w dropping 253k bpd. Overall inputs stand at 16.3m bpd and are higher y/y by 2.8 percent. Last year’s peak-to-trough cycle in refiner inputs saw overall demand fall 1.8m bpd. So far inputs have only dropped by 600k bpd from their peak near 16.9m bpd. Crack margins strengthened this week with help from lower run rates with WTI 321 and gasoil brent near $14/bbl and $10/bbl, respectively.

U.S. gasoline demand suffered an extremely steep w/w drop which was essentially noise due to the Colonial outage which prevented service in large swaths of the Southeast. PADD IB inventories fell by 220k bbls and are now at a y/y deficit. Overall mogas stocks added 2m bbls (mostly due to PADD III) and are higher y/y by 2.3 percent. PADD I stocks are now lower y/y by 6.6 percent and PADD III stocks are higher y/y by 10 percent.

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Gasoline futures were stronger this week from a Monday low near $1.27/gl to a Wednesday peak of $1.48/gl. Time spreads continue to moderate following Colonial-related gains but clearly remain in a technically strong pattern. RBOB Z16/H17 trade nmear -3.10 cpg on Thursday and is stronger by nearly 2 cpg since early August.

Related: Oil Tax To Increase Amid Low Crude Prices

U.S. distillate inventories fell by 1.9m bbls and are higher y/y by 7.6 percent. PADD IB inventories added 317k bbls (+11 percent y/y,) PADD II stocks fell 406k bbls (+1.9 percent y/y) and PADD III inventories dropped 919k bbls and are higher y/y by 2.8 percent. Distillate production at 4.7m bpd is lower y/y by 6 percent over the last month. Domestic distillate demand is roughly flat y/y at 3.8m bpd while exports at 1.4m bpd are higher y/y by 1 percent.

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Heating oil moved sharply higher this week from lows near $1.40 /gl to a high of $1.50/gl on Thursday. Futures have found ample support on the $1.40/gl area and are stronger by about 25 cents since early August. In spread markets Z16H17 climbed to its highest level since June on Thursday near -2.70 cpg.

Gasoil spreads continued to tighten this week as inventories broadly have gone deeper into y/y deficits in Singapore and Amsterdam-Rotterdam- Antwerp. Gasoil Z16/H17 traded as high as -9$/t on Thursday for its highest level in a about three months. As for inventories, Singapore’s distillate stocks fell more than 4m bbls w/w and are lower y/y by 8 percent. ARA gasoil stockpiles increased slightly w/w but are lower y/y by about 10 percent. y/y by

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By SCS Commodities

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