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Expert Commentary: How Much Further Can Oil Prices Fall?

Cushing oil storage

- The majority of recent oil market coverage has focused on bearish flies in the physical rebalance ointment including elevated OECD crude + refined product stocks and higher than forecast US production. We’ve also covered these developments and pointed to weak Midland-WTI, weak DFL Brent and weak Brent and refined product spreads illustrating some of the fundamental challenges that oil bulls face. However, we are increasingly pointing towards a different culprit for oil’s inability to punch through the mid $50s- the slowdown in the global macro reflation trade.

- Over the last six weeks markets have seen a distinct reduction in bullish enthusiasm and risk appetite due to 1- geopolitical risk in the form of conflict in Syria, potential conflict with North Korea and a previously establishment-leaning French election whose outcome is now murky (sound familiar?) 2- EM growth concerns concentrated on China and 3- policy setbacks for the US Republican party in pursuit of a low tax and deregulation agenda. The effects of these trends has been clear in markets with Copper, USD/JPY (among other risk on/off FX thermometers) and the US 10yr yield all making 2017-lows this week while S&Ps continued to move sideways and gold notched a YTD high. There is a risk-off tone governing markets at the moment and oil has not been immune. We credit this macro slowdown- rather than fundamental developments- for this week’s fatigue in oil.

- Despite the headwinds from a risk-off macro environment our view of oil remains positive. We see progress from current OPEC production cuts in moving the market towards balance and believe that the deal will be extended in May as inventories remain bloated and the Saudi’s push to maintain a floor in oil prices as a matter of pre-IPO national security. On the macro front it’s also important to note that the global growth outlook from government economic agencies, sell side financial institutions and central banks remains broadly bullish despite the aforementioned challenges. We could also easily see a reversal in the flight to safety trends if the French elections move to the center and rhetoric on Syria and N. Korea cools.

- As for oil economics the IEA continues to see decent growth of 1.3m bpd in 2017 while arguing that the supply/demand balance will dip into deficit in 2Q17. Over the last six weeks US refiner inputs, gasoline demand and distillate demand are higher y/y by 2.1%, 1.1% and 8.6% respectively which also contrasts the growth concerns implied by a depressed bond yields and base metals.

(Click to enlarge)

Low prices could fix low prices for brent spreads

Prompt brent spreads went full speed into what looks like deeply technically oversold territory to us lead by the prompt m1-m2 spread’s print of -56 cents on Tuesday. Stochastics and RSI look bullish to us at these levels and we also don’t see fundamental justification for an m1-m2 brent spread near -50 as the physical market moves into deficit. Current OPEC cuts and- in our view- high odds of a 6 month extension in May should also lend support to prompt structure in the coming weeks. It’s also noteworthy that DFL Brent bounced 10 cents late in the week following a 70-cent loss over the last two months. Related: What Does The Future Hold For Canada’s Oil Sands?

Back in the US, WTI spreads had been comparatively resilient in recent weeks before buckling under pressure from elevated US crude production and high stocks in Cushing. In 2h’17 the WTI M17/Z17 spread traded -1.48 on Friday for a 5-month low following several weeks of aggressive buying of -25 and -50 puts from funds and trade groups in the CSO market. US crude production climbed to 9.25m bpd this week for its highest mark in 20 months and a rebound of 824k bpd since July. Midland-WTI remained under pressure trading -1.45 which in our view highlights the most bearish component of the US crude market. On more positive note, this week’s EIA stats showed extremely strong US refiner demand which we believe will continue through the summer with help from strong crack margins across products (WTI 321 above $18/bbl this week.) We’re ultimately looking for a rebound in WTI spreads from these levels as OPEC cuts accelerate stock draws in the US especially if Cushing can find some relief from exports.

Gasoline build in focus for EIAs

• US crude data included several bullish highlights but investors were completely focused on an unexpected gasoline build in the USGC of 2.5m bbls. The takeaway for us is that traders are now looking for unanimously bullish stats in order to push the market into the mid $50s and higher.

• On a more bullish note we saw promising refiner inputs and refined product demand

• Elevated Cushing stocks and relentlessly climbing US production persist as bearish inputs

US crude inventories fell by 1m bbls w/w and are now higher by 4.9% y/y over the last four weeks. By region, PADD I stocks added 700k bbls and are +12% y/y, PADD II stocks added 1.9m and are +7% y/y, PADD III stocks fell 3m bbls and are +4% y/y and Cushing inventories fell by 778k bbls to 68.6m bbls. Production and lagging exports continue to add bearish pressure to the market with US output now at 9.25m bpd and exports falling to 565k bpd. Imports fell to 7.8m bpd and are higher y/y by 2%.

Refiner inputs were the most bullish component of this week’s report jumping 240k bpd w/w to 16.94m bpd. Overall inputs are +2.4 y/y over the last month with a regional breakdown of -17% y/y in PADD I, +14% y/y in PADD II and -1% y/y in PADD III. Refinery utilization at 92.9% is +1% y/y. As for refining margins in the US the WTI 321 crack traded near $18.30 towards the end of the week holding a $1 loss since early April. On the east coast RBOB/Brent also weakened by about $1 over the same period to $17/bbl. overseas, gasoil/brent continued its bullish trend printing near $10.50/bbl.

US gasoline data lead Wednesday’s selloff reporting an unexpected headline build of 1.5m bbls lead by a 2.5m bbl build in PADD III. Overall gasoline stocks are -1% y/y over the last month with PADD IB stocks -3% y/y, PADD II stocks +2% y/y and PADD III stocks -4% y/y. The RBOB/WTI crack traded near $19.50/bbl this week which should continue to incentivize strong gasoline production. On the demand side domestic consumption dropped to 9.2m bpd and is -2% y/y while exports are +67% y/y. 

(Click to enlarge)

RBOB flat price and spreads came under pressure following the unexpected PADD III build with futures falling from an 18-month high at $1.77/gl on the 12th to $1.64/gl at the end of the week. The prompt gasoline contract remains above its 50-DMA and continues to look technically strong to us despite this week’s correction. Spread markets look more bearish to us with M17/Z17 trading below 19 cpg this week for the first time since September ’16. Related: Bullish Oil Price Predictions Should Be Treated With Caution

US distillate stocks continued their bullish trend of sharp draws with a weekly decline of 2m bbls. Overall stocks are now lower y/y by 7% composed of a 3% y/y deficit in PADD IB, a 7% deficit in PADD II and an 11% deficit in PADD III. The front Heating Oil / WTI crack remains strong at $16/bbl which is driving a 9% y/y gain in production. Distillate exports jumped from 850k bpd the week prior to 1.4m bpd and are +37% y/y over the last month. On the domestic side distillate consumption fell 458k bpd w/w to 4.2m bpd and is lower y/y by 2% over the last month.

Gasoil spreads moved lower this week under pressure from elevated floating product stocks which are 12m bbls (19%) above their 5yr seasonal average. ARA gasoil stocks added 57k mt this week and are lower y/y by 7% but 22% above their 5yr seasonal average. In late week trading M17/Z17 gasoil traded -10.25 for a ~$2/t loss on the week.

Real / fast money diverge once again

The most recent round of COT data showed money managers getting long crude once again. In NYMEX WTI net length increased by 42k contracts (+16%) while ICE Brent net length jumped by 34k contracts (+8%.) The increases in net length came with help from liquidation in short positions in NYMEX WTI and ICE Brent of 30% and 18%, respectively.

Bullish enthusiasm also lead to buying in NYMEX RBOB and NYMEX Heating Oil which have seen net length increases of 90% and 53%, respectively, over the last two weeks. ETF flows saw money move in the opposite direction, however, with a weekly outflow of $266m in the USO capping a $328m outflow over the last three weeks.

By SCS Commodities Corp.

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Leave a comment
  • Naomi on April 23 2017 said:
    Texas break even is $15/bbl, but they pump to pay the loan whatever the price.
  • Kimberly V. Davis on April 23 2017 said:
    Was this article written by software!?

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