• Prompt WTI traded in a $48.40/$46.42 range through Thursday morning as bearish inputs included additional exports from Iraq following a completion of a deal between the Iraqi government and Kurds to reopen a 150k bpd Turkey-bound pipeline, increased refined product exports from Chinese refiners, bearish DOE stats which showed poor refiner and end-user demand and a (shaky) ceasefire between the Niger Delta Avengers and Nigerian government. On the bullish side, headlines that Iran was open to discussion about production ceilings in Algeria this September sent oil higher by about $1.40 on Tuesday and was revealing of the market’s continued fear of an unlikely OPEC deal. Going forward, we continue to see a choppy, range bound market with WTI between $42-$50.We still feel slightly more bearish than bullish however and would look to fade news items such as Tuesday’s bullish
Iran headline run via $5 wide put spreads in prompt maturity brent or WTI. On a longer horizon we would point to tightness in brent spreads this week as further evidence that the market continues to move towards balance and a protracted sub $40 move is unlikely.
• The rationale for our slightly bearish view at the moment includes strong core OPEC production, above-forecast US production and near- record crude oil and product inventories at major trading hubs from Cushing to NY Harbor to ARA to Singapore heading into peak refiner turnarounds which are already being exacerbated by multi-year lows in refining margins. As for trading flows, we also see the option market’s exceptionally bearish skew and massive selling in the USO as hints that sentiment in the market could turning bearish after the largest short- cover by hedge funds on record. Our chart to the right illustrates a surge in demand for put options while typically expensive ‘wingy’ calls are still the cheapest strikes in the market.
• US Fed watching remains the key macro input for oil leading up to the central bank’s meeting beginning September 20th. As of Thursday the EUR/USD traded in a 1.1355/1.1245 on the week while FX markets digested mixed comments from Fed officials. Seeing a range bound crude oil market in the medium term we will only become interested in EUR/USD or DXY moves if they help drive oil below $40 (which we think would be a good buying opportunity) or above $50 (for the opposite reason.) Earlier this morning Fed fund futures implied probabilities of rate hikes in September, November and December of .24, .28 and .44, respectively which suggests that a rate increase in September could catch FX traders off sides and create a buying opportunity in the oil market.
WTI spreads correct, brent still on the move higher
Front WTI spreads and WTI-Brent arbs both moved lower this week. In spread markets trade groups took profits following a four week rally while arbs continued to fall due to US inventory congestion and weak refiner demand. US oil rigs increased for an eighth straight week but US output fell by 49k bpd w/w. Leadership at Trafigura believes US crude exports will reach a record high in September as more Texas crude heads to Europe to take advantage of a >$1.50 WTI–Brent arb differential.
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By Thursday morning WTI V16/Z16 had leveled off near -1.35 and WTI Z16/Z17 traded close to -3.80. In swap markets the WTI Calendar 2017 strip traded near $51 after selling off $1 this week. WTI Spread option markets (CSOs) saw a considerable amount of liquidation of put-length on the -50 strike for 1H’17 while trade groups continued to sell flat calls on the same maturity. Our idea at the moment related to spread option markets would be to sell the WTI CSO X16/Z16 -50c/-100p strangle at 22 cents believing that heightened US exports should help stem bearish momentum in spreads while reduced refiner demand and high quantities of oil in Cushing, PADD II and PADD III will keep a lid on bullish moves.
Overseas there were several news items from OPEC members which helped move brent spreads. Firstly, Iraq reached a deal with the Kurdistan Regional Government to reopen a pipeline that had been shut down due to a payment dispute. The deal added 150k bpd of exports to the market in about 24 hours. Iraq’s OPEC leadership also stated that they would be unwilling to participate in any production limiting efforts as the country works to increase output over 4.5m bpd. (Bloomberg estimated Iraqi output at 4.36m bpd in July which was a 60k bpd reduction from April.) In Nigeria, the Niger Delta Avengers agreed to begin a ceasefire with the government that could ultimately return some crude to the market but our understanding of the situation suggests that Nigeria’s troubles will persist as a bullish input for the market in the medium term. (It is also important to note that Iraq’s recently completed deal to reopen the 150k bpd pipeline could expire in just a few months.) Most talk in the market from buy side participants and newswires continues to suggest to us that Saudi output will increase from its record high in July this month.
In the front of the curve Brent V16/Z16 rallied to -0.60 this week which is beginning to look slightly rich to us opposite a fundamental backdrop with several headwinds. We think that heightened supply from the US and core OPEC in addition to extremely poor crack margins heading into peak refiner turnarounds in the next two months will be the most pressing challenges for brent spread bulls. Yes, troubles remain in Nigeria, Libya and Venezuela and the phsyical market still appears to be moving towards balance but we view a contango of less than 30 cents at the moment to be overly tight. We would also note that prompt brent spreads at similar levels preceeded the 2016 market top in June and think selling prompt brent spreads on further strength could be a good strategy. In deferred spreads Brent Z16/Z17 traded near -3.50 Thursday and was lower by about 25 cents this week.
OPEC chatter leads to biggest short cover on record
As the market rallied in mid August there was a clear understanding that the massive short positions built by hedge funds in June and July were being covered and helping accelerate crude’s move higher. What we didn’t know at the time was that the combined short cover between ICE Brent and NYMEX WTI (for the week ended August 16th) would actually total 99k contracts for the largest weekly short cover on record. In NYMEX WTI funds were net buyers of 57k contracts about 99% of which was short covering. In ICE Brent, funds were net buyers of 64k contracts, 42k of which came from short covering. As prices corrected this week we expect to see some sort of moderation in this data and would not be surprised to see some fresh short positions enter the market.
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In product markets hedge funds added to their net short in RBOB from 1,300 to 1,900 contracts while in heating oil spec’s net length increased from 2k to 11k. In the ETF world the USO saw its largest net outflow last week ($299m) since March. We are paying close attention to that number after USO flows were on target this year buying the market’s low and sold the market until prices peaked in June.
Bearish outlook spurs strong demand for downside risk
WTI Z16 options got more expensive across the skew this week. At-the-money options traded near 38% for a w/w jump of 2 vols and 25d calls traded at 35% for an equal increase. On the downside things got even more rich as 25 delta and 10 delta puts both jumped 4 vols. As of Wednesday afternoon the market had seen its most pronounced put-skew in months as 25d puts traded at a 7.5 vol premium to 25d calls. 10 delta calls continued to trade at a discount to at-the-money options which continues to reveal an unusually small amount of demand for upside risk. Realized volatility for prompt WTI strengthened back towards 40% this week and the OIV index jumped about 3 vols w/w to near 38.5%.
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DOEs show poor demand from refiners and drivers
• US crude stocks surprised the market with a crude oil build of 2.5m bbls, a Cushing build of 375k bbls and a modest jump in gasoline stocks
• Demand remained frustratingly low as refiner inputs dropped 186k bpd while gasoline demand fell 103k bpd
US crude oil stocks added 2.5m bbls w/w due largely to a flood of imports into the East Coast. Overall crude stocks currently stand at 524m bbls (+16% y/y,) PADD II stocks are +9.5% y/y following a 570k bbl drop and PADD III stocks are higher y/y by 22% after a 515k bbl w/w build. Cushing stocks added 375k bbls. Imports at 8.6m bpd are higher y/y by 13% over the last four weeks lead by an increase of barrels into the Houston area. US crude oil production fell to 8.55m bpd (-49k w/w)
Refiner inputs fell 186k bpd w/w to 16.7m bpd and are lower y/y by 0.8% over the last four weeks. PADD I continues to be the demand laggard with demand in the region down 12% y/y. Inputs in PADDs II and III are slightly higher y/y. Crack margins rallied this week but remain problematic with RBOB/Brent near $10/bbl, WTI 321 near $13.6/bbl and gasoil brent near $9.8/bbl.
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Gasoline stats were lead by an overall build of 36k bbls against expectations of a >1m bbl draw. Most of the surprised build was due to PADD III where imports increased by 100k bpd. Overall mogas stocks are +8.5% y/y. PADD IB stocks decreased 192k bbls and are higher y/y by 26%. Inventories in PADDs II and III are higher y/y by 2% and 4.6%, respectively. Domestic mogas demand fell 100k bpd w/w buy is higher by 5% y/y over the last month. Exports at 454k bpd are higher y/y by 8.4%.
Gasoline futures were bounced between the $1.46-$1.51 area this week without pursuing any major trend. Futures remain comfortably above their July 29th low of $1.2760/gl. Spread markets firmed in the front of the board with U16/V16 trading over +9 cpg on Wednesday.
Distillate data showed a 122k bbl w/w increased which brought overall stocks to a 2.3% y/y increase. PADD IB stocks added 177k bbls (+7.2% y/y) while PADD II stocks added 27k bbls w/w (-3.2% y/y) and PADD III stocks are lower y/y by 5.7% following a weekly build of 9k bbls.
Heating oil future were slightly lower this week and traded near $1.48/gl on Thursday for a 5 cent loss from last week’s high. They are still nearly 25 cents above their Aug 2nd low of $1.2466. Prompt spreads continue to strengthen considerably with U16/V16 trading near -1.50 on Thursday for a 1-cent gain over the last three weeks.
By SCS Commodities Corp.
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