• OPEC leadership’s discussion of its upcoming meeting dominated oil market headlines this week and helped lead a $4 rally from Monday through Thursday in WTI from $42.55 to near $46.50. The week began with Venezuela’s President claiming that OPEC was close to nearing a deal and included comments from OPEC Secretary General Barkindo that a 1yr output limiting deal was in fact being discussed. The head of Iraq’s oil marketing operation stated that “this is the right time” to implement a stabilizing deal and even Saudis and Iranians came together at HQ in Vienna for two days to try and find common ground and discuss what a potential deal could look like. Meanwhile the market sent mixed messages in its outlook for next week’s meeting as OPEC comments fueled short-cover rallies in futures but demand for call options (as evidenced by our volatility chart to the right) remained weak. In keeping with recent trends, 25 delta call options continued to trade at an implied vol discount to 50 delta options which is striking given the non-negligible odds that OPEC could actually come to an agreement next week.
• Going forward we continue to like our medium term outlook for WTI of $42-$50 and would look to fade a sharp moves created by OPEC waves beyond those boundaries believing that bullish money flows in the $40 area and rapidly tightening refined product inventories mitigate bearish risk for crude while above-forecast output from OPEC, Russia and the US in addition to already sky-high inventories globally and abysmal refining margins should keep a lid on moves to the upside. We also view the recent breakdown in brent spreads as evidence that the larger trading groups see a congested physical market following the surprise upticks in Nigerian and Libyan exports.
• In the U.S. a crude oil draw of 6m bbls w/w and an east coast gasoline draw of 8m bbls (due to the Colonial outage) also fueled this week’s rally but US production at 8.5m bpd remains above EIA forecast after increasing for a second straight week.
• Away from oil markets the FOMC voted to leave overnight rates unchanged this week. Fed fund futures still suggest a 55%-60% chance of a rate hike in December but the Fed lowered its expected number of rate increases in 2017 and lowered growth and rate forecasts to ‘lower for longer’ levels more in line with bond market implications. The result in FX markets was a broadly weaker USD.
(Click to enlarge)
Inventory draws push WTI spreads higher
WTI spreads continued to move higher this week with help from substantial inventory draws out of PADD II and PADD III. Stocks in the Chicago area, Houston area and Cushing hub have combined to draw by 33m bbls since their peak in May and the decline has facilitated strength in spreads despite a 32% increase in US rigs since May and a US output chart which appears to have bottomed in June and surprised analysts to the upside. The WTI Calendar 2017 swap traded back up to $50 this week and COT data shows producer gross shorts at a 5yr high this week at 591k contracts (+19% since July.)
(Click to enlarge)
In the front of the WTI curve the 1-2 spread moved from a recent low of -0.76 last Friday to a high of -0.52 on Thursday for a ten week high as the aforementioned stock draws generated short covering in spreads and OPEC headlines were generally supportive for the front of the curve. Further back, WTI Z16/Z17 traded over -4.00 for a ten day high. CSO markets saw a signficant liquidation of 1Q’17 flat calls which trade groups had sold in recent months collecting 12-18 cents before covering the short at 4 cents on Tuesday.
Brent spreads buckle under Libya, Nigeria production increases
Surprise returns of Libyan and Nigerian exports continued to pressure brent structure this week which was exacerbated by a Reuters report which showed Russian output at a new record high over 11m bpd. In northern Africa Libya’s output was reported by Bloomberg to have reached 450k bpd this week following increased production from the Nafoura and Hamada fields and the Ras Lanuf export terminal- activated for the first time since 2014- shipped a 781k bbl tanker to Italy early in the week followed by a 600k bbl ship (same destination) in the middle of the week. Nigeria reported output near 1.75m bpd this week to Bloomberg adding that production will reach 1.8m bpd in October and 2m bpd in December after ceasefire agreements with the NDA have been succesful- so far. Nigeria’s Forcados stream (typical volume of 250k bpd with capacity of 400k bpd ) will also resume in October which would end an 8-month shut in following attacks on the pipeline by the NDA. Bloomberg reported on Thursday that the facility has a 1m bbl shipment scheduled for the end of September and eight cargoes booked for October loading with capacities ranging from 385k bbl – 1m bbl.
Brent 1-2 diverged from WTI spreads sharply by selling off from -0.45 on Wednesday to settle at -0.57 Thursday as the additional barrels from Libya and Nigeria further congested an already well supplied market. Brent Z16/Z17 traded near -4.20 Thursday afternoon and was essentially flat for the week. The Calendar 2017 brent swap traded up to $51.50.
Bond market still sees December rate hike ahead
On Wednesday the FOMC decided to leave the federal funds rate unchanged at 0.25% - 0.50% with hawkish caveats of three dissenting votes from members who believe that the US economy is prepared to accommodate a hike and follow up remarks from Chair Yellen which suggested an expected hike before the end of 2016. More dovishly, the Fed’s dot plot revealed expectations of just two rate hikes in 2017 instead of three. The bank also lowered their expected US GDP growth for 2017 from 2.0% to 1.8% as forecasts continue to dip towards forward rates and GDP growth that is more in line with the implied expectations of bond markets. On Thursday Fed fund futs implied 12% odds of a rate hike from the Fed at their November 2nd meeting and a 59% chance of a rate hike in December. The Bank of Japan also helped move rate and FX markets this week by shifting its policy to focus on a 0% yield target for the bank’s 10yr debt. Bond markets strengthened on the week following the CB action with the US 10yr yield moving lower to 1.63% on Thursday while the 10yr JGB traded -0.06%. In report dated September 7th KKR estimated that 36% of all outstanding DM government debt is now trading at a negative yield. Equity markets also reacted favorably to the FOMC non move with S&Ps trading back over 2,170.
(Click to enlarge)
In FX markets the shakeout from the above news was a stronger EUR/USD which helped boost crude oil by rallying from 1.1130 on Wednesday morning to 1.1240 Thursday morning. The DXY fell from a weekly peark of 96.3 on Wednesday to a low of 95.1 on Thursday and the USD/JPY dropped from 102.8 to 100.1. The ramifications for oil were obviously positive given the broadly weaker USD. Going forward, we continue to see any potential FX driven moves for WTI outside of the $42-$50 range as opportunities to buy weakness or sell strength given our rangebound view of the market due to supply tightening and bullish money flows that will occur near the $40 mark and strong supply gains adding to already bouyant crude oil stocks that will limit upside potential for crude oil until more signficant product stock drawdowns occur.
COT flows still neutral while real money buys the USO for size
(Click to enlarge)
Hedge funds were net buyers of NYMEX WTI last week to the tune of 24k contracts (+13% w/w) driven mostly by a liquidation of gross short positions of 29k contracts. In ICE Brent net length increased by 8k contracts to 359k as gross short positions were reduced by 9k.
In product markets gasoline length held by speculators nearly doubled from 11k to 20k and in heating oil net length fell from 10k contracts to 4k. The USO saw net inflows for the week ended September 16th of $128 million for its largest weekly inflow since the week ended August 5th. Total USO inflows have reached $179 million over the last three weeks.
Volatility still rangebound with a bearish tilt
WTI Z16 implied volatility moved around in the high 30%s to low 40%s this week as it has for the last few months while realized volatility (20-day basis) climbed from 39% to 41%. There was a modest bidding of calls this week with 25d puts trading at a 4% premium to 25 delta calls after spending most of the last 6-7 weeks at a 6% premium but wingy calls continued to trade at a discount to 50d options which is somewhat remarkable ahead of an OPEC meeting which is believed even by skeptics to have a slight chance of producing a production deal. As of Wednesday afternoon WTI Z16 25 delta puts priced at 41% implied vol, 50 delta options priced at 38% and 25 delta calls traded at 37%.
Crude draw helps spreads rally, but production remains above forecast
• US crude stocks fell by 6.2m bbls w/w and are lower by 19m bbls over the last five weeks as inventories slowly continue to normalize
• Gasoline stocks also continued to unwind their massive oversupply with an 8m bbl draw on the east coast due to recent issues on the Colonial pipeline. Gasoline futures and spreads moderated later in the week, however, after Colonial shipments resumed.
• US crude production in the lower 48 states increased for the third straight week for the metric’s first 3-week winning streak since December ’15 – January ’16.
US crude oil inventories dropped 6.2m bbls w/w and are higher y/y by 11%. PADD I stocks increased by 290k bbls (+12% y/y,) PADD II stocks fell 1.7m bbls (+8.6% y/y,) PADD III stocks fell 3.7m bbls (+15% y/y) and inventories in the Cushing hub jumped 526k bbls. Imports into PADD II increased by 322k bpd w/w to 2.7m bpd (+6% y/y) and PADD III imports fell by 531k bpd w/w to 2.9m bpd (+7% y/y.)
Refiner inputs fell sharply- 143k bpd- w/w but are higher y/y by 2.5% over the last month despite extremely poor crack margins in the US and abroad. Refiner inputs in PADDs I, II and II are -1% y/y, +3.4% y/y and +3.9% y/y, respectively. Refiner utilization at 92% is higher y/y by 1% after falling 0.9% w/w. In the US the WTI 321 crack rallied to $13/bbl this week and overseas the gasoil/brent crack strengthened to nearly $10/bbl.
Gasoline stocks fell 3.2m bbls w/w and are now higher y/y by just 2.9%. PADD I drove the decrease due to Colonial issues and east costs stocks decreased by a total of 8.5m bbls w/w for the largest weekly decline on record for the region. PADD IB stocks are now higher y/y by just 3% after spending most of the last four months at a massive y/y surplus and have dropped by 6.7m bbls (18%) over the last five weeks. Gasoline exports at 606k bpd (+45% y/y) and domestic demand at 9.65m bpd (+4.7% y/y) have also helped tighten RBOB spreads.
(Click to enlarge)
RBOB futures traded in a $1.45/$1.35 cpg range this week and moderated towards $1.40/gl following the resumption of shipments on Colonial. The Colonial news obviously took a larger toll on the prompt gasoline spread with RBOB 1-2 dropping to +3 cpg after trading near +8 cpg on Friday the 16th.
Distillate inventories had a larger than expected jump w/w of 2.2m bbls and are higher y/y by 8.6%. In PADD IB distillates increase by 108k bbls w/w and are higher y/y by 9%. PADD II stocks are higher y/y by 4% and PADD III inventories are higher y/y by 4%. Distillate production is lower y/y by 2% over the last four weeks in reaction to persistently poor refining margins. Exports at 1.3m bpd are higher y/y by 6.5% but domestic demand is lower by a staggering 21% y/y over the last four weeks.
In distillate markets HO futures were stronger this week bouncing from a weekly low of $1.37/gl to over $1.45/gl on Thursday. Heating oil spreads remained in contango despite Colonial’s outtage and peaked around -1 cpg.
Front gasoil spreads moved sharply higher this week through Thursday and have rallied about $2/t over the last two weeks to -1.75. Singapore reported a build in distillate inventories of nearly 4m bbls (-2% y/y) and Amsterdam-Rotterdam-Antwerp gasoil stocks fell 49k mt for a y/y decrease of 12%.
(Click to enlarge)
By SCS Commodities Corp.
More Top Reads From Oilprice.com:
- Market Update: Oil Crumbles After Saudis Pull The Plug
- Why Oil Prices Can’t Stay Low For Much Longer
- Russia And Saudi Arabia Playing A Risky Game Ahead Of OPEC’s Meeting