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Expert Commentary: Oil Market Tighter After Hurricane Harvey

Oil

- Crude oil flat price, spreads, refining margins and product spreads all mean-reverted this week as PADD III refineries came back on line to the tune of roughly 2m bpd and the remaining outages developed a more clear return time frame. Refining margins and product spreads still remain elevated but we were struck by the snap-back in crude oil time spreads and flat price while 2-month WTI volatility languished near 26%-29%. In our view, the quick recovery following such traumatic fundamental stress is great evidence of the strength of the sideways oil market narrative. Trading flows of crude oil and products were rerouted from the North Sea to LatAm to Singapore, massive refiner and production outages occurred and WTI bounced back to its pre-Harvey level at $48 in just three days.

- EIA data released yesterday has given us a picture of how harshly Harvey impacted crude oil markets across the value chain. The most important disruption was obviously in refiner demand which fell (literally off the charts) to 14.47m bpd for a w/w decline of 3.3m bbls. Shipping flows were massively disrupted as the Port of Houston’s closing lead to PADD III imports of just 1.48m bpd representing the lowest print going back to at least 1990 while exports fell from 900k bpd to just 150k bpd. Lastly, US crude production fell from 9.53m bpd to just 8.78m bpd (lower 48 production dropped by 783k bpd and there was a slight uptick in Alaskan production.)

- Energy Aspects estimates Sept 1 – Sept 10 USGC refinery outages at 3.3m bpd and also believes that the market is undervaluing crack margins for X17 and Z17 expirations. RBC commented that OPEC is making progress towards extending output cuts beyond April and that Nigeria could add a production target of ~1.8m bpd (via Bloomberg) on the potential next round of cuts.

- Libya’s 330k bpd capacity Sharara field reopened for business. The field had been closed since August 19th due to a pipeline issue and reduced output by 283k bpd. Chinese buying also reportedly helped Brent spreads as Bloomberg reported an uptick in WAF > Asia flows to a 5-month high in September. Bloomberg also reported five new VLCCs and ULCCs booked for China this week to be delivered in the next three months. Brent m1-m3 traded up to +30 cents today signaling continued performance of the global physical market despite the recent slowdown in Houston refining.

(Click to enlarge)

Brent, WTI spreads diverge

As Harvey landed in the USGC last week there were massive selloffs in Brent and WTI spreads due to the loss of at least 4m bpd of demand. For WTI, there was a modest recovery this week but the 40 cents contango in Dec/Jan still suggests some medium-term Cushing congestion. Brent spreads, meanwhile, told a significantly different picture and rallied to new YTD highs in the front of the curve on strong Asian buying and OPEC discipline. By Friday afternoon the Dated Brent vs. Front line swap traded to -22 cents while Dec/Jan recovered to trade 15 cents backwardated. The takeaway for us is that there appears to be an increasingly tight physical market which is snapping back quickly from lost Harvey demand.

Related: China Declares Support For Punitive Action Against North Korea

The most noteworthy component of last week’s domestic crude production data was obviously the steep drop off in US output via the EIA which printed 8.78m bpd for a w/w decline of 749k bpd. Market participants seem to be in agreement that production outages will be short lived and this week Devon Energy’s CEO commented that that vast majority of Eagle Ford production shut by Harvey will be running by the end of this week. The US crude rig count was flat this week at 759 and the producer/merchant gross short in the market fell by about 2%.

Hedge funds have a view!

Hedge funds were net sellers of WTI in the week ending August 29th after several months of slow moving, dull positioning that was aggressive in neither direction. Net length for the NYMEX benchmark fell by 106k contracts w/w (-42%) to a ten-week low of 147k contracts. The decrease in net length was due to a 78k increase in new short positions (+96% w/w) while longs were cut by 28k contracts. ICE Brent positioning was comparatively boring with a tiny decline in net length.

Product flows from speculators were expectedly bullish with traders working to take advantage of limited refiner activity. Net length in NYMEX RBOB increased to a 7-month high at 49k contracts while NYMEX Heating Oil net length moved to a 5-month high at 30k contracts. As for ETFs, USO flows were muted yet again with a w/w net buy of $77 million for a 3-week buy effort of $196m.

Option markets fall back in line

Crude option implied volatility almost got interesting last week with brief stints of +30% trading but all came to an end this week. As of Thursday afternoon, WTI V17 ATM options implied 27% while 25 delta puts implied 27.8% and 25d calls implied 27.6%. Speculative flows continue to look to sell ATM vol while buying wings in Cal ’18 with traders betting on range bound vol and range bound flat price. 20-day realized volatility printed 29% on Thursday justifying vols at current levels without giving any excuses to be overly bearish or bullish implied vol in the high 20%s.

(Click to enlarge)

EIAs show massive stress caused by Harvey

• This week’s data showed substantial disruptions to crude flows with a w/w decline in refiner demand of 3.3m bbls, a production decline of 749k bbls, a 750k bpd decline in exports and a 1m bpd drop in PADD III crude imports

• As for stress on time spreads, the overall impact on Cushing was modest with an addition of about 800k bpd into the hub

US crude supplies added 4.6m bbls last week and are lower y/y by 3.8%. By region, PADD I stocks jumped 1.2m bbls and are +4% y/y, PADD II stocks added 505k bbls and are -2% y/y, PADD III inventories increased by 1.7m bbls to -6% y/y and PADD V supplies increased 831k bbls to -2.5% y/y. PADD II imported 2.5m bpd of crude which is +2.5% y/y and PADD III imports printed 1.48m bpd which was lower w/w by 1.03m bpd. US crude production in the lower 48 states fell by 822k bpd w/w to 7.1m bpd. Related: The North Sea Oil Recovery Is Dead In The Water

US refiner inputs fell 3.3m bpd w/w and were obviously the most important component of the supply chain disrupted by Harvey. Looking ahead, we saw estimates that 2m bpd of refining capacity has already been restored and spreads seem to be behaving as if the balance will follow shortly thereafter. Crack margins remained extremely elevated which should alleviate some of the slack in demand near Houston. As of Friday afternoon, the gasoil/Brent crack traded up to $15.25/bbl while WTI 321 offered $23/bbl.

US gasoline stocks fell 3.2m bbls this week with help from a 1.1m bpd drop in production to just 9.5m bpd. By region, PADD I inventories fell by 2.2m bpd due to the Colonial pipeline closing while PADD II inventories fell by 960k bbls and PADD III stocks fell by 60k bbls. Overall gasoline stocks are -1.5% y/y, PADD I stocks are -7% y/y and PADD III inventories are +7.5% y/y. Demand data was obviously ‘noisy’ this week and showed a 418k bpd drop in domestic consumption while exports fell by 420k bpd.

US distillate supplies fell by 1.4m bbls this week driven by a 563k bpd drop in production (PADD III production was -686k w/w.) PADD IB inventories fell by 1.5m bbls and are now lower y/y by 18%. PADD II stocks were unchanged w/w and are +1% y/y, PADD III supplies added 800k bbls and are +9% y/y and PADD V distillate stocks fell by 412k bbls to -26% y/y. On the other side of the balance sheet US distillate demand sank 384k bpd to 738k bpd while domestic demand increased by 150k bpd to 4.1m bpd.

By SCS Commodities Corp.

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