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Expert Commentary: Why OPEC Has To Make A Deal Happen

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• Less than two weeks before OPEC’s next Most Important Meeting Ever the oil market is doubtful that the cartel will reach a meaningful supply reducing agreement. Traders have revealed skepticism that a deal to cut production to the Algiers-agreed range of 32.5m bpd – 33m bpd will be finalized in the form of bearish COT data, a bearish options skew and of course on the ultimate scoreboard where WTI has moved lower than pre-Algiers levels. The market has yet to completely write off OPEC, however, and Monday’s headline driven reversal off of the $42.20 weekly low confirmed that traders are still alert to the possibility of an agreement. In our view the cartel is slightly more likely to deliver a bullish surprise than a bearish one on November 30 due to the erosion of the previously iron-clad GCC members’ balance sheets. Given the massive fiscal damage that OPEC members have endured over the last two years we think it is likely they choose to ‘hang together’ via a watered down version of the Algiers plan rather than risk another painful trip below $40 and jeopardize their ability to inject headline risk into the market.

• Away from the OPEC noise we saw more positive signals in trading flows and supply/demand balances this week which we think point WTI into a $47-$55 range. In refined product markets gasoil stocks in Europe’s ARA hub had their largest w/w drop this year of 236k mt putting inventories at a y/y deficit of 24% and in the US implied gasoline demand reached an all-time high at 10.32m bpd with help from elevated exports. WTI also showed strength by shrugging off a disappointing EIA inventory report showing larger than expected builds in crude oil, distillates in gasoline while deferred spread markets were universally positive this week with sharp rallies in 2H’17 WTI and Brent in addition to 2H’17 Heating Oil, Gasoline and Gasoil. Lastly, it is worth noting that Tuesday’s trading flows included one of the largest option orders the market has seen in recent memory with a fund buying roughly 20k Brent G17 $51 calls and more than 10k WTI G17 $51 calls laying out roughly $50m in premium in the process. On the bearish side, however, the prompt Brent 1-month spread sank to -1.10 in late trading Thursday serving as a reminder of the substantial overhang of crude inventories in the Atlantic and eastern trading hubs.

• Currency markets continued to march on in a bearish-oil fashion this week with the DXY trading to a 13yr high at 100.1 while the EUR/USD fell to a 11-month low at 1.062. As of Thursday Fed Fund futures implied a 91% chance of a rate hike suggesting that a move in overnight rates to 50-75 bps is now priced into bonds and currencies.

Strength continues for 2H’17 Brent and WTI spreads

US producer data began the week with an increase in the rig count from 450 to 452. Rigs have increased by 43% since their May low of 316 but are still down by 72% from their 2014 peak. Crude oil production was roughly flat w/w at 8.68m bpd and is higher by 253k bpd from its July low. The US producer gross short position grew by nearly 40k contracts w/w to 596k as the Calendar 2017 WTI swap traded near $49.50 and the Calendar 2018 WTI swap traded near $51.50

WTI spreads moved sharply higher this week from Z16 through Cal ’17. In the front of the curve WTI F17/G17 ran from -0.78 on Monday to a weekly high of -0.64 on Wednesday before moving back towards -0.70 on Thursday. Further back in the curve WTI M17/Z17 maintained its current support tend by moving from -1.55 on Monday to a weekly top of -1.05. CSO markets reacted bullishly to the move in spreads with trade groups buying 2H’17 flat calls and liquidating length in puts rather than fading the rally. Skew in spread option markets remained almost perfectly flat with the WTI CSO G17/H17 25-cent out of the money put and call both valued at 10.5 cents.

(Click to enlarge)

Prompt brent spreads also moved higher this week but continue to yield more than $1/mo in contango due to still-climbing supplies out of Libya and Nigeria. Libya was reported to be producing more than 660k bpd so far in November and Nigeria was reported to be closing in on 2m bpd. Between the two countries the gains represent an increase in supply of 1m bpd since August when production for both countries bottomed out at 260k bpd for Libya and 1.4m bpd for Nigeria. As of Thursday afternoon the Brent F17/G17 spread traded near -1.08 but M17/Z17 Brent yielded just 25-cents of contango per month at -1.50.

Fast money puts foot on the bearish gas

COT data for last week showed a massive decrease in the net long position held by managed money which was largely driven by fresh short positions entering the market. In NYMEX WTI net length fell by 31% w/w (74k contracts) due mostly to an increase in gross short positions of 83k. ICE Brent length fell by 23% (80k contracts) due largely to a 56k increase in short positions. The addition of new short positions between NYMEX WTI and ICE Brent of 139k contracts is nearly double the second largest weekly increase in shorts (75k in early August ’16) going back to January 2015.

Related: Are The Saudis About To Reveal The Best Kept Secret In Oil?

Product markets echoed the bearish sentiment in WTI and brent (albeit to a much lesser extent) with RBOB net length falling by 2k contract to 40k while net length in Heating Oil dropped from 17k to 8k. In ETF land, however, fund flows remained strongly bullish. USO investors pushed $227 million into the fund last week creating $496m in inflows over the last two weeks- the largest over a two week space since February.

DOEs dissapoint with growing supplies across the board

• Wednesday’s stat report lead by larger than expected builds in crude oil (+5.3m,) gasoline (+746k) and distillates (310k)
• Refiner runs increased by 309k bpd which is line with expectations but the WTI 321 crack dropped to its lowest level since February
• Implied US gasoline demand higher y/y by 7%

US crude oil inventories added 5.3m bbls w/w and are higher y/y by 7.7%. On a regional basis, PADD I stocks fell by 843k bbls despite a flood of imports into the east coast, PADD II stocks added 1m bbls (+3.7% y/y,) PADD III stocks uncreased by 4.9m bbls (+12% y/y) with help from increased imports and Cushing inventories increased by nearly 700k bbls to 59.2m bbls. Imports into PADDs I, II and III continue to drive elevated crude stocks with this week’s effort of 8.4m bpd. Over the last ten weeks imports have averaged 7.9m bpd which is higher y/y by 700k bpd.

Refiner inputs continued to climb in line with seasonal norms jumping 309k bpd w/w to 16.1m bpd. Inputs are flat y/y over the last month and still have another 700k bpd of upside ahead in the coming weeks to meet 2015’s seasonal peak of 16.8m bpd. Unfortunately crack margins moved sharply lower this week lead by a drop in the WTI 321 crack below $12/bbl for the first time since February. The LLS 321 crack dropped below $6/bbl this week and overseas gasoil/brent fell to $10/bbl.

US gasoline supplies expanded by 746k bbls this week and are higher y/y by 3.5%. PADD IB inventories moved higher by 1.4m bbls w/w and are higher y/y by 5%. In the Midwest PADD II stocks fell by 276k bbls and are higher y/y by 2% while PADD III inventories are higher y/y by 10% following a 358k bbl draw. Domestic gasoline demand jumped 146k bpd to 9.4m bpd and is higher y/y by 3.4% while exports at 960k bpd are higher y/y by 119%.

(Click to enlarge)

RBOB futures moved steadily higher Monday – Thursday from a low of $1.268/gl on Monday to over $1.35/gl on Thursday. Monday’s print below $1.27/gl represent a 2.5m low for gasoline but the September 1 mark of $1.2668 held support. Spread markets in 2h’17 were stronger during the week with RBOB M17/Z17 trading up to 20.5 cpg backwardation on Thursday for a +2 cent rally over the last two weeks.

Related: Is There Enough Pain To Force An OPEC Deal

US distillate inventories increased by 310k bbls w/w and are higher y/y by 6%. PADD IB stocks fell by 257k bbls and are higher y/y by 7% while PADD II stocks fell 520k bbls to a y/y surplus of 22% and PADD III stocks are flat y/y following a 1.1m bbl build. Domestic distillate demand fell to 3.9m bpd and is lower y/y by 5% over the last four weeks. Exports at 1.2m bpd are higher y/y by 2%.

Heating oil futures strengthened this week on the back of crude’s bullish move with the prompt contract moving from a low of $1.37/gl on Monday to over $1.46/gl on Thursday. Spread markets followed suit with HO M17/Z17 moving from -8 cpg contango on Monday to -7.3 cpg on Thursday.

Overseas, gasoil inventories in ARA continued to plummet this week with their largest w/w draw of 2016. Inventories in the hub fell 236k mt and are now lower y/y by 24%. Gasoil spreads responded in kind with M17/Z17 jumping from -19.50 to -16.0. Distillate inventories in Singapore increased by 1.3m bbls w/w but are still lower y/y by 4% over the last three weeks.

By SCS Commodities Corp.

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